Thursday, May 8, 2008

Commodities and Oil

The press is slowly catching on to the global commodity story and the expanding impact on people’s lives. The real story is still the fact that the price of oil has increased four fold over the past decade, yet global production is clearly stalled at 87,000,000 barrels per day. If anything, it is getting less elastic as the industry is scrambling to patch over localized declines.

The current headlines are about food prices and that is more a scare than a tangible problem. A huge investment is taking place this spring and we can count on bumper crops this fall and a return to normal pricing there or at least a sharp increase in stocks.

Other commodities are all ramping up production and we have already seen price abatement. They will get cheaper with any slowdown or just the advent of new supply already financed into the pipeline. As far as they are concerned we should be more concerned with China’s and India’s ability to absorb the planned increases.

This all means that everything except oil will be in a strong supply position after the next three years of investment build out. We can actually dismiss them unless we have to buy potash this year at $400 per ton. Don’t worry though, they are doubling capacity.

Oil is the problem. We are going to displace at least 15,000,000 per day of oil production somehow over the next three to five years one way or the other. I must admit this is more a gut figure rather than a brilliantly calculated estimate based on doubtful statistics. I am also putting out a scary time frame to underline that this is not necessarily caused by dropping production as by reallocation.

It will happen very painfully if oil abruptly runs up to $300 per barrel. In that case the private car everywhere will be run of the road to release the oil for necessary industrial and agricultural use. It is our real strategic reserve. If this type of oil shock materializes, it seems likely to happen this summer. It will start with a production shortfall of a couple million barrels that is impossible to cover.

In the mean time, the trucking industry is preparing to switch over to LNG fuels which will not be short supply for a long time. I suspect that many other diesel based operators will do the same. This will single handedly switch out millions of barrels of oil from the market and may account for much of that 15,000,000 per day reallocation that is needed.

The auto industry is already switching over to hybrids and other patches that can reduce the reliance on oil. Most of our current rolling stock is destined to be either scrap a lot earlier than usual or hanger queens. Do not be surprised if rationing becomes necessary.

I am currently optimistic that this can all unwind slowly over several years. It then allows all the adjustments to be made in a normal flow of business mode. It also allows huge additional oil resources to be brought on stream to cushion the developing transition to a non hydrocarbon sustainable energy world. The very best solution is maintaining the current level of 87,000,000 barrels per day over a couple of decades while the resource is continuously reallocated by price to the most important uses and slowly squeezing out inefficient uses like the automobile.

In that case, we could expect oil to be completely out of the transportation business fairly quickly. Let us hope it does not turn out to be a crash program.

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