False Hopes -- Bad Policy -- Economics Wins

When we hope for the best, we often hope for the impossible. We want to believe that we can put a glass panel on our roof and have all the free electricity we want. We want to believe that we can stick a windmill in the air and pay nothing more for electricity. We want to believe that enzymes will chew up biomass and excrete clean fuel for free. We want to believe there is no need to burn anything to produce all the power we want. We want to have our cake and we want to eat it too. We want the proverbial free lunch.

The per kilowatt cost of electricity produced by photovoltaic cells has fallen dramatically over the past 30 years. The efficiency gains are not over as high fuel prices have given numerous companies the urge to invent the "super cell". Scientist are researching everything about solar energy they can think of. Billions of dollars are being spent. Recently, the cost has fallen very rapidly and is less than half the cost of a decade ago. It still costs about 100 times as much as it costs to burn coal!


It is true that coal is a dirty fuel. If one accounts for all the external costs (according to a study done by the Paul Scherrer Institute in Switzerland), including the pollution, the cost of solar is still more than 3 times the cost of burning coal. We want cheap solar but what we have is coal and cheap oil, even when we pay the Saudis $135 per barrel.

The two cheapest ways to produce abundant electricity is by nuclear power and by oil. The problems with oil are that most of it is used as transportation fuel and that our environmentalist have made bad choices about what to protest. We should be encouraging drilling and nuclear power and discouraging the burning of dirty coal. Of course, politicians tend to avoid speaking out against coal or the environment, we all want a clean environment but at what costs.

HOPE THROUGH TECHNOLOGY

While most every one has heard about the progress being made in solar energy, most have not heard about the progress being made in nuclear energy. New technology and the standardization of plants are dramatically lowering the cost of nuclear power. Nuclear currently cost from 4.5 to 9 cents per kilowatt hour. Coal cost from 6 to 23 cents per kilowatt hour. Include the costs of pollution and coal cost from 15 to 23 cents per hour. In America we produce half of our electricity with coal even though it cost two or three times as much as nuclear power.

Our old nuclear plants used only a small percentage of the uranium and produced a very high percentage of waste. The life of old plants has been extended 20 years beyond their original estimated life and they are producing much more power as a result of improved fuel. The volume of wast is going down while the efficiency is going up. Westinghouse recently announced another major improvement. The company estimates a 50% increase in power plant efficiency as a result of a classified technique that uses nano-technology. GE recently announced a patent on a laser technique for refining fuel that will cut the cost of fuel by as much as 70%!

GROUP THINK

So many people pine for low cost wind or solar energy that the media is full of pictures and stories. People really do not want to hear that clean wind and solar power are very expensive. A recent issue of Fortune Magazine had at least a dozen pictures of windmill farms. Dreamlike windmill "inventions" have been common in magazines like Popular Science for at least 50 years.

According to the Paul Scherrer Institute, the cost of electricity produced by windmill ranges from 20 to 50 cents per kilowatt. In the range of 4 to 12 times the cost of nuclear power, before the latest nuclear advances were developed. Once group think sets in, it is a powerful force. It was group think that has caused congress to waste money on ethanol, wind farms and solar subsides while prohibiting drilling for oil. Many ethanol plants are on the edge of bankruptcy because the cost to produce the product, even after the 46 cent government subsidy is greater than the value produced. Alcohol in car engines was tried 110 years or so ago and it was found to be problematic back then.

Once a group think mind set is established the facts are dismissed until they cannot be dismissed anymore. It took $7 per bushel corn before people were ready to hear that food based ethanol is not the answer. It was only after the price of gasoline reached $3.20 that attitudes toward drilling for oil began to change. Today, polls show that from 57 to 71% of Americans believe we should drill for oil. Congress is finally under pressure to stop spending billions on fairy tales. In the long run economics wins.

CHEAP NUCLEAR POWER

Change takes time. I was seven years old in 1957 when, theoretically, US schools were integrated. Nine years later, Roland Douthit was the one black student at my high school. Today, a black man is the democratic nominee for President. Like it or not, some votes will be cast for Obama only because he is black and some votes will be cast against him only because he is black. Change takes time.

The problems at Three Miles Island in 1979 caused a 30 year set-back in nuclear power generation. Since that time, billions of people have breathed noxious air. The Chinese will close down factories a few weeks before the Olympics in order to reduce noxious coal fumes. The good news is that China plans to build 30 nuclear power plants within the next 12 years and 6 of them are under construction now. Better still, there are 35 nuclear power plants under construction somewhere in the world right now. This does not include the reactor finally being completed in Tennessee. Will America continue to pay Venezuela $135 per barrel or will it join the rest of the world in building "clean burning nuclear power". Currently, 9 US companies have permits pending to build 31 nuclear plants. Without looking up numbers, my guess is that more than 40,000 oil wells will be drilled in America this year. Drill, Drill, Drill is a part of the solution but drilling is like the false hope of wind, solar and biomass if we think drilling will provide all the resources we need.

SEVENTY-ONE AND GROWING

At last report, 71 nations have promised to help eliminate terrorism, to help eliminate nuclear bomb production and to jointly share in the safe production of nuclear fuel. India is close to joining the group. The Indian Prime Minister faces a difficult choice, he can agree to join and be forced to face elections by December or he can refuse and do significant damage to the Indian economy. Economically speaking, all nations, including Iran, should join the group. The USA and all of the major economic powers in the world are pressing hard to make it politically correct for Iran to join.

The countries that spend 4 cents per kilowatt on energy will eventually dominate those countries that spend substantially more. Deciding not to pay an extra 400% for wind power or an extra 1,700% for solar should be an easy choice. Drilling for 5 cent oil should also be an obvious choice. It is sensible to spend on clean energy research but it is not sensible to spend billions subsidizing the production by any method. Unfortunately, the process of winning congressional districts has resulted in government subsides for every energy source. It is also unfortunate that huge taxes are collected on some sources in order to subsidize the others. "Big Oil" has won a few battles but it is a heavily taxed industry. "Big Oil" has been the convenient scapegoat.

EXXON'S SURPLUSES

Every good is priced such that there is both a consumer and a producer surplus. This means that when Exxon sells a gallon of gas for $4 it could have easily charged more or less and the consumer could have easily paid more. As a profit making company, Exxon does not charge the maximum price it could. The maximum profit is reached though a combination of high volume and "moderated price". In other words, if Exxon unilaterally raised its price to $5 per gallon, it would not sell nearly as many gallons and its total revenues would fall, its profits would probably also fall.

From the consumer point of view, Exxon could raise the price a few pennies and still sell a lot of gas. This means there are always people who could pay more. I submit that Exxon has probably saved more people more money in the past 50 years than any other company in the world while making more profit than any other company in the world. Although Exxon is despised by many, it is a very well run company. It is a very efficiently run company. It does not wast its resources. As a result of its efficiency it can charge a small mark up and still make a nice profit.

Exxon's profit margins are quite low when compared to many businesses. Computer companies, advertising companies, drug companies and many more have much higher profit margins. In a free economy, the word profit should be a positive word. Exxon sells a lot of oil because it is good at what it does. As a result, millions of people benefit, consumers and shareholders. In the long run, economics wins.

CONDI SAYS -- MY WORD IS GOOD!

Condoleezza Rice has told the Iranians that Americans want permanent friends not permanent enemies. This week, proposals have surfaced in regard to an quasi-embassy in Iran. About the same time, Condi's signature appeared on the latest UN 5+1 offer. This offer includes the concession to allow Iran to continue to refine fuel at the current rate while negotiating the final agreement. A Qatar Minister says that Iran will respond to the latest offer "soon".

Yesterday, the British Foreign Secretary, David Miliband, said, "There is a massive prize for Iran on offer... if Iran is willing to behave...". He says the offer includes "tough measures balanced by generous incentives". It is wonderful to know that so many countries are working toward a peaceful settlement.


Iran could probably work many years and not reach the current proficiency of nuclear refinement by GE. The problem is that Iran only needs a few small nuclear bombs to wreck havoc. It is know that Iran has the plans to build small bombs and it has the rockets to deliver them. From an economic point of view, it makes no sense for Iran to waste years of effort on a process that is no where close to the efficiency of the GE process. The UN offer includes free uranium fuel for Iran!

Should there be a quasi-embassy in Iran, it will help to lower the bomb, bomb, bomb Iran mentality. While we do not want war with Iran, we cannot risk allowing them to build nuclear bombs. The threat of war must be left on the table, however, the threat of war could be reduced by paring a fuel production limit with the establishment of a quasi-embassy. The Iranians would gain comfort from seeing the presence of Americans in country. Full diplomatic relations must come only after a comprehensive treaty is signed. It is nice to know the potential agreements have reached the stage where Condi is willing to sign off!

The price of oil is down $4+ this morning. Inventories increased even while two of the largest Iranian fields are "sequestered". We can get along without Iranian oil if we must. We cannot get along with Iranian nuclear bombs or terrorist bombs.

NC POLITICIANS SAY DRILL, NO DRILL, DRILL, NO DRILL

Sue Myrick, congresswoman from Charlotte, has introduced a bill to allow OCS drilling, it is supported by the congresswoman from Forsyth. Sue cites a US Department of Interior study that estimates at least 29 Trillion Cubic Feet of natural gas off our coasts. The study goes on to say that the total could be 420 Trillion Cubic Feet or more! We do not know how much is there but, for the sake of political triangulation, it is better for politicians not to find out. It is hard to confuse an issue if the facts are clear!

Our Senators are split. Burr supports drilling, Dole does not. Burr voted against the wasteful farm bill, Dole is the power politician who wins goodies for her district at the expense of us all. She is proud of getting $25 billion in subsidies for vegetable growers in Southern States while forcing those vegetable growers to support hundreds of billions of other subsidies. Why should a tax payer who grows his own vegetables pay any farmer for growing vegetables? Why should anyone else?


Our governor does not support drilling. He and his buddies in the legislature like to play power games too. In this case, they have forced power plants to be inefficient in exchange for goodies. They allow Duke Power to charge more in a three way split between Duke, the politicians and the lobbyist. The price per citizen is only a few cents here and a few cents there. The people of the state are like sheep being sheared. We like having our backs massaged by the shears.

Drill, Drill, Drill -- And....

A long-term reader responded to my diatribe about the huge international move to nuclear power with the words, "drill, drill, drill". I think he has been listening to Larry Kudlow.

The fact of the matter is that the drill, drill, drill phenomenon has reached new heights and will not go a great deal higher. In 2000, there were about 1,100 rotary oil well drills operating. The count early this year, 3,400, an increase of 309% in 8 years! And, these are not the low powered rigs of the 1970's. Some of them complete a well in 8 days! remain on site! to drill again and again! from the same location! A small patch of ground can now be used to cover many square miles as the wells are angled. Should we drill at ANWR, an area smaller than Washington DC will be used to explore and area greater than the size of South Carolina. The caribou will roam in peace. When production starts, the servicing costs are reduced by the fact that 40 or more wells end at one location. In 2000, the USA accounted for 45% of all rotary rigs, approximately 500. This year, the USA has 1,900 rigs operating or 56% of all rotary rigs! The USA has seen an increase of 380% in 8 years. The effort is on in America to find more oil; the score is 380 to 309.


The correct question is not drill, drill, drill but where, where, where? The congress has restricted drilling to the played out or least productive locations. The result: the US proportion of total oil production is going down even while we drill more wells than anybody else. It is only in America where the congress has put massive areas, about 85% of the areas of known reserves, off limits. Thus, we drill fast and hard but to less and less effect. Our oil companies are being forced to spend heavily to drill in largely played out areas. Never-the-less, progress is being made. In 2005, the USA had 130 horizontal rigs working. This year there we have 550 so far. A 423% increase in only 3 years. Sizable new production is the result of horizontal drilling combined with the process of fracturing porous rocks. The process is expensive but the oil companies are doing what they do best, producing oil. The misguided have tried to force the oil companies into other businesses, such as ethanol production. This is like requiring a professional basketball player to teach the game of chess during the off season, some could do it but others know they can't.

OFFSHORE DRILLING

The Rigzone web site provides information about offshore drilling. There are currently 176 floating rigs working. These massive drilling ships are leased at an average cost of better than $300,000 per day, 109 million dollars per year, each. The annual cost to lease these 176 ships is about 19 billion dollars. They operate virtually non-stop. Very expensive crews are at work 24/7, 365 days per year. Crew members are given rotations on shore leave. While on site, crews work long hours for week after week. One does not spend $300,000 to lease a rig and then shut it down for holidays. The costs of operating these ships is many times the cost of the leases. A single well in deep waters can cost 100 or even 200 million dollars. Drill, drill, drill, non-stop!

In addition, there are 364 jack-up rigs in operation. These rigs lease for an average of $150,000 per day. They too are operated 24/7. Drill, drill, drill at an additional annual lease cost of 20 billion dollars. Annually, hundreds of billions of dollars are being spent on drilling.

Since there are not enough rigs available, more are being built. The demand for steel (for ship hulls and for casings, etc) has been very high in recent years as the worlds infrastructure has tried to catch up with the new demand. The good news is that we almost have. Even so, Brazil recently leased offshore rigs for as much as $600,000 per day. Brazil has ordered $30 Billion worth of new rigs. Drill, drill, drill. Brazil has discovered what appears to be more than 100 billion barrels of oil. It will be several years before this oil comes on line. The most massive discovery in US Gulf waters, the Thunder Horse Field, was discovered in 1999 and was expected to come on line in 2005. It just recently delivered its first oil. The pipelines from Thunder Horse have been connected to Atlantis and Mad Dog. It is no small trick to build a pipeline on the ocean floor two or three miles deep. On the other hand, a billion barrels of oil is nothing to sneeze at.

SAMOTLOR

One of the biggest oil fields ever discovered produced about 16 billion barrels of oil between 1965 and 2003. During 38 years of production, about 17,000 oil wells were drilled in this field, an average of 440 wells per year, drill, drill, drill. By 2003, it was considered to be a depleted or a dying field. At its peak, about 2.5 million barrels of oil flowed from this field 365 days per year. The flow rate gradually fell to 300,000 barrels per day. This field is in Russia where the scientist believe in the abiotic theory of oil creation. They do not believe that all oil was made from dinosaur bones or from rotted plant material from the age of dinosaurs. They believe, as I do, that oil is being constantly "produced" by microbes, 5 x 10^ 30 of them, the number is right, the estimated number of oil chewing microbes on this earth is 5,000,000,000,000,000,000,000,000,000,000.

The good news is that BP stepped up with 10 billion dollars to purchase a half interest in this field. BP formed a new venture with a Russian company and has since drilled 4,500 new wells (900 per year), drill, drill, drill. These have been horizontal wells. They extend for up to 4 miles. The porous rocks beneath these horizontal wells are fractured, using water under high pressure and sand particles to maintain the cracks. The cracks allow additional oil to seep up, that's what I said, seep up, from the depths below. In the past 5 years, the flow rate has doubled. The extra 300,000 barrels per day works out to a retail price of about $15 Billion per year. BP shareholders deserve the profit because their company put 10 billion dollars plus development cost at risk.

LESSONS LEARNED? NONE?

The average person can not seem to wrap his brain around the size and relative values of the energy market. People with considerable "brain power" are easily side tracked. For thousands of years, there has been the dream of abundant power from wind mills and, as kids, we learned how to focus the sun to fry ants. I have no data to support my belief that there have been hundreds of windmills abandoned for every single one that is producing energy today. However, I know that my father once hauled two windmills from North Dakota to North Carolina only to discover that the permits would cost him more than the value produced. We simply do not seem to appreciate the "effort" that went into making coal, oil and gas for us. We have been given great gifts. Perhaps the real problem is that we are too proud to accept the gifts given? Drill, drill, drill.

Jimmy Carter proposed that we wear sweaters in the winter and that we tax the oil companies wind fall profits. Who among you is willing to spend 100 million dollars drilling a hole that may produce zero return? Most of you own a tiny piece of Exxon in a mutual fund such as an S&P Index fund. Exxon is a very profitable company and it produces a massive consumer and a massive producer surplus. Both consumers and shareholders benefit greatly from the efficiency of Exxon.

Theoretically we understand fundamental laws such as gravity, the conservation of energy and supply and demand. In practice, democrats are once again proposing wind fall profits taxes. Jimmy Carter used billions of dollars from his wind fall profits taxes to develop synfuels, have you put any synfuel in your car lately? The fact is that the wind fall profits tax made things worse not better. After all, the laws of economics tell us that if you want to reduce the quantity of a good and to increase its price, tax it. Today, you and I are required to pay high prices for oil so that politicians can waste our money on very expensive wind mills and very expensive corn oil refineries. It costs at least 35% more to make power with windmills but, that is OK, your taxes can be used to cover the operators losses.

YES, DRILL, DRILL, DRILL IN AMERICA!

The big ships are drilling mostly in foreign waters. America has vast untapped resources. What has basically happened in America has been the political marriage of socialist and environmentalist. The socialist believe in command and control economies and the good intentions of the environmentalist have been subverted. Americans are being forced to breath noxious coal fumes while trillions of cubic feet of clean burning natural gas sits. In Alaska, we actually pump billions of cubic feet of gas, produced in conjunction with oil production, back into the ground because construction of a gas pipeline continues to be blocked.

We breath noxious coal fumes while construction of emission free nuclear power plants are blocked. In the USA last year, 50 or so coal miners died and millions of Americans suffered from respiratory problems while Harry Reid blocked the storage of nuclear waste. US citizens pay billions of dollars to Venezuela each year. Some of our money goes to train terrorist and to buy bombs that are used to blow up innocent men, women and children. Some of our money is used to support FARC while democrats refuse to allow American companies to sell goods to Columbia.

Seventy one nations have signed a new treaty designed to eliminate support for terror while supporting UN supervised consortium to refine nuclear fuel. Signors to the treaty cannot have it both ways. They cannot support terrorist bombs or hide nuclear bombs and participate in this extra cheap fuel. GE has patented a new nuclear fuel production process. Laser beams are used to produce fuel at a fraction of the cost of the old process. It will take years to build the refinement centers but they can be ready by the time new power plants are constructed. The time to start is now.

Drill, drill, drill is not enough. Less than half of our energy consumption is oil. About half of our electricity is fueled by coal. Most of the rest is fueled by natural gas and nuclear power. A small amount is fueled by hydro. A very small amount is fueled by oil. The amount produced by wind power is relatively close to nothing; solar power is also close to a big nothing. Wind power receives average subsidies of more than $23 per megawatt and it still is a relative zero. The HEE HAW routine applies: "Doctor it hurts when I do that." "Then don't do that!" The French get 80% of their electricity from nuclear and they export power. The USA needs to stop shooting itself in the foot with wind fall taxes and $5,000 subsides for cars. We can go from 20% nuclear to 80% nuclear if we choose. If the "super battery", whether a hydrogen cell or not, is developed, then we can convert nuclear power to transportation fuel.

The simple answer to our energy problem is to replace income/payroll taxes with consumption taxes. The laws of economics tell us that the change would result in an increase in our income and a decrease in our consumption. What is not to like about that! A tax on carbon would make dirty coal less attractive. It would make wind mills, solar and nuclear more attractive. A reduction to the income/payroll tax would offset our costs in the short run and pay us a bonus in the long term. The response would be rapid. If we all knew the tax on gas was going up 10 cents per year for the next five years and that our payroll tax would fall by an equal amount, we would all find ways to reduce consumption and thus we would lower our individual tax burdens.

One of the beautiful things about a consumption tax is that foreign oil sheiks would pay a portion of the tax. For example, the laws of economics tell us that a 10% increase in the tax on gasoline would not result in a 10% increase in the total price. The increase would cause a shift in the point where the demand curve crosses the supply curve. The result might be an 8% increase in the total price and about a 12% decrease in the revenues to the oil sheiks. The consumer might save $100 in income/payroll taxes for each $80 increase in consumption taxes.

DRILL, DRILL, DRILL BUT REFORM THE TAX CODE! FREEDOM!

We Agree! On Nuclear Power!

There is a coalescing around nuclear power. In Japan, a Fast Breeder Reactor, closed down in 1995, is set to re-start soon. In India, a new Fast Breeder Reactor is under construction. France just signed a nuclear deal with Algeria. Russia just signed a deal to supply China with a billion dollars worth of nuclear fuel and equipment. Seventy-one nations have signed a treaty endorsed by Russia and the USA that will assist in the safe development of safe nuclear power. Most importantly, the attitude of Americans has changed. A number of ethanol plants are being shut down and 13 companies have applied to build 31 nuclear plants in America.

John McCain has proposed the construction of 45 nuclear plants. Once this process is underway, many more than 45 will be built. McCain has also proposed a 300 million dollar prize to the developer of a "super battery". No prize is needed because the race to develop a "super battery" is well underway. Billions are being spent and the prize for success will certainly be many times the 300 million dollar "tax payer" prize. McCain also has proposed a $5,000 tax credit for those who buy a zero emissions car. McCain is trying to be the best democrat on the ballot. Maybe republicans should just stay home. Instead of Robin Hood, candidates for President are becoming Hood Robins. Just like what happened with ethanol, it will be the poor who will subsidize expensive electric vehicles.


Obama has endorsed nuclear power, provided the waste can be properly stored. The massive 123 Agreement submitted to congress on May 13, it becomes law 90 days from that date if not voted down by congress, includes reprocessing and storage of spent fuel.

Oops, there is still need for more coalescing. Democrats in congress have cobbled together a bill that would prohibit the 123 Agreement with Russia. Whose side are these guys on?

The congress is also on a witch or devil hunt. The congress is trying to blame futures traders for high oil prices. The congress uses the word speculator as if a speculator is the devil incarnate. For every devil who trades a futures contract, an angel must take the other side! Both the buyer and the seller are making a guess as to which way the price will go. To the extent that speculators are right, they reduce the volatility of the market and help us all. If the price of fuel must go up, it is better for it to go up some this year and a little more next year than to jump in price next year. Right now, the speculators are betting on lower prices next year. As a result, they are actually keeping prices down. The problem has been that even the smartest of speculators did not foresee how huge the growth in China and other developed nations would be or the extent to which the "global warming crowd" would be able to distort markets. It is absolutely silly not to drill for oil because of the air temperature. Coal produces much more C02 than does oil and much more than natural gas. The USA could easily have more than 500 Trillion Cubic Feet of Gas off our coasts. We need to find out.

The worldwide move to avoid global warming took on a life of its own. Europe is using less coal in its energy mix. Less coal and no growth in nuclear required an increase in drilling for natural gas (not nearly enough in the USA) and thus fewer rigs available for oil drilling.

Coal is a dirty fuel. It can be cleaned but the cost is high. One of the beauties of abundant nuclear power is that it will make clean coal affordable. It is one of those political-news-media ignored facts that the richer a nation becomes, the cleaner it becomes. The US has relatively clean water and air. China is forcing half its cars off the road over the next 7 weeks in order to try to have clean air for the Olympics. China has over produced goods in recent months so that coal fired electricity plants can be closed down prior to the games. Whenever possible, more expensive natural gas has recently been used in China to avoid burning dirty coal. The push to be ready for the Olympics will be over soon.

The energy markets have been in a "perfect storm". Storms are temporary. If we assume that the 123 Agreements are going to go though (the one between Turkey and the USA went into effect on June 2), then the odds become high that many nuclear power plants will be built. Nuclear plants will effect the price of motor fuels. Speculators who believe the price of oil is going to $200 will make different bets if they believe the price is going to $70. The good thing about financial speculation is that premiums change in an instance. Still, it will take time for markets to adjust. Nuclear power plants take 5 years from breaking ground to finish. The good news is that a number of plants are already under construction, with China leading the way. The other good news is that several big oil projects are being finished (including the one in Saudi Arabia that is allowing the increase of 1.2 million barrels per day by next year) and that several more will be in the coming months and years.

It is a shame that both major candidates for President of the USA believe in raising taxes in order to pay for pet projects. To paraphrase Milton Friedman, the good intentions of the powerful does not grant them the right to do wrong. Nuclear power can be built in abundance. The abundance of resources does not excuse us to waste resources. We need to change from an income tax system to a consumption tax system. Those who save their income should not be taxed for doing so. We will not reach a consensus on a consumption tax for a long while but for now, it is great to know that the world is coalescing around the construction of clean, safe, nuclear power.

The War Between Saudi Arabia and Iran

Yesterday, the Saudis held a conference to assure an oil thirsty world that supplies will be adequate. This conference was held just a few days after the Saudis accused the Iranians of using Bahrain's citizens to spy on Saudi Arabia. There is no love lost between Iran and Saudi Arabia. At the conference, the Saudis spoke of increasing production while Libya spoke of potential decreases by Libya, Algiers, Qatar and Venezuela. The situation in the Middle East is always more complicated than it seems. The Libyans are Sunnis. Did they show support for the Shiites of Iran or are they simply after keeping the oil price high? Does the support of Venezuela help or hurt Iran's cause?

British Special Forces have evidence that Iran is supporting the Taliban against the government of Afghanistan and the US has evidence that Venezuela has 5 bases where Hezbollah terrorist are trained. Those who want peace know that Iran is the ring leader of war. It is clear that Chavez is nothing but a petty dictator. The response of Chavez was to nationalize a milk plant to "cure" the problem of milk shortages in Venezuela. As is typical of command and control economies, now that Venezuela has nationalized a number of industries, shortages are the only thing in abundance.


There are exceptions to every rule. The Saudis produced 9.6 million barrels of oil per day for some months following Katrina. Production continued at an average of about 9.4 million barrels per day until prices fell significantly in the fourth quarter of 2006. Saudi production was cut by a million barrels per day by June of 2007. The high prices of 2008 induced a climb to 9.2 in April, to 9.5 in May and the announcement of 9.7 in July. The Saudis are rationally responding to the market price. In the meantime, Iran has 30 million barrels loaded onto ships and has offered this oil to any taker for $6 per barrel below market rates. The Iranian oil minister, Ghanimifard, said just a week ago that the oil would not be discounted. Bloomberg reports that 13 oil tankers are still parked. Bloomberg cannot confirm the 30 million barrel figure but there is no indication that the oil has been sold. Ghanimifard says the seasonal maintenance of heavy oil refineries will be finished by the end of June and the oil will start flowing again, and the Easter Bunny will deliver. His words were directed to the Iranian people. Ahmadinejhad just closed down another critical news paper.

India has worked its way into a bargaining position. India completed a huge refinery just a few months ago and is looking for a long term supply contract. The oil being offered by the Saudis is a good fit. The new refinery is designed specifically for the heavy - sour crudes that the Saudis can add to the market quickly. A major Saudi field has been mothballed for several years while the Saudis have waited for higher demand for sour crude. The Saudis say they can add 2.8 million barrels of production by the end of 2009. The Indian refinery is huge but it can only handle 1.2 million barrels per day. India is trying to play Iran and Saudi Arabia against one another. Iran, Pakistan and India continue to assert that the IPI pipeline, a 7.5 Billion Dollar gas pipeline, should be built. Those who desire Iran to give up its nuclear warhead ambitions are ready and willing for Iran to sell gas and oil, as soon as a deal is made on the nuclear/terror issue. The UN Security Council and Germany have offered free nuclear fuel to Iran as one of several incentives to "make a deal".

Whack a Mole -- In Canada?

The good folk at Stratfor report that Hezbollah seeks to pull off a major terrorist attack, perhaps in Canada, as the way to convince Iran to continue its support. My take is that any attack right now would be bad news for Iran. The EU will meet to discuss additional sanctions tomorrow. Syria, which has negotiated a deal with Israel in regard to the Golan Heights, Lebanon and protection of Israel from rocket shots from Hezbollah, supports the end of Hezbollah terrorist activities. The negotiations with Iran must be handled carefully because a trapped animal is prone to lash out. Still, little by little, the wall around this trapped animal is approaching completion. For example, a "Shiite Awakening Council" in Iraq has accumulated 3 million signatures on petitions asking Iran to stay out of Iraq!

Goldman's Joke

A couple of weeks ago, when jet fighters from Israel were engaged in joint maneuvers with Greece, the price of oil made its biggest one day jump ever. This past Friday, negotiators re-told the story of the maneuvers to "turn up the heat". The maneuvers were suddenly being described as a "practice run". Goldman predicted oil prices of $200 per barrel back when the maneuvers were taking place. This past Friday, Goldman used the report of maneuvers as a good time to offer twisted logic in concern to oil demand in China. After a meeting with Hank Paulson, US Secretary of Treasury and former Chair of Goldman, China made a significant move to curb oil demand. The consumer price in China was raised by 18% to $3 per gallon. China will need to raise prices another 30% to reach market rates. The 18% jump was huge.

The average American now spends 9% of his disposable income on fuel. Averages, like all statistics, sometimes hide the truth. The truth is that many "big city Americans" ride subsidized trains, buses and subways. Many of these Americans spend 2% or less on fuel. Many rural Americans spend 16% on fuel while many others spend 10% while paying extra taxes to support the 2% price. Americans who spend 16% can live with $4 gasoline for a while, a tough price to pay but doable. Three dollar gasoline in China is a more serious blow to the family budget. Officials need to end wasteful use of fuel by raising the price to the market price but they must take the price up in steps in order to avoid the kind of shock that could cause armed protest.

The 18% increase in the price was a blessing to Chinese oil companies. They were being squeezed by high wholesale but restricted retail prices. The Goldman logic is that because fuel will become more available in China, now that the price is higher, the total usage will go up. This is another one of those short-run versus long-run issues. Give China another 30 years of rapid growth and the country will use as much oil per capita as the USA (except that they are into battery powered vehicles). Give them an immediate 18% increase in price and the fear of additional increases and they will find ways to cut back in the near term.

UN negotiators have reportedly offered Iran the option to begin talks without suspending production of uranium. The UN will accept a freeze at current levels of production as a way to get the next step of the negotiations moving. Iran needs to take the deal because its oil market is drying up and it could miss the chance to join a nuclear consortium that will refine fuel.

If you take a few steps back, the view is interesting. After three mile Island, it appeared that nuclear power was dead. Since that time, tens of thousands of coal miners have died and millions of pounds of toxic fumes have poured out of coal fired power plants. Hundreds of thousands of people have died early deaths due to air pollution.

Today, there is a world wide scramble to build nuclear power plants. Over the past 30 years, many billions of dollars of subsidies have been dolled out in support of windmills. The facts are that wind power cost about 3 times as much as nuclear power and that all these subsides have gotten us to only about one half of one percent wind power. It took a lot of time, a lot of waste and a lot of deaths, but the majority now supports drilling for oil and building nuclear power plants. Grandpa told me to stay on the road because it is really hard to get back on after you run into a ditch. Nuclear power ran into a ditch 30 years ago but it is finally back on the road. Is it ironic that Saudi Arabia is a major player in getting nuclear power back on the road?


The War Between Saudi Arabia and Iran

This "cold war" is actually between Iran and most of the rest of the world. A friend says he wants the USA to reach total independence from foreign oil. I asked him about bananas. He said he has a choice to buy bananas or not. Yes, he does. He has a choice to buy gasoline or not. We choose to buy bananas from the tropics because they are cheap. We choose to buy oil from Saudi Arabia because it is cheap.

The Saudis own a lot of oil and India owns a lot of bananas, does it not make sense that they remain dependent on one another? Why should the Saudis even consider trying to raise bananas in their deserts. My friend seems to think that one can get along without bananas much easier than without fuel, but how about corn, wheat and barley? Which is strategically more important, food or oil?

The tricky thing is that governments must create a false crisis in order to "move the agenda". "Peak Oil Theory" gets a lot of press because drilling for oil in the USA was purposely restricted. To get "permission" to build nuclear power plants, required an energy crisis.

After the "war to end all wars", America withdrew from international affairs. The results were horrible and the next war cost about 80 million lives, included more than 500,000 US servicemen. To reach the promised land of peace and security, nations must build strong international relationships. In the grand scheme of things, it is pretty amazing that millenniums of war in Western Europe have ended. It is pretty amazing that Saudi Arabia, Israel, Western Europe, Australia, Canada, China and Russia are all cooperating in trying to reach a peaceful settlement with Iran. I am thankful that all these countries and many others are "on our side". We do not desire to take anything from Iran. We only want to abide in peace. The odds of peace in the Middle East are as high as they have ever been.

A Quick Turn

Just a few weeks ago, a number of broker dealers suggested that most of the big airlines were flying toward bankruptcy. Last week, a deal was made for these same brokers to help CAL sell 11 million shares of stock. Today, brokers are calling their clients telling them that they have a good CAL deal available. Part of their spiel is that CAL will pay the sales commissions. For CAL holders, the additional shares are dilutive. My favorite comparison is to the Oakwood Homes dilution some 20 plus years ago. A lot of investors took the dilution as extremely bad news but the extra cash was used to build additional capacity right at the start of a "jump phase" in the business.

CAL is prepared to maintain the most efficient major carrier fleet in the USA. Midwest Air just announced that it will park all 12 of its MD-80s. The company will furlough 25% of its pilots and restructure its remaining routes to fit its remaining fleet of Boeing 717's. The "old SUV s" and the "super sports cars" of the airline business are being parked. The newer and more efficient "buses" are flying full and the ticket prices are going up. Higher fares on the most fuel efficient planes will lead to higher profits.

CAL has made a major deal with UAUA. The deal will not close for many months, but the direction has been set. Governments are allowing major carriers to "merge without merging". The integration of airlines has proven to be difficult. Agreeing to cooperate in markets has proven to be the way to cut costs and to increase revenues while avoiding the process of integrating operations. The process could easily ultimately lead to a merger of CAL and UAUA. It will also make a deal between AMR and BAY all the more likely. Trust busters will view a deal between British Airways and American as necessary to fair competition, rather than a monopolistic move by the "big boys".

The first quarter profit of Exxon was enough to buy all the shares of AMR, UAL, DAL, NWA, CAL, Alaska Air, JBLU, LCC and AirTran, with a billion dollars left over. Airline stocks are cheap.

Reader Comment -- $1,000 for Some Kids, Not for Others.

A regular reader teased me Saturday. He said, "you really do not like government subsides do you?" NO!

Government "incentives and disincentives" have unintended consequences that only government can "fix". When the government fixes one problem, it creates three more.

The $1,000 tax credit for children is an example of the crazy results promoted by the government. Some of you will laugh and say that a $1,000 annual tax credit is not enough to cause you to have a child. That might be true but the laws of economics are clear. Taxes and anti-taxes do effect behavior. Some Americans have at least one extra child today because the government pays.

But wait, who receives the $1,000 "bonus"? Not the poor, they are paid more than $1,000 per child in other subsides. Not the rich, they do not qualify. The $1,000 is a tax credit but the poor pay no income taxes and the "rich" are subject to the AMT and thus do not get the credit. So, a small percentage of the middle class are being paid $1,000 per year to have children and, due to many other subsides (details at another time), the poor are being paid many times $1,000 to have children.

Once again, the laws of economics are clear, pay for poor and middle class kids and you will have more; charge extra for rich kids and you will have less. The beauty for the politician is that the increase in the number of poor kids becomes the rational for having more government programs to help poor kids. The next thing you know, mothers are being paid to leave their husbands. While many a single mother does a great job of raising kids, the chances of a child from a single home making it though high school in 4 years is relatively slim. The odds of years in prison are relatively high.

Iran is subsidizing the bombing of innocent men, women and children. It is my hope and belief that the actions of Saudi Arabia to help cut off the income of Iran, will help end the practice of governments paying for terror.

The Chicken or the Egg: Strong Dollar or Weak Oil: High Investment or High Return

Markets put things in the right order. Market mavens often put things upside down, backwards or both.

Which comes first, a strong dollar or weak oil prices? My favorite market TV show is Kudlow and Company. Larry Kudlow does a good job of applying economic principles to money and politics. Larry is a smart man but he sometimes joins the crowd in getting things backward. In recent weeks, he has been on a "strong dollar kick". He has wanted the Secretary of the Treasury, the FOMC chairman and the President to "talk up the dollar" and to thus bring the price of oil down.


The dollar will strengthen if the US adopts the right policies. All the talk in the world will not rescue the dollar. To his credit, Kudlow has more recently pushed "drill, drill, drill" for US oil reserves. The US dollar will strengthen when oil prices come down, not the other way around.

Oil prices are acting like a tax. High oil prices are depressing economic growth. To offset this tax, the FOMC has lowered short term interest rates. In the short run, the FOMC has been caught in a negative feedback loop; every time the FOMC lowered rates, the price of oil went higher which meant that even lower rates were needed to offset the tax. Now that the forces of supply are weighing hard on the price of oil, the tax is going to go away. Lower taxes will mean stronger growth and stronger growth will lead to both a stronger dollar and ultimately higher interest rates.

Even here, the TV talking heads often get the chicken before the egg when they suggest that it is higher interest rates that lead to a stronger dollar. Keeping in mind that inflation is the result of excessive money, the answer to what interest rate policies do depends on ones time frame. An increase in short rates will actually cause long rates to come down after given time to work. It is a stronger economy that pushes up the dollar but it is a strong economy that pushes up the demand for oil. When capacity is restrained, a stronger economy is not possible without a spike in oil prices; once capacity or economic efficiency has been increased, the economy can grow without putting the same amount of pressure on oil prices. In the short run, a decline in oil prices is a lowering of perceived inflation, but will this lead to lower interest rates? Brian Wesbury is one Chief Economist who believes lower oil will lead to higher rates. We must remember that interest rates are composed of two parts; growth and inflation. The good news is that the growth component of interest rates is about to increase relative to the inflation component! High growth and profit by US businesses should cause a flood of investment into the US (especially if the McCain - Rangle corporate tax rate cut comes through).

The Chicken or The Egg: Inflation or the "news"?

As I have mentioned many times, inflation is a lagging indicator. Inflation actually goes up in the short run as a result of a slow down in the economy. The example I have used is the airline business. In a slower economy, airlines cut back on capacity which allows them to raise the price. The result is a lot of very negative talk near the end of an economic slowdown when the slowdown is suddenly accompanied by reports of extra high inflation. It should be no surprise that the "news" about inflation is even more of a lagging indicator. High inflation hits but the financial figures do not show up until a month or two later and the "news media" is like a flock of chickens that eventually discovers the source of food. The chickens do the most squawking when they see the food arriving and after the food is gone, they are relatively quiet while eating. Right now there is a lot of squawking about inflation but the worst is already over.

The Iraqi Oil Law or Increased Iraqi Oil Production?

Iraq has struggle to reach an oil law agreement. The Kurds want to control the northern supplies, the Shiites want to control the southern supplies and the Sunni's don't want to be caught in the middle without revenues. The Maliki coalition must have the support of some Kurds and some Sunni to function. Isn't democracy grand? We all hate having to deal with the dumb lumbering giant called democracy but it is far better to battle at the voting box than with knives, bullets and bombs.

Since the government has not been able to pass a nationwide oil revenue sharing law, the decision has been made to bring on new production first. Exxon, Shell, Total, BP and Chevron are in final negotiations to provide technical assistance to increase production over the next two years. It is anticipated that 4 to 500,000 barrels of daily new production will be online by year end. This new production will give the people hope, revenue, and confidence. The democratic government will be strengthened. The opponents to an oil sharing law will be tempted by the presence of an increasing flow of revenues that need to be split.

The Oil Law or the Security Agreement?

The Iraqi foreign minister says that the July 31 deadline for a security agreement between Iraq and the USA will be met. The agreement will cover: 1) the number of troops and bases, 2) the lack of commitment to defend Iraq (this agreement cannot include the promise to defend Iraq against outside forces or it would become a treaty subject to the disapproval of congress), 3) the immunity of US troops from Iraqi courts, and 4) the power of US troops to arrest and hold Iraqi citizens.

Secretary Rice has made it clear that US security negotiators are not involved in the negotiations between the oil companies and Iraq. Several of these oil companies had major investments in Iraq some 36 years ago. The plan is for them to be paid a portion of the oil they produce. Back in the early days of Texas, the common split was for the oil producers to get one barrel out of every eight, a 12.5% share. Based on the history of nations which have nationalized fields, the one out of eight is a very good deal. Mexico, for example, kicked out the major oil companies years ago and is now close to having to import oil. To solve this problem, Mexico is considering allowing these "pros" to produce the oil, in exchange for a share. I am sure the split for very expensive deep water oil is much higher than one of eight. The telling story is that the estimated reserves in Iraq have been increased by about 200 billion barrels because these major producers have the know how.

The details of the SOFA (Status of Forces Agreement) are best left to the "pros" as well. What is going to be interesting is the agreed upon troop levels. We might see a major withdrawal if the two parties agree that 140,000 US troops are not needed, now that Iraqi forces are functioning well. The proper sequence here is victory and then withdrawal not withdrawal and defeat.

The Democrats Have Done It Again

A deal was just made between Bush and the democrats. Additional war funding of $162 billion was just passed. Triangulation politics required the dems to get this issue out of the way well before the elections. Pelosi was once again caught in a no win position. Democrats cannot admit the war is going well nor can they vote to withdraw. Using the football analogy, it would be silly to quit the game with the ball sitting on the 1 yard line, first and goal.

Nancy had to swallow twice. She swallowed the $162 billion in funding and she swallowed her pay-go rules again. You may recall that the democrats took the house in 2006 by promising to end the war and to not borrow any new money. They said they would practice "pay-go". The irony is that they added other bells and whistles without funding these items either. The extended unemployment benefits added is one of the typical democratic response to an economic slowdown. This is not a which is first, the chicken or the egg question. In this case, the democrats decided it is better to kill the chicken, eat it this summer, and not worry about the coming shortage of eggs this winter. Once again, the policy is to pay someone not to work, rather than to give a tax break to someone who is willing to work more.

The other addition to the bill was to increase GI college benefits from $40,000 to $90,000. As one whose college tuition was paid for by the GI bill, I certainly support GI benefits. I drew $242 per month from Uncle Sam for 4 years after Vietnam. Hanging $90,000 in front of a five year vet is a very different proposition. Our all volunteer army requires different strategies. The left should not try to bribe a professional soldier to leave the service. We need the best and the brightest to receive the best military education available.

One of my favorite movie scenes is that of Mel Gibson playing William Wallace in Braveheart. When Wallace was being tortured to death, he used his last breath to scream "Freedom". Some years after his death, at the Fields of Bannockburn, Scotland won its independence. Throughout the centuries, many people have died in defense of freedom. Wars should be avoided if possible but they should be fought to win. After voting to enter the war, it is the responsibility of the congress to fund the troops.

Natural Gas Prices Up or Gasoline Prices Down?

The great run up in the price of oil has not been accompanied by the price of natural gas. Based on the BTU value, either natural gas is very cheap or oil is very dear. Now that Qatar is shipping billions of cubic meters of LNG, its seems more likely that the price of oil will move toward the price of gas.

Over the longer term, the environmentalist must appreciate the chicken or the egg power question. Many environmentalist hope to replace gasoline engines with electric engines. The Plug-in hybrid is the rage but it is being charged by coal fired power plants. Hundreds of thousands of people die each year as a direct result of coal mining and coal power. We have trillions of metric feet of clean burning gas available. The north slope of Alaska can fill our needs for many years.

McCain has caught up with the 123 Agreement reached between the USA and Russia. McCain proposes that 45 nuclear power plants be built in the USA between now and 2030. He proposes that the permitting process be reduced to 2.5 years or better. You cannot replace gasoline cars with electric cars unless you have the electricity to spare. You do not help the environment by converting from oil burning cars to electric cars fueled by standard coal burning power plants. The reason a tax on carbon with offsetting payroll or income tax breaks is better than a cap and trade tax is because the carbon tax is applied to all sources of carbon prorata. The market then determines which fuel is used after taking the carbon costs into account. The correct sequence is to get the permitting of the nuclear power plants underway so that improved batteries can be charged 7 or 8 years from now.

Sanctions or Bombs?

The lefties have posted, all over the Internet, their belief that Bush is preparing to bomb Iran. Bush could have started with that strategy in 2002, but he didn't. He has followed strategic military advice and taken out the easy targets that surrounded Iran. He has gotten the world to mobilize around sanctions as a method of avoiding war.

Condoleezza Rice is every where, she's every where. She just made her 20th visit to Jerusalem. She just spoke at a Heritage Foundation Meeting where she talked about Pakistan, China, India, Iran and North Korea. She just met with Ban Ki-Moon and encouraged him to "get involved" with the Shebaa Farms negotiations. She is prepared to let many others share the credit for achieving peace agreements. She is on the way to China to visit earthquake victims and she will visit South Korea afterward. She has pressed the UN to act on Zimbabwe violence. She is keeping a high profile. Once again, she has presented the Iranians with the powerful argument that the US does not make permanent enemies but we do make permanent friends. We prefer no sanctions and no bombs but sanctions are our choice between the two.

Prime Minister Brown, Energy Secretary Bodman, Vice-President Xi Jinpiing and many others will parley with the Saudis this weekend. The Iranian oil minister will be present when the leaders at this conference make it clear that there is going to be increased supply and reduced demand until the price comes down. It should become clear to Iran that Iran's oil is not necessary to the rest of the world.

China just made a substantial contribution to this effort, more so than the announcement of 200,000 more barrels of production from the Saudis. The Chinese just raised the domestic price of oil by 18%. This is probably the first of several moves to take the price to the market price. Can you imagine the shock. What if you lived off of $4,000 per year and suddenly saw the price of gasoline jump 18%? Would you drive less or eat less?

Peak Oil or Peak Gasoline Demand?

Many environmentalist believe we are near "peak oil", the maximum level of production before world wide production declines set-in. Dan Yergen says we might be at Peak Demand, the point at which we find substitutes for gasoline. If Russia, China and the USA each build 45 nuclear power plants, plug-in hybrids might be well on the way to replacing the internal combustion engine.

It is believed that the latest bombing in Iran was placed by Shiites to kill Shiites with blame pointing at Sunnis. The purpose was to restarte the secular war between Sunnis and Shiites. The start of WWI was an assassination. Ahmadinejhad claims to have thwarted an assassination attempt by leaving Baghdad earlier than scheduled. Desperate measures for desperate times.

If Iran and the US Congress will get out of the way, private enterprise will find the energy we need at the lowest cost possible. Yesterday, a democrat proposed that the US Government take over the US refining business. The government just had to privatize the senate food service due to massive losses. If the government cannot run a restaurant, how can we expect it to run a very tough and complicated business. How would you like to take the chemistry classes required to be an oil refinery engineer? How would you like to be in charge of a plant where volatile liquids are heated to high temperatures in order to separate them into more volatile liquids?

Dumb and Dumber!

Over the past several weeks, McCain and Obama seem to have been playing a game to see who is dumb and who is dumber. While their success at gaining their parties nomination for president shows political skill, neither has demonstrated an understanding of basic economic laws, until recently.

Last week, Obama said, "Globalization and technology and automation all weaken the position of workers". Can you picture the daily life of a factory worker 100 years ago and compare that image to today's reality? Obama must have smoked a little weed with his leftist friends.

McCain is famous for his support for campaign finance reform. Obama has announced that he will forgo the $83 million dollar government grant (and the restrictions tied to it) and raise as much as he can to run his campaign. So far, he has raised $262 million dollars. If the result would not be so tragic, it would be sweet revenge for McCain to lose this election as a result of his attempts to have government rules and regulations replace the free market of words and ideas.

FREEDOM

You would think that McCain, a war hero, would relish the last word of William Wallace. To McCain's credit, he is listening to the advice of others. His anti drill attitude was wrong but it has been replaced. Doris Kerns Goodwin, who wrote a biography of Abe Lincoln, likes to note that Lincoln was willing to say that times have changed and so have I. When McCain voted to not drill in ANWR, the price of gasoline was $1.63 per gallon. Obama would vote today not to drill in ANWR or on the OCS. McCain has changed his position on the OCS and is studying his position on ANWR. Sometimes, we have to put the chicken first and at other times we must understand that without eggs there will be no more chickens.

As conservation steps take hold, the money not spent on oil will be spent on something else. BUY, BUY, BUY! Something else!