I think the idea that we are going to be faced with higher oil prices in the future is something that every investor needs to consider. Not only so that proper consideration is given to having a portion of your portfolio dedicated to oil related investments, but also so that proper consideration is given to how higher oil prices will impact all of your holdings.
There doesn’t have to be a lot of research done before you are able to reach the conclusion that higher oil prices are the new reality. Here are a few things to consider:
1) Discoveries of oil reserves peaked 40 years ago despite advances in technology
2) We no longer discover any super giant oil fields, so we can’t offset those already in decline
3) The oil we do find is in harder to reach places (deepwater) or is more expensive to produce (oil sands)
4) We don’t just have declining production but also increasing demand as billions of people in developing countries move to a more developed lifestyle
5) In the United States we have 700 cars per 1,000 people while in India and China the number is closer to 30
6) The majority of the world oil supply is held by countries that are willing to restrict its availability in order to increase pricing
A very thoughtful and well known investor issued a similar warning not just about oil but about all resources in his summer 2009 letter to investors. The investor was Jeremy Grantham, and here are some of his comments :
“We are simply running out of everything at a dangerous rate. We apparently have trouble processing numeric issues of this kind, and this missing faculty will cause considerable grief.
We do not understand the implications of exponential or compound growth rates: the main implication being that they are impossible to sustain.
No better example of resource limitation in the face of both denial and strong efforts can be found than U.S. oil production. As is well known, we have been on the steep downslope of production since 1974 despite our best attempts to “Drill, baby, drill!” The largest oil discovery in the Gulf in the last 20 years will keep our engines running for a mere 41 days. Nothing we do can
reverse the decline, and drilling our reserves faster has been described as “oil independence through more rapid exhaustion of our reserves!” Coal reserves of the highest quality – anthracite – are basically mined out everywhere, and the second choice – bituminous coal – has probably
also passed its peak. All attempts to maintain the growth of total hydrocarbon output must now depend on subbituminous coal, lignite (which is a little bit better than burning rock, but not much), and tar sands, which are themselves increasingly energy- and water-intensive to exploit.
Modern agriculture has been described as a way of turning hydrocarbons into food. Without cheap energy – a singlegallon of gas is the energy equivalent of 100 hours of old fashioned
labor – the world would certainly have trouble producing half of the current food supply, and that fraction could be substantially less. Hydrocarbons are not only critical to farm equipment and food distribution over very large distances, but also play a dominant role in fertilizer production. With sparse hydrocarbon usage, American agriculture would have to be totally and painfully
restructured away from very large scale monoculture. Hydrocarbons are very efficient in the use of manpower but surprisingly inefficient with everything else, including output per acre and output per unit of energy.
This would be a dangerous situation with zero population growth; in fact it would guarantee that per capita growth would slow. Yet population growth in the last century has been the fastest in the history of man.
It should be obvious from simple arithmetic that population growth is on a direct collision course with increasingly scarce resources. For millennia, food constraints held the world’s population nearly constant. About 12,000 years ago, these constraints were altered significantly with the
start of organized agriculture. Then, around 200 years ago, the so-called Agricultural Revolution – the introduction of science to farming – allowed for another doubling in output. All of this was dwarfed, however, by the harnessing of hydrocarbons – the sun’s energy stored over hundreds of millions of years. This remarkable patrimony is now about half gone, and some time in the next 10 to 40 years, half of all of our resources will have been used or, stated another way, one last doubling will remain. We are looking at the last of 14 doublings in the past 250 years.
We are, if you prefer, 13/14ths of the way through the game in exponential terms! At 1% growth in hydrocarbon consumption, which would be a dramatic reduction in the growth rates of the last 30 years, our reserves would last for merely one more generation. As we move through our
remarkable and irreplaceable hydrocarbon reserves, the price will, of course, rise remorselessly to ration supplies. Hydrocarbons will increasingly be limited to their highest and best uses (probably) petrochemical feed stocks and aviation fuels. The price rise, which for a while is quite
likely to be parabolic – rising at an increasing rate rather than a steady rate – will have an immediate effect on the price of all agricultural products. Also affected will be the price of all metals, which too have become extremely energy-intensive, as has hydrocarbon production itself.
This transition away from carbon-based fuels could have been relatively painless on paper, but in real life our species has such a modest ability to deal with distant outcomes or to defer gratifi cation that a bad ending is probably inevitable. We need, it seems, the shock of a
Pearl Harbor to really gear up and make sacrifices. “
