Wednesday, May 28, 2008

Axiom Quarterly, 05.27.2008

[06.07.2008 - Yesterday, oil prices skyrocketed by nearly $11, just one day after a brain-numbing, $5 jump. The impact has been detrimental. Immediately, the NYSE has fallen 400 points, and the dollar has dropped sharply in FOREX trading. But that is just the immediate impact; more dire consequences are sure to follow, delivering a series of painful consequences rippling through our economy...I guess now people will listen...This entry will remain posted indefinitely with more up-to-date charts for some time. --gh]

With a degree of helpless consternation, most American business owners and consumers have sat back and watched the stratospheric rise of crude oil prices over the last several months. Put into perspective, the price of Light Sweet Crude is now up approximately 100% from last year, touching just over $135 per barrel last week, and gasoline prices are subsequently much higher--already over $4 per gallon in eleven states across the country. This "super-spike" in energy costs has had a perplexing ripple effect on many other sectors of the U.S. economy. In addition to raising rates, logistics enterprises, for example, have been compelled to idle vehicles and to squeeze greater efficiency out of the remainder of their fleets, all in order to save on fuel costs, and airlines have had to become creative in their own fee structures, now charging travelers for their luggage. The automobile industry has also announced large furloughs of production facilities, because demand has fallen for once-popular vehicles. Likewise, retailers faced with their own slump in revenue are now critically reassessing their offerings and raising prices on some goods, just as the wholesale costs of those goods begin to reflect rising transportation and storage costs. In total, the economy is now reeling as it contends with the inflationary pressure brought on by these climbing costs, and consumers are feeling squeezed.

With commodity prices in what seems to be a perpetual upswing, many are asking what has provoked this momentum. To that end, the range of answers has been broad and not necessarily mutually exclusive of one another. Certainly, supply factors can provide transparent and comprehensive reasons for concern, but moving beyond, say, a short-term pipeline disruption anywhere in the world, or even new ethanol-blending requirements that complicate the refining of gasoline, there are other theories pitting the best minds in business against one another. In one camp of analysts, traders and pundits, there is a prevailing thought that the reason for these higher prices is rooted squarely in the fundamentals of supply and demand. They contend that impressive growth in the hyperactive, developing world, particularly in BRIC nations, has increased aggregate demand for a finite amount of resources, and so, prices are beginning to reflect those pressures. Meanwhile, a second troupe of market-watchers argues that speculative investing, more so than basic economics, is driving much of the unruliness in the marketplace. While this latter camp acknowledges the presence of demand pressure, they say that current commodity prices are too high in many instances to be an accurate reflection of that pressure.

Regardless of what either camp is postulating, the facts remain very clear: our developed world was built on hydrocarbons, and current and foreseeable economic development in new and notable places like Dalian, China, or Abu Dhabi, UAE, is readily dependent on those same hydrocarbons. Of all the hydrocarbons, oil is king, and we use it in ways that most people never realized, whether to create plastic packaging for foods or to refine the fuel needed to ship our products across country. Today we lift approximately 85 million barrels of oil per day from the earth, but as impressive as that seems, it is important to note that even 85 million barrels is not enough. Global demand for the black gold, at this moment, stands at 87 million barrels per day. Consequently, from this singular fact, even the most uninformed observer can understand how prices for crude can be high, as well as why reserves are being tapped.

As businesses and consumers become more vocal about their energy insecurity, leaders around the world are exploring new options for bringing home the resources necessary to keep their constituents happy and economies afloat. Sure, many are urging conservation, and some are exploring the use of alternative energy. However, conservation does not sustain robust economies, and with the exception of Brazil and a few European nations, the technology needed for meaningful, alternative energy usage is still years away for full implementation. And so, these world leaders are now left with little choice other than to compete in what Paul Roberts, the author of The End of Oil, called "the great race".(1)

Of course, this race is not a new phenomenon, but now more than ever, with nations scouring the earth to secure the energy resources they need, the momentum and ramifications of this race are becoming painfully apparent to the general public, insofar as net importers increasingly are finding themselves in inhospitable territory, venturing into often politically unstable countries and cutting deals with vile regimes. In fact, when a contractor is kidnapped on the Dark Continent, or when political zealots threaten to nationalize yet another private company in Moscow, or even when oil production is compromised in the fields of Kirkuk, the news can send shockwaves through global markets, and demonstrate a fundamental shift in the geopolitical pecking order of nations, wherein net exporters of King Oil are now gaining more than just influence.

Many pundits and analysts, like foreign-affairs expert Fareed Zakaria, call this fundamental shift, rather strikingly, "the rise of the rest". Yes, that is to say "...the rest of the world". For his own part Mr. Zakaria categorically points to this shift of hegemony as a defining moment of opportunity. "The underlying reality across the globe is of enormous vitality," he wrote in a recent Newsweek adaptation from his new book, The Post-American World.(2) "The expansion of the global economic pie has been so large, with so many countries participating, that it has become the dominating force of the current era. Wars, terrorism, and civil strife cause disruptions temporarily, but eventually they are overwhelmed by the waves of globalization."

Of course, nothing should be viewed so optimistically, particular in geopolitics. If the mad race to sustain the livelihood of the Hydrocarbon Man is inadvertently producing a new class of global superpowers--and it is--then it important to remember that many of these nations are very dissimilar to those in the developed world. In fact, though wealthier, some of these countries are either still plagued by their share of appalling corruption and internal instability, or they harbor the type of desire for hegemony that might threaten their regions of the world. At this juncture, while most are already familiar with Brazil, Venezuela and Mexico in the Western Hemisphere, this consultancy will take an opportunity to identify some of the oil-exporting, developing nations of the Eastern Hemisphere (those producing over 500k per day) and note some of the risks associated with their energy production:

v Tunisia
v Algeria
v Libya --- For years, this North African was on the United States' short list of favorite foes. However, after the terror attacks of 9/11, the revolutionary socialists ruling Libya began to cooperate in the American war on terror, and normalized relations ensued in 2006 as a result. Nevertheless, the country remains poorly noted for its human rights record, and while Shell and ExxonMobil have returned Libya to do business, no one should easily expect a genuine liberalization of that economy or its oilfields.
v Cameroon
v Chad ---Though awash with oil reserves, the people of this African nation remain absurdly impoverished, with infant mortality rates cited at 1 in every 10, and its government stands as one of the most corrupt on earth, as it rests in the hands of the country's ethnic minority of Muslims.
v Egypt
v Sudan ---The genocide conducted by the Janjaweed, under the auspices of the Sudanese rulers, has made headlines in the Western world. It is widely believed that the ruling Arabs in Khartoum seek to expel or eradicate the Africans, in order to have unabridged access to the country's oil wealth in the western Darfur region. As a result, thousands of Sudanese refugees have been seeking asylum in...Chad.
v Nigeria ---The story of this country on Africa's west coast has been the same for years now and is perfectly depicted in the events that took place in May, 2006. At that time, some 200 people were killed when a deliberately ruptured pipeline exploded, and foreign oilfield workers were being killed and kidnapped on the streets of Lagos. Though the fifth largest exporter of oil to the United States, Nigeria is riddled with political discontent spawned, quite assuredly, by the overwhelming degree of poverty affecting the population.
v Equatorial Guinea
v Gabon
v Sao Tome
v Democratic Republic of the Congo ---After approximately fifty years of civil unrest, the instability does not appear to be subsiding in large parts of the country. The global NFP organization Doctors Without Borders has documented the spread of any number of debilitating illnesses, while also raising considerable attention to the stunning number of rape cases by rebels and military personnel, alike.
v Angola
v Syria
v Yemen
v Saudi Arabia ---Though stable and considerably affluent today, the words of strategist Peter Schwartz do warrant a degree of consideration: In Saudi Arabia, population growth is over 3% a year, and the average family size is nearly seven. In 1974, the population was 7 million, today it's 24 million, and in a decade, it'll be 34 million. Oil revenues haven't risen as quickly: the pie has stayed about the same, but the slices are getting smaller and smaller, and the country's educational system has produced a very large number of unemployed young men-who are listening to radicals. So we're seeing a real opposition movement in Saudi Arabia, and we're trapped...(3)
v Iraq
v United Arab Emirates
v Iran ---Though this prince of Persia does not directly supply any oil to the United States, it does export a considerable amount to China. In exchange for oil, China has paid handsomely by often throwing its weight in Iran's corner against the U.S., and if that was not enough, the Chinese have willfully paid their bill to Iran with guns and other military equipment.
v Quatar
v Kuwait
v India
v Russia ---The rise and accumulation of power under Valdimir Putin has been an issue of quiet alarm on the global stage. Putin's efforts to transform Russia into an energy superpower has not drawn much criticism, but it is important to note that he has demonstrated his willingness to use energy as a weapon, in order to influence governments and markets.
v Thailand
v Malaysia
v Brunei
v China ---Though a net importer, primarily to sustain the constant roar of its manufacturing capacity, China is lifting considerable oil supplies from the earth, close to home, in the Strait of Malacca and near the Spratly Islands of the South China Sea. These production units has been a mild point of contention with some neighboring countries, but as "the great race" heats up, it is certain that China could potentially seek to formally secure its claims in those waters.
---Reports of considerable oil and gas find in Tibet and in places the Xinjiang province could be advantageous for that nation's energy appetite. However, the reports also prompt questions about the prospects of the government's intentions in those areas, particularly when some thought is given to its poor human rights record.
v Azerbaijan
v Uzbekistan
v Kazahstan
v Turkmenistan

When surveying the macroeconomics of this issue, it is often easy to ignore the fact that the real story about rising energy costs is largely personal and bifurcated. There are a few very real beneficiaries, just as there are those who are woefully impacted, though admittedly, the latter group might be a bit larger in size.

Bob and Jayme Ruszkowski are among the latter group that is feeling the pain of these rising costs. Roughly five days of every week, the couple makes a forty minute trek from Slidell, Louisiana, to their sales jobs in Metairie, Louisiana. Understandably, the pain at the pump has been very real to them. "We don't expect it to get any better in the near future," explained Mr. Ruszkowski in a written interview. "We only take necessary trips in the car--no more driving around just to get out of the house for a ride along the Gulf Coast." Mr. Ruszkowski even went further to explain that he and his wife have decided to redeem credit card bonus points for gasoline gift cards, rather than convert them into frequent flyer miles. The strategy is intended to help offset the rising energy costs.

For some, though, those same rising energy costs have meant greater personal prosperity. For no group is that more true than for the oilmen in the Houston-New Orleans mega-region, where a countercycial economy has taken shape, courtesy of their efforts to supply just over a quarter of the nation's oil and gas needs. Standing among that lot is J.L. Harrell, a widely-regarded exploration and production consultant of over thirty years, and owner of J-Bird Consulting, LLC.* When asked to comment about his own feelings on the unprecedented energy costs, Mr. Harrell uttered one word: "Good!" He was en route to production operations in remote Belle River, Louisiana, when he went further to explained that these heady prices were good for oilfield workers, owners, contractors, and shareholders, because the amount of work was likely not coming to an end soon. Of course, such zeal might seem to echo the same sentiment of an earlier era that rendered many oilmen bankrupt when oil prices went into a freefall, but Mr. Harrell brushed away that thought, quickly contending that this time was different for two reasons. First, "[w]e learned a lesson then, and it's not the same generation of oil companies and decision-makers," he said, going further to add that this generation is smarter and more cautious than those who came before them. Secondly, he pointed to the fundamentals, and spoke ominously, "The places where we thought we wouldn't run out of oil--well, they're running out. That's a fact."

For his part, Mr. Harrell seemed quite confident that the current upswing in the prices of hydrocarbons was here to stay. He reiterated his point that supplies were peaking, and as a solution, for a time, he said, "We have to work hand-in-hand with the green [interests]", because, in order to sustain, the nation is going to need to drill in places long deemed to environmentally sensitive. When asked if alternatives could make a difference, Mr. Harrell scoffed. "That's the biggest joke out there," he said, because, without real government leadership and incentives, in his view, alternative energy development and deployment will never be taken seriously enough to attract investment.

That said, perhaps it is only poignant to note that, at the conclusion of the telephone interview, Mr. Harrell went on to say that asking oil companies to be the biggest investors in alternative energy did not make much sense to him. After all, like him, oilmen had absolutely little incentive to see these heady prices go away. Rather, he suggested, the investments needed to come from a different funding arena, one that would work independently of today's energy companies. And so, when asked who should comprise that arena, or what should they invest in, Mr. Harrell answered, bluntly, "I don't know the answer to that question." And he did not say another word, leaving every indication that, until someone did have an answer, the high energy prices are simply here to stay.

Gary C. Harrell is the principal and managing director of Axiom Strategy Advisors, LLC. For additional information, please write

# # # # #

1. The End of Oil: On the Edge of a Perilous World. Paul Roberts. 2005.

2. "The Rise of the Rest", Newsweek. Fareed Zakaria. May 12 2008.

3. "Big Thinking", Across the Board. A.J. Vogl. January/February 2005.

*J.L. Harrell is the father of Gary C. Harrell, the founder and managing director of this consultancy. The objective participation in this quarterly by the elder Harrell has been greatly appreciated.

Copyright 2008 All rights reserved; Axiom Strategy Advisors, LLC


mike carson said...

Always informative. I did not know that about the Saudis. If the poor got angry and a civil war broke out there, then we are all in trouble. Thanks for these perspectives, Gary.

nick bailey said...

Question: how long does it really take for an increase in the market price of gas to get over to the retail price? Is it really as quick as a day or so??

Digger in LV said...

Okay if the whole world wants 87 million barrels and there are only 85 millon, then there is a problem, correct? And this is a daily problem, correct? Is there something we can do to fix this? Do we need to drill for more oil? I am starting to think so.

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