Chris Nelder - Angel Publishing

The Oil Export Crisis Has Arrived

Last March, my study of the effect of peak oil on U.S. imports had brought Mexico to the forefront. As our #3 source of imports, the crashing of its supergiant Cantarell field had put the future of our oil supply in serious jeopardy.

The possibility that Mexico's oil and gas exports to the U.S. could go to zero within seven years looked very real.

As I explained in that piece, rising domestic consumption coupled with declining supply puts an ever-tightening squeeze on imports. I have found no evidence that policymakers are paying any attention to this critically important dynamic, but it is the very point of the peak oil spear.

Were it not for the market meltdown and recession, it would have pierced our vital organs. Instead we felt a pinprick. Hardly anybody realized what it really was, and most ran off on a wild goose chase for evil oil speculators.

Now Venezuela has appeared on my radar for similar reasons... only this time, we're really going to feel it.

Let's begin with a review of Mexico's exports.

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Mexico

Shortly after publishing that article, I casually remarked to my friend and fellow energy analyst Gregor Macdonald that Cantarell's production could fall to under 0.5 million barrels per day (mbpd) by the end of the year.

I arrived at this somewhat startling conclusion by calculating the effect of its decline rate — 38% at the time and accelerating — on production of 0.77 mbpd in January, down precipitously from its 2.1 mbpd peak in 2003.

Gregor's recent data sleuthing on Cantarell found its production in December 2009 was 0.527688 mbpd, just a hair above my estimate.

To update the data on Mexico, it's now our #2 source of imported petroleum because Saudi Arabia has fallen from #2 to #4.

As of November 2009 (the latest data available) the U.S. imported 1.08 mbpd of crude and finished petroleum products from Mexico. Its exports to the U.S. peaked at 1.46 mbpd in 2004, the same year as its production peaked. Net exports (production minus consumption) fell to 1.06 mbpd in 2008.

Mexico Petroleum Supply, Exports to U.S. and Net Exports. Source: EIA. Chart by Chris Nelder.

For the years 2005-2008, Mexico's exports to the U.S. declined by 0.51 barrels per day. In 2010, supply is expected to fall to 2.5 mbpd — nearly half a million barrels per day less than 2009.

Mexico nationalized its petroleum operations in 1938 in a constitutional amendment and handed over total control to the state oil company Petróleos Mexicanos (PEMEX), with predictable results.

Oil now provides more than 40% of the country's revenues, which have been used to pay for a vast array of public services and line the pockets of the oligarchy while starving investment in both upstream activities (new oil supply) and downstream (finished products).

Consequently, Mexico's oil reserves have decreased by more than 75% in two decades (owing partly to the correction of a previous, ridiculously inflated figure), production has begun to decline and exports are falling fast.

It now imports $4.5 billion a year worth of gasoline, $10 billion a year in petrochemicals, and 25% of its natural gas, mostly from the U.S. This despite having nearly 13 billion barrels of proven oil reserves and more than 50 billion barrels of (unproven) reserve potential.

Mexico would be in a far better position, were it not for its hostile stance on foreign participation. PEMEX simply lacks the technical ability to develop its more difficult, remaining resources — particularly deep water.

Venezuela

As of November, the U.S. was importing 0.9 mbpd from Venezuela, making it our #3 source. Its exports to the U.S. peaked at 1.8 mbpd in 1997, the same year as its production peaked. Net exports (production minus consumption) have fallen 38% from the 1997 peak of 3.1 mbpd to 1.9 mbpd in 2008.

Venezuela's oil exports to the U.S. have been declining markedly since 2004, after a long period of relative stability. From 2004 through 2009, Venezuelan petroleum exports fell 0.7 mbpd.

Venezuela Petroleum Supply, Exports to U.S. and Net Exports. Source: EIA. Chart by Chris Nelder.

Like Mexico, Venezuela is endowed with enormous energy resources and could be producing at a far higher level. Estimates of its oil reserves range from 153 billion barrels of certified proven; to 513 billion barrels technically recoverable in the USGS' January estimate; to 1.5 trillion barrels in offshore potential, if you believe the effervescent Dr. Marcio Mello of Brazil.

Most of it is heavy oil, a low-grade which must be upgraded to synthetic crude.

And like Mexico, President Hugo Chavez has exiled the Western oil companies who might have made the investment to bring those resources to market.

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A Nation in Free Fall

The good times rolled for Chavez in the first years after his election in 1998. His socialist programs to rebuild the country and raise its standard of living were popular but expensive, and soon began to fail under the crush of declining energy supply.

Oil revenues make up 90% of Venezuela's foreign earnings, so its dependence on oil exports is extreme.

Billions of dollars in profits from the national oil company, Petroleos de Venezuela SA (PDVSA) were diverted to welfare programs and into the pockets of oligarchs, while investment in future petroleum and power supply languished.

The precipitous drop in oil prices since mid-2008 only compounded the revenue shortfall.

Oil production has fallen 25% since Chavez was elected, and a long, devastating drought has cut into its hydropower supply, of which 73% comes from the massive Guri Dam.

Chavez responded by nationalizing most of its petroleum operations and its grid in 2007.

In 2009, another 76 oil services companies on the Maracaibo Lake were taken over. The projects now sit abandoned, waiting for PDVSA to compensate the displaced operators and put them back into operation.

Almost half a million hectares of land were seized in 2009 with the rationalization that it was underused.

Measures to counter the declining hydro supply have been implemented in a haphazard fashion, resulting in frequent, unscheduled blackouts, including seven national blackouts since 2007. Malls and government offices have had their hours of operation cut and water rationing has been imposed.

"Some people sing in the bath for half an hour,'' Chávez cried at a cabinet session in October. "What kind of communism is that? Three minutes is more than enough!''

In January, a wave of public protest erupted, prompting Chavez to implement a rapid series of desperate measures.

Rolling blackouts were imposed in the capital city of Caracas. After a few days of protests, Chavez lifted the blackouts and fired the electricity minister. Blackouts are expected to be reinstated in an effort to keep hydro reservoir levels from falling to the point of collapse.
A recent report gave the power shortage a paradoxical twist, indicating that power from one of the state refineries may have to be diverted to the grid, cutting distillate output by 200,000 barrels per day — or more. This will result in less heating oil for China, who will make up the loss by burning more coal.
Chavez devalued Venezuela's bolivar currency by half; the president went on to nationalize a chain of French-owned supermarkets over alleged price gouging.
He ordered cutbacks in the operation of state-run steel and aluminum manufacturing operations, which account for up to 20% of the country's power demand.
This week he turned to Cuba for help on how to cope with the power shortage, since Cuba has been through similar problems. The island nation is providing tens of thousands of energy-efficient lightbulbs and cloud-seeding technology to Venezuela.
Last weekend, he forced six television channels off the air for failing to broadcast one of his speeches — up to six hours in length — in a continuation of his campaign for "communicational hegemony." Since December, all radio and television networks are required by law to broadcast his speeches live, whenever he chooses to make one.
Nationwide student marches have been met by troops armed with rubber bullets, and at least two deaths have been recorded.

Chavez has said he's prepared to take "radical measures" should the situation worsen, begging the unsettling question of what could be more radical than what he has already done.

Looking East, Not North

Now Chavez is turning east for help in developing his nation's oil and gas resources. Recent agreements include a $20 billion joint venture with Russia to develop the Junin 6 field in the Orinoco oil belt, with a potential top production rate of 450,000 barrels per day.

China has agreed to build a refinery and develop the Orinoco heavy oil fields, and Venezuela has guaranteed 560,000 barrels per day to China this year.

Venezuela has launched its first major auction for drilling rights in more than a decade, for access to areas east of the existing operations in the Orinoco. Developing the leases will be expensive because of their distance from the existing infrastructure, and winning bidders are expected to make offers in the $10 billion-plus range including early payments of at least $1 billion, financing plans, and commitments to build the necessary roads, pipelines, ports, and upgraders. Potential bidders include Spain's Repsol, Japan's Mitsubishi, the UK's BP, and Chevron.

Given the sheer size of its resources, it's too soon to declare the end of Venezuela's glory days in the oil patch. However, it does seem likely that the new barrels it brings to market will be headed east — not north — and Western producers will have very little stake in the projects.

Chavez will put exports to the U.S. on a short path to zero the first chance he gets.

Oh Imports, Where Art Thou?

The combined decline in imports from Mexico and Venezuela for 2005 through 2008 is 0.89 mbpd. If the trend continues in 2009, then over 1 mbpd will have disappeared from the U.S. import stream in the last five years — a decline of 8% from 2004 levels.

Since 2007, the loss of production from Cantarell alone was 0.7 mbpd, but the recession cut U.S. demand by 2 mbpd, effectively masking the decline. This raises the question: If U.S. demand rises from here, where will those barrels come from... and how much will they cost?

The U.S. is not only in first place worldwide in its demand for oil, but in paying the market rate for it. Nobody else buys 8.5 mbpd of crude at retail.

Drivers in Venezuela are still filling up for 25 cents a gallon, even as their exports decline.

Mexico's gasoline prices are more on par with the U.S., but its consumption has been rising steadily since 1997 and continues to cut into exports.

Saudi Arabia's domestic consumption is currently growing at the rate of 7% per year, following a trend of more than three decades. It uses a whopping 1.5 mbpd — 1.8% of total world oil supply! — to desalinate water, at the equivalent of 7 cents a gallon.

Before the OPEC cuts of 2009, its exports to the U.S. had essentially flatlined at 1.5 mbpd since 2004.

Exports from our #5 source, Nigeria, have also declined — from 1.17 mbpd in 2005 to 0.98 mbpd in 2008.

In fact, of the top five oil exporting countries to the U.S., representing 63% of our crude imports, only Canada posted an increase (of 0.2 mbpd).

The combined annual net oil exports from our top three exporting countries — Canada, Mexico and Venezuela — illustrate our situation:

Combined Annual Net Oil Exports From Canada, Mexico and Venezuela. Source: Jeffrey J. Brown, Samuel Foucher, PhD, Jorge Silveus.

Given the very modest increases from unconventional domestic production and Canada, the decline of imports from Mexico and Venezuela means the U.S. will be increasingly forced to depend on suppliers farther afield — the very same suppliers that China has been buying into in size. The "collision course with China" that I wrote about in July 2005 has nearly reached the point of impact.

It also means that when oil prices rise again, the pain will be far greater for the U.S. than it is for our top suppliers. Next time, the spear of declining oil exports will puncture a lung.

The oil export crisis has arrived... We just haven't felt it yet.

Production, consumption, and export data herein is the latest available from the EIA.

Until next time,

Chris

Thanks to the following individuals for their contributions to this article: Venezuelan oil expert Carlos Rossi for sharing excerpts from his forthcoming book, The Completion of the Oil Era: The Economic Impact; Gregor Macdonald for sharing his data on Cantarell; and Jeffrey Brown and Samuel Foucher, for their work on net exports data and the Export Land Model.

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Green Energy: The Belle of the Ball in 2010

Every once in a while, the tone of the energy market shifts in a way that seems subtle at the time, but is a major turning point in hindsight. I believe one is happening now.

January 2007 was such a moment, a time of palpable excitement around renewable energy. Solar, wind, and other renewable plays exploded that year, and First Solar (NASDAQ: FSLR) gained 866%.

July 2007 offered another, when the IEA had its "come-to-Jesus moment." The depletion of mature oil fields was finally out of the bag and in plain view, and it worked a sea-change on the debate about the future of oil. Fairy tales of endless growth gave way to a more earnest discussion about whether unconventional oil could replace conventional oil, which had flatlined since the end of 2004.

I marked Memorial Day 2008 as the moment when peak oil emerged from obscurity in the media, and the debate shifted from denial to serious inquiry. My intensive study of the subject, Profit from the Peak, had just been published and numerous media appearances followed where I explained what peak oil was about.

Now, anyone who is paying attention knows what it means (or at least think they know what it means), and the topic is casually included in financial and news discussions.

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But those were mere eddies compared to the wave I can feel building now. It's as if all the political momentum — indeed the entire public dialogue about energy — has suddenly changed from Brown to Green.

In the wake of the failed Copenhagen talks, and with the potentially imminent death of cap-and-trade legislation, the world seems to have realized what I've been saying all along: It's better to incentivize than penalize. Focus on generating renewable energy first, and then worry about the emissions that remain.

Automobiles

Peak oil awareness has clearly motivated the auto industry to shift aggressively into electric propulsion. Toyota U.S.A. President and COO Jim Lentz said in November, "Our model on future energy is that we will probably see peak oil some time around the end of the next decade, so whether it's 2017 or 2020, it's gonna be some time in that neighborhood."

GM Vice Chairman Bob Lutz was even blunter in his keynote at the LA Auto Show in December: "Going forward, the automobile industry simply can no longer rely on oil to supply 98 percent of the world's automotive energy requirements."

Their response has been dramatic. Toyota's Prius and GM's Volt are their new flagship products. BMW, to my great relief, has abandoned its hydrogen car program and is going full-throttle into electric cars. Nissan and Mitsubishi are tooled for mass production of their electrics. Better Place, the recharging infrastructure and battery swapping play, has raised $700 million and it's not even in operation yet.

Rail

Rail is moving back onto the U.S. national agenda, with $8 billion in new grants for high speed rail announced this week as part of its $13 billion share of the federal stimulus package. Florida is expected to capture $2.5 billion of that for a high speed link from Orlando to Tampa. A $171 million Department of Transportation loan announced this week will green-light the rebuilding of San Francisco's Transbay Terminal as a high-speed rail depot while the project's $400 million federal stimulus application is reviewed.

To be sure, $8 billion is a paltry beginning-perhaps 2% of the federal commitment that will be needed to really rail-ify America. The San Francisco-Los Angeles high speed line alone will cost on the order of $40 billion. The full cost of installing high speed rail and intra-city light rail across America will be somewhere in the low trillions, it will probably take us decades, and most of the interstate links will have to be federally funded.

The stimulus money for high speed rail isn't part of some comprehensive national transportation strategy to counter the peak oil threat, because no such strategy exists. But it could be the best investment in the hastily conceived, shovel-ready jobs stimulus package, because it will give us in a critically important long-term asset.

For perspective on that $13 billion, consider that Beijing is already executing its plan to build a $556 billion high speed rail system linking nearly all its provincial cities in the next five years. The Shanghai-Beijing link alone is expected to create half a million jobs. And unlike the $779 billion in the U.S. stimulus package that will not go to rail projects, Beijing's investment will result in a permanent and absolutely vital asset.

Were the U.S. doing anything of the kind, I might never worry my weary head again about peak oil.

Wind and Grid

A study released this week by the U.S. Department of Energy's National Renewable Energy Laboratory (NREL) showed that as much as 30% of the eastern seaboard and the Midwest could be powered by wind, and 20% could be done by 2024 — if the transmission lines existed.

NREL estimates the grid will need 20,000 new miles of backbone at a cost of around $90 billion. Building it would create around 280,000 new jobs and give us a critical long-term asset. It's a perfect example of appropriate federal investment in national infrastructure, yet it faces NIMBY opposition everywhere. A heavier hand may be required to push it through. It's good to see transmission reform legislation making its way through Congress now, but I pray it doesn't blow up into a states' rights hubbub.

Compare that to the $42 billion HVDC "super grid" that nine European countries plan to build around the North Sea that will enable all of them to use renewable power, whether it's being generated by offshore wind in Denmark, wave power in Scotland, solar power in North Africa, or hydropower in Norway. It will form the heart of a much larger, $400 billion pan-European super grid; a critical link in achieving the EU's 20% by 2020 target.

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Or compare again to China, with its $217 billion investment in electric grid infrastructure from 2006 to 2010 alone.

The good news is that while building the electric infrastructure of the future isn't cheap, it isn't expensive either. The NREL study concluded that the avoided future cost of coal-fired power would more than offset the cost of the new grid infrastructure. We must assume that's before even factoring in any externalized costs, or any peak-oil adjusted estimates of the future costs.

However we'll have to move faster. NREL's 20% scenario is based on 225,000 megawatts (MW) of new wind capacity, or 16,000 MW a year through 2024. The U.S. installed only 10,000 MW of new capacity in 2009 according to the AWEA, so we'd have to post a 60% growth rate from current levels to deploy that much.

Meanwhile, ten times that — more than 100,000 MW of offshore wind capacity alone — is currently under development in Europe.

Solar

Solar power is making progress on several different fronts.

The snowball of Chinese solar manufacturers opening plants in the U.S. rolls on, with the announcement that Suntech (NYSE: STP) is building a new plant in Arizona.

Distributed local generation is making great strides. In California, the Southern California Edison utility has launched a competitive bidding process for 225 MW of rooftop solar capacity, with a project size of 1-2 MW. Another 250 MW will be purchased from independent solar developers. Utility PG&E is expected to launch a similar 500 MW offering soon. Even better, a proposed feed-in tariff for 1 to 10 MW-sized renewable projects is in the works. The progress for bellwether California in distributed generation bodes well for the rest of the country, suggesting that transmission grid support for utility-scale solar may become less of a hurdle for the industry as a whole.

Incentive programs elsewhere in the country continue to enjoy enthusiastic receptions where the price is right. A new $4 million incentive offering for residential and small commercial solar in Massachusetts was fully subscribed in the first four hours this week, reflecting a strong build-up of demand. Generous rooftop solar incentives in states like New Jersey and New York are being exhausted and replenished yearly.

Materials research in photovoltaics (PV) continues to show promise as well, in areas like cell backing materials, adhesion methods, new cell formulations and production methods, and longevity testing and hardening. PV looks well on its way to cutting costs on a Moore's Law curve.

Building efficiency is also enjoying an explosion of subsidies and new plays. Watch this space for developments in that sector.

Brown Going Down

Meanwhile, things aren't going too well for the fossil fuel sector, which is under attack on every side.

Oil remains precariously balanced on the narrow ledge of prices, as does natural gas to a lesser extent. The supply of both remains sufficient to keep the specter of shortage marginal pricing at bay. Inventories are reasonably high, and prices aren't high enough to induce new drilling for high-risk or high-cost prospects. Even so, the worsening outlook for the refining sector continues to support the price of gasoline and other finished products.

Costs remain a bit too high for the comfort of marginal producers, as evidenced by an interview with Royal Dutch Shell CEO Peter Voser in London's Financial Times this week. The company was no longer counting on growth from tar sands production, he said, and its plan to expand operations in Albert by roughly half a million barrels per day remained shelved. Conventional oil and gas drilling is their new strategic direction, simply because the costs are so much lower than for tar sands development. (This, of course, is no surprise.)

The commodities markets in general seem to be showing signs of post-traumatic stress disorder, or at the very least recency bias. The trade is overwrought on fairly inconsequential signals, and there seems to be a roughly equal balance between those expecting higher and lower prices. I'm beginning to suspect that this will be a low signal-to-noise ratio year for the commodity sector, with traders slugging it out in a narrow price range and fewer solid tradeable opportunities than the last several years offered.

Concerns over public water supply contamination from hydraulic fracking shale gas operations aren't going away, and the EPA has set up a consumer complaint hotline. We simply don't have enough information yet to know whether the issue is overblown or a serious enough problem to kill the practice. However, public sentiment isn't likely to yield to science on this issue any time soon and could dampen the enthusiasm for new shale gas development.

The effort to stop mountaintop removal in coal operations isn't going away either, and emissions control is still very much in play at the EPA.

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The news is nearly all bad. The fossil fuel industry wakes up every day to a drumbeat of reports on oil spills, tanker traffic interruptions, environmental lawsuits, and so on, but their main sales pitch to the public is a weak one about jobs. Their message continues to fall hard on the consumer's ear, which is much more attuned now to the questions on long-term supply, security, and sustainability.

The Browns are looking more the lumbering, hidebound beast every day; meanwhile, a thousand alternatives sprout around them. They trumpet their investments in clean energy, but the fact remains that it still represents a small fraction of their investment in new BTUs overall.

I don't know what to call it: the Great Eye, the hive mind, the ideasphere... but it has turned and its attention is fixed on renewables. The Browns will find it hard to get any love this year, but the Greens will be the belle of the ball.

Until next time,

Chris

Note: If you want to see where the Greens gather to do business, you should join my colleagues and Green Chip International editors Sam Hopkins and Nick Hodge at the ReTech 2010 conference in Washington, D.C. taking place February 3-5. You can choose from 6 different informational tracks that will get you up to speed on all the changes taking the U.S. and global economy from Brown to Green. Check the conference website for more information.

Survival Strategies for Systemic Failures

This week I had my first up-close-and-personal experience with sandbags.

The five-storm series lashing the Bay Area this week is expected to dump at least 15 inches of rain on my area, and the second lash was a whopper.

Torrential rains. Biblical rains. Raining lions and wolves. Thunder like the drums of doom. Lightning splitting redwood trees. Pounding hail.

I'll spare you the details, but a ridiculous arrangement of a drainage culvert under the street and another pipe running under my wacky rental house failed. I woke up to a torrent of water sweeping against the house, causing the wall in my office to buckle and water to seep into the carpet.

The landlords were MIA. I had to take action.

Fortunately, my town has its act pretty well together. I quickly located my nearest location to pick up sandbags and the pile of sand, and 13 bags and two trips later I succeeded in diverting the water away from the house. "The Wreck of the Edmund Fitzgerald" droned on in my head as I contemplated the consequences of bad urban planning and the virtues of good emergency planning.

As I write, the fourth storm has arrived, and it's a wet one. I can only hope that my temporary measures hold up. Barometric pressure readings in San Francisco and San Diego broke their record lows this week.

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Now, I don't want to complain. Last January was the third-driest on record with a lousy .58 inches of rain and temps in the 80s. It was gorgeous weather, but unsettling because it felt so very wrong. My plum tree bloomed far too early and the harvest was so weak I didn't even bother breaking out the canning gear last year. Plus, Lord knows we need the water.

But when infrastructure is pushed to extremes, it can fail...and as I saw so clearly this week, there is no stopping a flood.

I took a few lessons from the experience.

Rebellion as a Survival Strategy

As I discussed in last week's article on secession and the green power rebellion, when you have to take the situation into your own hands, you do.

The first thing I did with the sandbags was block the inlet to the culvert, and divert water across the street. I figured the city might be unhappy with me, but I had to crimp the incoming flow and limit the damage somehow. (Don't get excited - I did give the fire department my address, and tell them what I intended to do first. They said to call if I needed help.)

My temporary disabling of a tiny part of the city's infrastructure, because I had to, is a minor case of a larger point. As I wrote last week, the almost-state of Jefferson nearly seceded from California and Oregon, and Marin County is trying to take control of its electrical power procurement, for the same reasons: because they felt they had to.

Two weeks ago, Gov. Schwarzenegger said that California couldn't afford to be a "donor state," getting 78 cents back from the feds for every dollar it sends in, anymore. One tactic suggested by Andrew J. Chang and Justin L. Adams, former economists for various California state governors, in an SF Gate editorial, would keep $5 billion in the state instead of paying it in federal taxes via a change in state tax deduction rules.

If a California tax rebellion is in the cards — again, out of self-preservation — it would disable some the federal financial infrastructure just as surely as my sandbags did that culvert.

Still Doing "A Heckuva Job"

Falling back on your own resources only works, however, when you have them. What can Haiti fall back on now? Very little. Their external dependency has never been so vivid, nor has the lesson on how weak emergency response can be.

More than a week after the earthquake, critical medical supplies like antibiotics still aren't getting to where they're needed. It took days for water and food to get from the Port-au-Prince airport to people less than a mile away.

It would appear that much of our emergency response remains ad-hoc, even after the lessons of Katrina and Rita. Why, after all the disasters we have lived through, are there still no standard operating procedures to mobilize volunteer medical personnel, food and water, cash contributions, earth-moving equipment, and temporary shelters?

Instead we have a reported inventory of several thousand Katrina trailers that were never used. We rely on a Twitter rumor mill to learn how to contribute cash or food, and share tips on how not to fall for scams. We have to bully airlines into waiving baggage fees so volunteer doctors on tiny church budgets can even get to the scene!

The only organized response we seem to have is the military one, which comes with a whole set of its own problems, and is sorely stretched when faced with widespread disaster.

Is this the best we can do, America? Is this what I have to fall back on, if my state's utter dependence on external connections fails?

Earthquake: A Thought Experiment

I wondered: If a major earthquake had hit California instead of Haiti, just before this deluge arrived, where would we be right now? Say, an 8.1 on the San Andreas Fault followed by an 8.0 on the Hayward Fault a few days later, putting the major population centers of Los Angeles and the Bay Area out of commission?

Where we'd be is in a world of hurt. The repercussions would last for decades.

Grocery store shelves could empty in three days or less, and stay empty for a long time. Gasoline supplies would probably be locked down immediately. Flooding and snow like we're having this week could render key arteries impassable at a critical time.

I don't know how long it would take for civil order to break down in, say, LA if the grid was down for a few weeks and emergency services were interrupted, but I do know that it took less than 48 hours after Katrina.

Backup power is virtually nonexistent. Worse, nearly all of the grid-tied solar systems would be down along with the grid, because they don't have backup and the grid lacks micro-islanding capability.

Aid shipments into California could be restricted to the ports in a heartbeat. Earthquakes like that could easily take out the handful of roads, rail lines, and power transmission lines that would add up to critical failure.

It would also be an absolute death blow to the state's balance sheet. The cost of recovery alone would do the job, let alone the lost revenue from oil and gas and food that can't get to market anymore. Would it be bailed out, or somehow absorbed by the federal structure? Could it be? Would the federal government borrow another couple-trillion dollars just to repair California?

Or would California fall back, and reorganize into local regional structures?

Is California so different from Haiti in its self-sufficiency? Could I not become a natural disaster refugee as easily — in a heartbeat?

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To take the idea to a broader level, we know that there is no plan for oil shortages in America, and that our grid security is a joke. After decades of inaction and delay, there is little reason to hope that these issues will be addressed at a national level — even as their urgency grows.

Since we are now staring down the barrel of peak oil, should we not start thinking about smaller municipal fallback strategies and prepare for the day that oil shortages start to bite?

The U.S. has a strategic petroleum reserve, but where is the cash reserve for massive emergencies? Most households have one, but not cities, counties, states, or the federal government. Here in "earthquake country," residents are repeatedly reminded to keep enough food, water, batteries, and so forth stocked up to survive at least three days. Yet at the municipal level, that backup doesn't exist.

Resistance or Resilience?

It doesn't have to be this way.

There's no technical reason why cities or larger regions can't "island" from the main grid and fall back on their own power supply. Texas is currently the only state that can. There is no technical reason why every building and every city can't have its own backup power supply. Many towns have enough rooftop solar potential to refrigerate food, keep communications and furnace fans working, and supply a minimal amount of lighting. The enabling grid enhancements and demand management technology are available off the shelf, and the investment would be modest.

Every town, county, and state could have a mobilization plan for its local medical, food, and water resources. With the array of communication technologies available, there's no reason why local talent can't be organized at a moment's notice. If Wal-Mart can run a just-in-time global supply chain, surely we can get a few doctors to the scene of a disaster in 24 hours.

Entech Solar (OTC: ENSL), a tiny company that used to be known as WorldWater & Solar Technologies (former ticker: WWAT), had a beautiful little system called Mobile MaxPure, which could be driven to a site on a trailer and within 30 minutes, provide enough solar power to run water pumping and purification systems, command center equipment, and satellite phones.

After being on the market for several years, it was discontinued last year, presumably due to a lack of demand. If we were serious about emergency response, there would be thousands of them in storage, ready to be driven or delivered by helicopter on a moment's notice.

Every house with a lawn and every city with a park could be growing local food supply instead. If the 3,000-mile-long food distribution chain breaks down, there should be a subsistence-level supply of 20-mile radius food to fall back upon at the very least.

Nor is there any reason why towns and counties must rely on the banks for financing the build-out of local solar capacity. The banks have demonstrated for over a decade that they just don't get it. It's time we stopped looking to them. Local capital alone could finance enough local solar and backup supply to meet critical loads — if it were organized.

Options even exist for transportation backup. In places like Portland, OR, or Boulder, CO, a small army of bicycles with cargo trailers could be mobilized at any time to deliver food and critical supplies over the most broken of roads, if they had those strategies to accompany their bicycle-friendly urban planning.

We have the technology and the capital to do all these things. The only reason we don't is because we value the present more than the future. We resist saving for a rainy day. We choose short-term gains over long-term security every time.

Awareness of these issues does seem to be growing, however, particularly at the township level. And I think it's one of the hottest off-the-radar investing sectors.

As the complex of challenges around peak energy and climate change unfolds, I fully expect that awareness to evolve into action. Hundreds of companies will stand to benefit, in areas like water purification, power backup, smart grid technology, rooftop solar, and emergency response.

Unlike national strategies, making a household or a small town minimally self-sufficient in energy and food seems to be a small enough chunk to bite off. In our meeting last week, the mayor was actually quite interested in my vision of energy self-sufficiency for my little town.

Thousands of towns like mine could implement their own solutions before the debate on national strategies even begins.

At this late hour, I'm betting they will.

Until next time,

Chris

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The Renewable Power Rebellion

I speculated in my article last week on how Southern California and Arizona might fare in a relocalized future where small regions are forced to become self-sufficient.

This week, we'll draw some insights from communities that have gone local.

Jefferson, the Almost-49th State

Following two previous unsuccessful rebellions in 1852 and 1854, residents of the area from roughly Mt. Shasta in Northern California to just above Coos Bay in Oregon made a serious attempt to secede from the states in 1935, out of frustration over the lack of state support for their critical transportation infrastructure needs.

A Time magazine article from 1938 lauded the area's "rich deposits of chrome, copper, gold, iron, coal, limestone, and platinum beneath an evergreen blanket of several billion feet of virgin timber," which remained largely inaccessible for a lack of good roads and rail.

It described how a local self-made resource magnate named Gilbert Gable had tried to get approval from the Interstate Commerce Commission to build a rail link from Port Orford over the mountains to the Southern Pacific rail line 50 miles inland, in order to bring the region access to eastern markets. A rival group made its own bid for a rail connection from the SP line to Crescent City, on the California-Oregon border.

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Both applications were denied by the ICC. The examiner commented, "Recent army reports show that the prospect of future growing importance of the ports of Port Orford and Crescent City definitely may be discarded as a factor of consequence in this proceeding."

Frustration grew until November 27, 1941, when the residents created a provisional government and elected a governor, declaring themselves the State of Jefferson, the 49th State of the Union. A Proclamation of Independence was published and pamphlets were distributed. Armed citizens put up road blocks on the main north-south artery of U.S. Highway 99 where they collected tolls for crossing their new state line.

The Proclamation's intent was clear: "Until California and Oregon build a road into the copper country, Jefferson, as a defense-minded State, will be forced to rebel each Thursday and act as a separate State."

One week later, amid much fanfare, the state's new governor was inaugurated in Yreka. Signs had been posted around town saying: "Our roads are not passable, hardly jackassable; if our roads you would travel, bring your own gravel." Hollywood showed up and shot some newsreels.

But three days after the inauguration, the whole thing was over with the bombing of Pearl Harbor. The nation united behind the war effort and built good new roads into Jefferson to access its much-needed copper and timber.

Some useful observations can be drawn from the Jefferson experiment.

First, it highlights the importance of getting resources to market. In an age when declining fossil fuels increasingly jeopardize truck transport, alternatives will be needed.

Locals may have to find ways to finance the rail and ship transport infrastructure for their goods — even if they have to do it on their own. Government officials are typically shortsighted about securing critically important infrastructure.

Second, it demonstrates that even in the not-too-distant past of the U.S., regions can (and will) secede if the support of larger entities fails. The notion that our union could fall apart under the pressures of the coming decades is hardly outlandish.

Indeed, I didn't have to wait long for the fulfillment of my prophecy last week that California should expect another debt downgrade. This week, S&P cut its rating on California's $63.9 billion general obligation debt from A to A-. More severe budget cuts are sure to follow, starting with health and human services. As the budget squeeze rolls downhill, it's forcing counties and cities to follow suit.

Issuing IOUs to state residents instead of tax refund checks is one thing; but when schools, law enforcement, food assistance, and basic transport begin to fail, it's another thing entirely. The impact of such cuts always hits the welfare and working classes first... people who would rally for secession if their state and nation failed them.

I have personally heard locals near the southern Mendocino County border joke about blowing up the Highway 101 Bridge in Hopland, if the worst should happen and hungry hordes from Southern California begin to migrate north. I've also heard residents of the redwoods have no great love for those of the plastic lands.

Some thought experiments may be useful here.

If our critical infrastructure were to become unreliable as state and federal unions fail, which communities would fare best? Those utterly dependent on freeway transport, like Dallas; or those with ample rail, seaborne, and pipeline capacity, like Houston? Those who can disconnect from the grid, like Texas; or all the other states, which cannot?

As Scott Pugh of the Department of Homeland Security said at the ASPO conference last year, "Texas can secede from the union any time they think they should."

And where would the boundaries of the new regions be drawn? Would I, as a resident of the Bay Area in California, prefer to end up in Mexicali, with its massively overbuilt and overpopulated deserts... or in Jefferson, with its low population, timber and minerals, farmland, ample rainfall, and a working rail and port infrastructure?

Where would offer the better opportunity to secure a food supply within a 100-mile radius: Las Vegas, or a town in rural Iowa?

Which has the most old-school, low-energy shipping infrastructure to fall back on: Baltimore or Chicago?

The Marin County Secession

Another type of secession is playing out right now, right here, which could become a model for the rest of the country.

In 2002, California passed a state law (AB 117) allowing communities to form their own entities to buy electrical power as so-called Community Choice Aggregations (CCAs). The notion is that CCAs could choose to buy more renewable energy than the existing investor owned utility (IOU) monopolies provide, while those utilities continue to own and maintain the distribution network and billing.

State revenues normally distributed to utility energy efficiency programs, plus the usual charges per kilowatt-hour, would be redirected to the CCAs, enabling them to buy green energy and alleviate the need for building new peak-capacity plants (typically powered by natural gas). Customers are automatically enrolled in the CCAs unless they opt out.

According to the New York Times, the nation's first test of the concept in Ohio has been an unmitigated success with 126 municipalities participating in 67 CCAs, providing power to about 800,000 customers with only a 5% opt-out rate. The latest supply contract signed by one of the CCAs, the Northeast Ohio Public Energy Council (NOPEC) offers rates 6% lower than the local utility. Thank you, Ohio.

In California, however, it's been a long road for those who have taken it. None have succeeded yet.

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San Francisco is very close, with several bids for potential suppliers in hand. It intends to obtain 51% of its electric supply from renewables by 2017 — more than double what the ineffectual state renewable portfolio standard (RPS) mandates.

The Kings River Conservation District in the San Joaquin Valley, the farming area that forms the southern part of California's Central Valley, tried to form a CCA since the law was passed but has essentially given up. It was simply going to cost them too much to fight the opposition of PG&E, the state's largest utility.

With 15 million customers, PG&E has the budget and the lawyers to easily win a pitched battle with a struggling farming community. Instead, Kings River has opted to issue bonds and build its own power plants running on local solar, micro-hydro, and biomass resources.

In Marin County, where I live, the effort to create the Marin Energy Authority (MEA) CCA has been under way for six years. The county and all but three cities within it have so far chosen to join the MEA, which is scheduled to sign a power supply contract with Shell Energy North America on February 4. At that point, the majority of the county's customers would be enrolled in the program — unless they opt out.

The MEA aims to source 25% of its supply from renewables initially, growing to over 60% by 2015, and eventually to 100%.

PG&E has launched a multi-pronged assault on the MEA, feeding sour analysis and misinformation to a grand jury investigating the proposal; creating negative press; sending out a direct mail assault full of distortions under the auspices of a "Common Sense Coalition," which I stapled to my wall, and sending consultants to represent its views at local government meetings.

With the contract deadline at hand, the battle has intensified as city councils and the county board of supervisors decided whether to remain with the program.

I have followed the MEA since its creation, including brief correspondence with Paul Fenn, who authored the CCA laws, and conversations with local elected officials who support the MEA. Over the last two weeks, I showed up at my city council and county meetings to share my view on why it's imperative for municipalities to take control of their own renewable energy procurement. And I have a meeting scheduled this week with the mayor to explain my reasons in more detail. I consider it my civic duty and a fulfillment of my resolution to work harder on local solutions.

CCAs are a different sort of secession than the State of Jefferson, but the aims are really the same: to let local communities take advantage of their resources when their faith in the state has failed.

Smart grid technologies and rooftop solar need not wait for sweeping support from the federal and state levels. Indeed, given the extraordinary fiduciary stress that federal and state governments are under, I don't believe local communities can afford to wait for it. Local supply is now the name of the game. God bless the child that's got his own.

Add in "micro-islanding" capabilities, so small services areas can disconnect from the larger grid and get by on their own distributed generation capacity, and you have the seeds of a full-blown renewable power rebellion. I have no doubt that if we pulled out all the stops on local generation capacity, and pumped water up the mountain as storage capacity, that we could get by on our own just fine.

After years of watching my state government fail to meet its renewable energy targets... of watching my utility monopoly stymie the rapid deployment of renewables... of watching the public utilities commission install a torturous obstacle course of red tape in the path of rooftop solar... I'm willing to carry that rebel flag.

It might be the only way forward.

Until next time,

Chris

The Future of the Southwest: Localization and Carrying Capacity

For the holidays this year, I stuck with my vow to never fly again at Christmas and opted to drive the roughly 1,600 mile round trip instead.

It's only a couple of hours longer than flying, each way, a bit cheaper, and a whole lot more enjoyable. (And as for the carbon footprint, it's hard to say but probably smaller.)

On the way, I had ample time to muse about the future and take in the on-the-ground reality of the Southwest. Foremost in my mind was the question: How will these communities fare in the transition to a localized, renewably-powered future?

As I explained in my final columns of last year, I am pretty much done with talking about the problems of peak oil (really, "peak everything") and climate change. That message is tired, and the tipping points have arrived. The time for ringing the alarm bell and counting on federal or state solutions has passed. From now on, we all need to be eyes-front, focused on what we can do locally.

So I'd like to begin this year by sharing a few observations I made on my trip...

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A View from the Road

California's Central Valley — the source of 8% of the nation's food supply — was my first long stretch southward through endless fields producing garlic, lettuce, fruits and nuts, grapes and raisins, and other produce. Staggering under the combined pressures of rising agricultural input costs, a falling water table, reduced water flows from the Sacramento Delta, and immigrant labor issues, it offered a clear window into the economic malaise of California's farming communities.

Just four days before Christmas, shopping mall parking lots looked only one-quarter full and the roads were mostly empty. Seemingly every industrial building along the highway through Modesto had a "For Lease" sign on it. The first hopping-busy shopping scene I saw was a flea market in the little farming town of Kingsburg. Highway marquees offered hotel rooms for $35 to $40 a night in Fresno. And in Bakersfield, the majority of billboards offered legal help to fight speeding tickets.

From there I headed west into one of the few places on earth that you're likely to see an oil pumpjack in a vineyard: the Kern County oil fields, where "horse head" pumps still wheeze away, squeezing the last drops from giant fields that have been in production since the late 1800s.

A few miles farther down the road I climbed into the Tehachapi Pass, the site of one of the nation's oldest (and one of the world's largest) wind farms, producing over 1.4 billion kWh per year of electricity. Originally built in the early 1980s and updated over the years, it offers a unique look at evolution of wind technology, with over 5,000 turbines running the gamut from small, old, broken ones to modern 1.5 MW monsters operating at over 40% capacity factors. The area is slated for additional development this year, including a new 30 MW project by Western Wind Energy (CVE: WND).

(Sorry for the less-than-professional quality cell phone pics from the road. I could have found better ones online, but I liked the foto vérité of these.)

Continuing on through several hours of open desert strewn with plastic bags (if you still need a reason to carry your own reusable shopping bag, consider that one), I made my way into Mohave County, Arizona, along much of old Route 66. I soaked in the nostalgia of remnant, weathered hotels and restaurants from its glory days. A few isolated watering holes now sport their own wind turbines and solar PV arrays, but from what I overheard and saw on the local Craigslist, a job — any kind of job — was hard to find in these parts. Things have been tough ever since the real estate bubble popped.

This is mostly mining territory: a blue-collar, staunchly conservative county. Yet fully a quarter of a local rag I picked up — the Economic Development Journal of Mohave County out of Bullhead City, Arizona — featured stories on energy. There was fuss over the water requirements and transmission line siting for a proposed $2 billion, 340 MW parabolic trough concentrating solar thermal power (CSP) plant. New state rules requiring utilities to develop demand-side energy management and efficiency programs were discussed in detail, as was the award of Energy Star status to eight county buildings. There was even an account of a recent presentation by a university professor on peak oil.

I continued on to my family's cabin under the shadow of the Mogollon Rim, a roughly 200-mile-long escarpment at the edge of the Colorado Plateau that spans much of Arizona. It's an area well loved by the great Western novelist Zane Grey, who had a cabin near ours. We cozied up there for a week in wood-fired comfort in freezing temperatures, including a day spent fighting with old manually-oiled chain saws and laying up more wood, during which I momentarily wondered if it wasn't actually easier when I was a kid and we did it using a two-man cross-cut saw. He who cuts his own wood heats himself twice, as they say.

On the return trip, I detoured up to the Grand Canyon because I hadn't been there in many years. Unfortunately, it wasn't the best day to visit. A snowstorm had blown in to the Kaibab Plateau just as I arrived, making for very poor visibility (and some sketchy driving, even in 4WD).

The Kaibab, of course, is the site of one of the sharpest lessons in carrying capacity in American history. Beginning in 1906 at the order of President Teddy Roosevelt, hunting was banned and livestock grazing was curtailed in order to encourage the population of some 4,000 deer who made their home there. The following year, the Forest Service embarked on a program to kill the natural predators of deer, including mountain lions, wolves, coyotes, and bobcats. The deer population exploded and reached around 100,000 before overbrowsing of the sparse habitat caused them to starve to death. From 1925-1926, an estimated 60,000 deer died of starvation and the rangelands were permanently damaged, leaving it with a far lower carrying capacity. American wildlands management practices were forever changed, as we learned the importance of keeping animal populations within the ability of natural environments to sustain them.

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Mad Max Wasteland or Desert Oases?

The same lesson remains to be learned, however, with respect to human population. The problem of making our world sustainable is infinitely more complex.

What is the true carrying capacity of America, if the San Joaquin Valley's water problems persist? About one-fifth of California's total electrical power demand is used to pump water; about four-fifths of the water pumped in California is used to irrigate agriculture.

The ability of the state to build sustainable power supply — like those turbines in Tehachapi — has direct implications on the nation's food supply. Likewise, much of the population of Los Angeles could not exist without the massive pipeline system that brings the city water from the Colorado River.

How will the little mining towns of northwestern Arizona fare as fossil fuels decline? They'll still be able to ship their minerals by rail along the freight tracks I paralleled on Route 66, but they'll need to have alternate sources of revenue if peak oil quenches economic growth.

Supporting those proposed solar arrays and grid connections could mean the difference between thriving and shrinking, which explains why in a parched, windswept, and sun-baked land like Mohave County, the need for local water and energy supply is urgent enough to override the usual political bent and make strange bedfellows of Republicans and renewable energy advocates. Such alliances will become more common in a century of decline. Necessity wins over ideology every time.

In the Bay Area where I live, the last few years has seen an increasing incidence of water main breaks and exploding transformers, sewage spills, bridges becoming unsafe, and roads becoming more patch and pothole than pavement, as its aging infrastructure crumbles and fails. Governor Schwarzenegger went begging the federal government this week for financial aid, and proposed privatizing prisons in an effort to close a budget gap that now runs into the hundreds of billions. A downgrade of the state's debt rating seems inevitable for a state that is too big to not fail. Where will the revenue come from to fix all this, and keep the water flowing to the San Joaquin Valley, plus build out a new renewable energy and rail infrastructure?

Arizona's in only slightly better shape. A week before Christmas, Arizona Governor Jan Brewer told her cabinet to slash spending sharply and push criminal alien prisoners back onto the Feds as quickly as possible, as she faces the prospect of borrowing $700 million a month to stay operational, and a looming 2011 fiscal year deficit of $3.4 billion. Solar power could be a massive financial boon to the state, but popular support has been sluggish and the leadership has been slow to understand the energy-water nexus. The solar potential of Arizona is far greater with photovoltaics and air-cooled CSP than water-cooled CSP.

The food production of the San Joaquin; the wind turbines in Tehachapi; the oil fields of Kern County; the solar resource of Arizona; the water resources of the Rockies that sustain its dense low desert populations... these all depend in one fashion or another on a complex, interconnected infrastructure of commerce powered by cheap fossil fuels.

No one has even begun to seriously add up the costs of transitioning it to renewable power and rail transport. The tab will run into the double-digit trillions for the state of California alone. If the state fails — and I think it could — then where will the investment come from? Can we still imagine a debt-based federal infrastructure spending program that would utterly dwarf the New Deal? If not, then the transition will be financed and built from the bottom up... or not at all.

I'm still betting that trillions of dollars will be spent over the coming decades to cut waste, build more wind turbines and solar plants, erect a long distance HVDC transmission grid, implement a smart grid with micro-islanding capabilities, stimulate a rail renaissance, and try to keep the American machine humming.

That's why I call it "the greatest investment event of the century." The investment opportunity in the Southwest is absolutely staggering, if the capital can be found.

But should those efforts prove too little, too late — and by my count, we're already 30 years too late — the long-term fate of individual communities will be largely decided by what they do in the next two decades. What they have at the end of that period may be what they'll have to live with for many decades afterward. The resources they depend on today may be stranded.

My family may indeed fall back on the old cross-cut saw to cut our firewood. The Tehachapi locals may have power, but struggle to maintain food supply. The mining towns of Arizona may wish they'd done more to deploy solar, especially water-pumping solar systems, when the getting was good.

Communities that localize their supplies of food, water, and energy, with a sharp eye on local carrying capacity (which is to say, those who have the ability to disconnect from the complex systems around them and be self-sufficient), could have a reasonably good future. Those that don't may find themselves following the deer of the Kaibab Plateau.

The question for investors is this: Fifty years from now, will Route 66 be a blasted wasteland of ghost towns, a Mad Max relic of the fossil fuel age... or a string of small, self-sufficient oases, each with their own solar arrays, wind turbines, backyard gardens, and railroad depots?

I'll have more to say on that subject next week when I write for Green Chip Stocks.

Until next time,

Chris

All photos by Chris Nelder

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Energy Outlook for the Next Decade: Part 2

Last week, I explored some of the big themes for the coming decade. For my final column of the year, I offer my specific outlooks for oil, natural gas, coal, renewables, uranium, efficiency, water, and agriculture.

Oil

Oil will probably spend 2010 rangebound between $60 and $75, but could fall lower if the deflationary recession persists.

As I discussed in Part 1, it will probably take until 2012-2013 for demand growth to push the current 4-5 mbpd of spare capacity back down to the 1% breaking point, but then we should see another price spike.

For reasons I have discussed previously, I'm no longer convinced that the next few cycles of oil prices will breach the $147 peak or the $33 low set in 2008. But if Cohen's diagram (see Part 1) is correct, then we should continue to expect higher highs and higher lows, with oil peaking somewhere around $160s and bottoming around the $50s in the next cycle (with an error bar of perhaps $20!).

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The best way to play it will be to scale in on the descent and scale out on the ascent, rather than trying to time the tops and bottoms.

By mid-decade, I think the world will be convinced that the peak of oil is in the past, putting an end to that debate. The realization should kick off an intense round of competition to secure the remaining resources, drawing more Chinese money to Canada, Brazil, and Africa, and committing the U.S. to retaining its military foothold in the Middle East.

Coal

As much as I hate to say it, coal is poised for a long-term bull market. As oil, and then natural gas decline, the world will fall back on it as the cheapest hydrocarbon of last resort in the next decade. It will be the fallback feedstock for liquid fuels for cars, trucks, and airplanes, plastics, and industrial chemicals.

The world will groan under the CO2 output of the devil we don't know, but will choose it over the devil we do know: economic decline. Therefore I expect the better part of the coal boom to fall in the latter half of the decade, as emissions concerns are overridden by economic pressure. Coal-to-liquids, in particular, will be the recipient of heavy sponsorship from the military and aviation sectors.

Natural Gas

The next decade outlook for natural gas is the most uncertain of all. The current glut in North America owing to the shale gas boom could be resolved in one of two ways: It will either continue through the decade, if long-term production rates are sustained at high levels, or it will crash around 2013-2014 if production falls rapidly after the initial burst of output, as some analysts believe.

There simply isn't enough data to make that call at this point, but my gut feeling is that there will be a short-term boom for the next few years, and a significant load will be shifted from diesel to CNG for transport trucks. Then supply will peter out before the end of the decade, with some ensuing panic.

Boom-and-bust cycles will characterize the North American gas market until prices stabilize above $7 per thousand cubic feet. LNG export capacity will continue to grow in the Middle East and Russia, but most of it will go to non-U.S. customers, and the North American market will remain largely domestic.

Uranium

As a spate of recent news reports have recognized, the global uranium supply is running low. We've nearly worked through the stockpile of uranium from retired nuclear weapons, and the quality and availability of fresh ores to mine is falling. As I do not see any significant momentum toward next generation reactor designs, I believe light water reactors will continue to dominate the nuclear sector, which means another decade of high demand for uranium.

While uranium supply peaks or declines, demand will continue to increase as new reactors are built, particularly in China and India. Nuclear power will not add a significant amount of primary energy to the global mix, but uranium will be a hot commodity. It will see at least one, and maybe two boom-and-bust cycles in the next decade.

One no-brainer investment in this sector would be Cameco Corporation (NYSE: CCJ). They've been making good progress lately and I think they will succeed in pumping the water out of their Cigar Lake mine and putting it back into action.

The whole uranium producer group should be a long-term hold for the decade.

Agriculture

At this point, I can't really think of any reason to be bearish about agriculture. Fertilizer and grains will be hot throughout the decade as we try to feed the world's growing population and combat the decline of oil with biofuels.

The added pressure will only exacerbate the problems inherent in commercial agriculture, accelerating the boom in organic and local food production.

The encroaching desertification of California — along with price spikes in oil — will make it increasingly difficult to export its produce to the Midwest and East Coast (unless by some miracle we get very serious, very quickly about rail in this country). This will have wide-ranging and very long-term implications for U.S. food supply.

GMOs designed for drought tolerance and water efficiency plays in the ag sector will figure prominently. Both technologies will probably see a frantic investment bubble this decade. How long they can hold back the tide of climate change and desertification will remain an open question in the ‘10s.

The long-term trend for agriculture is much easier to identify. By the end of the century, nearly all of our food supply will have to be relocalized. Those who are paying attention, however, will realize it by the end of this decade.

Accordingly, farmland will continue to be a hot market throughout the decade, particularly in Africa, Asia, Central and South America, and possibly Canada.

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Water

Water will be one of the biggest investment areas — and socially speaking, one of the biggest pressure points — of the next decade, due to climate change and simple population overshoot.

This month brought three fresh examples of the issues we're facing:

In a classic case of the energy-water nexus, the long-running drought in South America has reduced Venezuela's hydropower supply enough to force them to cut back on oil refining activity, with the end result that they'll have less heating oil to send to places like China this winter. China will make up the loss by burning more coal.
Much of East Africa received only 5% of its normal rainfall in November, putting millions of people at risk of starvation.
A new report found that the aquifers supporting the Central Valley of California, a region that produces 8% of the U.S. food supply, have lost more than 30 cubic kilometers of water (about 8 trillion gallons) since 2003 due to drought, reduced water exports from the Sacramento Delta, and too much groundwater pumping.

Water desalination and purification have long been a major investment focus in the Middle East, but the American Southwest, Australia, Africa, and South America will join them this decade as new markets in desperate need of solutions. Technologies running the gamut from personal water treatment to city-scale water desalination will benefit from this potentially enormous market.

Efficiency

Efficiency is by far the low-hanging fruit in our declining energy future, and this will be the Decade of Efficiency. Consider this simple metric: It takes $4-$5 in solar PV to generate the same amount of energy that $1 in insulation measures will save.

Cash for Clunkers and Cash for Caulkers were only the beginning of a long decade of incentives for higher efficiency. Not just cars and buildings... but appliances, combined heat and power applications, district heating from co-located waste heat generators, and dozens of other approaches will be vigorously pursued. By the end of the decade, I expect the efficiency of U.S. appliances and vehicles to approach what Europe enjoys today.

The largest niche in efficiency will be retrofitting homes with insulation, caulking, windows, and solar generation. Small businesses doing energy auditing and building efficiency upgrades — like San Francisco's Recurve, who have figured out how to scale their businesses — will be home runs. By the end of the decade, I also expect building efficiency, good passive solar design, and low water use to be mandatory elements of architectural college curricula.

Building the smart grid will be a top priority for this decade, along with at least the first part of a long-distance national HVDC grid. Not only will it enable the growth of renewable power, but it will be a saving grace in helping us cut the waste and make the most of our existing grid power supply.

Renewables

Renewable energy is still at the beginning of at least a 30-year secular bull market, and the decline of fossil fuels means the sky's the limit for its growth outlook. I doubt that we'll see again in our lifetimes the kind of growth that will happen in this next decade. I'm talking a once-in-a-century bull market here.

Solar and wind will continue to be the dominant technologies and receive strong investment, led by China and a few other projects like Masdar City and then moving into widespread adoption in the U.S. and the unsolarized parts of Europe (France, I'm looking at you!) by the end of the decade.

The intermittency problem of wind and solar will be largely solved this decade, as new storage solutions come to market. Hundreds (perhaps thousands) of companies, small and large, have been working on a whole array of approaches to the problem, and I expect a few winners to emerge this decade. My bet that that a combination of vehicle-to-grid technology, flywheel storage, and large battery arrays or ultra capacitors will be the early winners. But there are many others, including stationary micro- or nano-scale hydrogen storage (but not hydrogen vehicles), pumped water, and compressed air.

If regulatory and financing hurdles can be overcome — and I think they can in the next ten years — concentrating solar power (CSP) also holds enormous potential for cracking the storage problem at grid scale in solar-rich regions.

As high as my long-term hopes for it have been, I reluctantly conclude that the geothermal sector will continue to see sluggish growth for at least the first half of the decade, due the difficulty of raising financing, regulatory, and underwriting hurdles and technical issues.

Uncertainty over whether "enhanced geothermal" (deep, hot rock) projects cause earthquakes has shut down two major projects this month. The AltaRock Energy project north of the Geysers in California — the first major test of enhanced geothermal in the U.S. — was terminated immediately after another major project in Basel, Switzerland, was permanently shut down in response to a government study showing it was responsible for damaging earthquakes in 2006 and 2007.

Likewise, it appears marine energy technologies are still lacking the research and development support they need to reach commercial viability. I do expect at least one or two of them to get there by the end of the decade, but I don't see them taking much market share.

Final Thoughts

The list of x-factors that could utterly change the outline I've offered here is so long that it questions the wisdom of even trying to attempt a decade-long outlook. Disease, war, natural disasters, monetary policy, drought and climate change, geopolitics, sovereign default, energy failures... you name it, it's in the mix.

The one constant we can be sure of is human nature. I'm digging into some ancient history in search of clues to the future, and I suggest that you do, too.

As we teeter on the peak of the biggest wealth bubble in human history and stare into the abyss, we would do well to learn the lessons of the past. Ours will not be the first empire to crumble, and there is nothing new about how or why it will happen. The only difference is the distance we have to fall.

It's been a tough year and a wild decade, and I'm sure most of you will be happy to put it behind us. The next decade will be considerably harder, but it will force us to rethink our values and chart a more sustainable course into the future, as well as present some of the greatest wealth-making opportunities of all time.

For example, my colleagues Sam Hopkins and Nick Hodge are venturing out into emerging markets like Peru, China, and Morocco to find clean energy investments that will allow developing countries to leapfrog carbon-intense, rich-world energy habits. And as they report from the field, subscribers to their Green Chip International stock recommendation service will benefit.

Again, my mind is drawn back to Dickens' critique of the British aristocracy in light of the French Revolution. The coming decade, as then, could be the best of times, it could be the worst of times.

One thing is guaranteed: It will not lack for excitement.

Until next time,

Chris

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Investment Themes for the Next Decade

Instead of the customary next-year outlook, I am closing out the decade that John Perry Barlow so aptly termed "The Uh-ohs" with a two-part article outlining my view of energy for the next decade.

I will begin with the big themes and move on to specific fuels in Part 2 next week.

What We Have Learned

Except for a possible limited glut in natural gas (more on that next week), I now consider as axiomatic that the supply of nearly all commodities is effectively static. The ability of high prices to stimulate new production has failed, or will soon fail, in every case.

Very simply, humanity has begun to bump its head against the ceiling exactly as one would expect when population increases exponentially on a finite planet. I detailed this theme in my very first article for Angel Publishing in 2006, "The Great Awakening," and the three years since have only served to reinforce my convictions... which at the time were considered "fringe."

The events of the second half of the Uh-ohs made the whole world aware that we're getting down to the margins of fundamental needs like food, energy, land, and water.

"The # 1 Oil Play in the Country"

With the rest of the nation in recession, one state is enjoying a real live oil boom.

It's all happening in North Dakota, where the Bakken -- a massive oil formation -- has already become a major force in our domestic energy picture.

And now, geologists tell us, we may be looking at a "second Bakken"... one that could easily double the Bakken's 4.3 billion barrels of recoverable oil.

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Oil prices spiked when the margin between supply and demand fell to under 1%, taking the prices of everything from food to building materials with it. China went on a massive shopping spree, snapping up hard assets wherever it could around the globe.

Farmland in undeveloped countries became a hot market, as developing countries began seeking ways to feed their burgeoning populations. The push to make biofuels from corn had unintended consequences on food supply, prompting riots and price increases for grains and meat.

We realized that wildlife is disappearing at an extraordinary pace and that global fish populations are crashing. We saw coral reefs dying, and learned of the "Great Pacific Garbage Patch," a mass of tiny pieces of plastic floating between the Western U.S. and Asia and estimated to be as large as 5.8 million square miles.

We also heard a steady drumbeat of stories about how water was becoming a problem all over the world under the combined pressures of growing populations and climate change, and was increasingly playing a role in other complex systems.

I won't continue the sad litany — if you've been reading me for awhile, you've heard it. The important concept is that there are no supply-side answers to commodity demand beyond current levels.

Watch Your Head

If supply is static, then we must focus on demand to understand where prices are going, a factor which has more to do with the health of the global economy than ever before.

I anticipate a sharp correction for the U.S. economy some time in 2010 — probably in the second or third quarters — as the plaster applied to the holes in the economy over the last two years begins to crack. Tight credit will continue to constrain growth for several years; although mid-decade I do see potential for more government-driven spending on energy infrastructure (and hopefully, rail).

I expect China to continue to outperform and delink from the U.S. economy over the next decade, provided the latter at least stabilizes. If the U.S. should suffer another sharp fall in the next ten years — and the risk of its doing so by the hand of hyperinflation is certainly non-zero — then it will exert significant drag on China, as well.

Generally, I expect demand growth for commodities in the developing world to compensate for OECD reductions, keeping overall demand flat-to-rising throughout the decade. It is likely that the U.S. will see itself increasingly priced out of the market for oil and mineral assets.

As demand bumps repeatedly against the supply ceiling, prices will continue to follow the pattern in Dave Cohen's chart from August:

Volatility of future oil pricing. Source: Dave Cohen, "The Next Oil Shock"

At this point I would put the "we are here" mark a little farther to the right, near the top of the first upslope, as oil has been range-bound in the $70s. Somewhere around 2012, however, I agree with Cohen's expectation for demand to overcome excess supply and cause prices to spike sharply again.

There is no guarantee that the 4-5 year period from peak to peak in this first complete cycle of the second half of the Age of Oil will be a useful indicator. The period of the following cycles may lengthen or shorten, and will be heavily influenced by macro factors like monetary policy. However it does, at minimum, give us a reasonable expectation that we might see two more such cycles over the next decade.

Therefore successful investors will learn to play the range, selling higher highs and buying higher lows. Sentiment on the dollar will continue to be a useful signal, as investors continue to use commodities and gold as safe havens against inflationary fears.

A Few More Themes

Desperation measures like big water projects and aggressive production of biofuels and coal-to-liquids will probably move forward, even if they're ultimately doomed ideas. Self-interest and political popularity will continue to trump science, and blow up more than a few investment bubbles.

Self-reliance will continue to enjoy a surge in popularity, at least among the 10% or so of the population who are inclined to it. I expect millions of backyard gardens to bloom in the next decade, along with an explosion in residential and small commercial solar thermal and PV. Survival gear and guns should also enjoy continued growth.

I maintain my view that carbon capture and sequestration will be a boondoggle (although it may enjoy a period of investment froth), and the entire focus on carbon emissions will be ineffectual, because it is a backwards approach to the problem. One cannot effectively deal with the problem of climate without first understanding energy. I predicted that Copenhagen would be a failure, and I remain convinced that whatever progress we do make in reducing carbon emissions will only come from deploying efficiency and renewable energy.

As I detailed in November, hard assets will continue to be a hot sector for most of the next decade, at least until investors in them start meeting some resistance (such as hostility to foreign investment and rising nationalism). Next week, one country is losing control of more than $273 billion worth of rare earth metals. My colleague, Ian Cooper, has outlined everything in his latest special report. You can access that report by clicking here.

Gold has been an extremely crowded trade this year, but as long as the world continues attempts to print its way out of a depression that is fundamentally caused by failing fuels, its bull market case will be intact. However, the volatility will be rough and hard to trade. I would be more comfortable taking a modest, perhaps 10% exposure to gold and simply holding it through the decade.

Finally, I believe the coming decade will see a continued and widening disparity of wealth, at least in the U.S. The ranks of the poor will swell, and the buying power of the middle class will be destroyed. A growing resentment toward the rich seems inevitable, and I expect it to lead to some degree of social unrest. It would not surprise me at all to see America elect a hard-right, authoritarian president in 2012 or 2016.

In summary, I believe the defining characteristic of the next decade will be our coming to grips with the limits to growth. We're going to become increasingly sensitized to the decline of natural capital, and our vulnerability to the effects of climate change. Conflicts will erupt over everything from fossil fuels to ecological services (like water purification), and when they do, self-preservation will triumph over lofty concerns like climate change or garbage in the Pacific every time.

Next week I will offer my specific outlook for oil, natural gas, coal, renewables, uranium, efficiency, water, and agriculture — so tune in for that.

As I realize this column runs so close to Christmas Day, I hope these somewhat dark themes find you in thoughtful contemplation, not dread, as you relax with family and enjoy some of the benefits of civilization at its peak.

As I like to say, these are the good ol' days. That will be my meditation, and I hope it will be yours. There is more to life than money, and our moments of peace and joy are priceless.

Until next time,

Chris

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You Can't Trust the 2010 EIA Annual Energy Outlook

Suppose you worked at the Energy Information Administration (EIA), the agency within the U.S. Department of Energy charged with keeping data and making projections on energy, and you had to produce an annual report with a scenario for the next 25 years.

Being an intelligent and informed investor, you might grapple with the $147 to $33 range in oil prices over the last year and try to imagine how such volatility might happen in the future.

You might be tempted to model a few economic factors such as GDP growth rates and credit availability, and how they affect investment in energy supply.

You might consider the price at which producing a barrel of oil or a thousand cubic feet of natural gas becomes profitable, and the price at which it becomes too expensive and destroys demand.

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You might take peak oil, peak gas, and peak coal into account, since the best available models on those subjects all suggest peaks within the time frame of your scenario.

You might extend the line tracing the 40-year trend of declining U.S. oil production.

You might look at the steadily falling prices of power generated from wind and solar and the steadily increasing prices from fossil fuels, and include those in your model.

You might take a cautiously optimistic view of the future of unconventional fuels like shale gas and biofuels, since their commercial history is short and good data is hard to come by...plus there are all those niggling questions about things like long-term production rates, net energy return and fuel-vs.-food tradeoffs.

You might include a tip of the hat, at least, to some sort of future pricing for carbon emissions, since it's all the rage right now and it seems likely that something will happen along those lines before 2035, even if this year's Copenhagen summit is a failure.

You'd wind up with thousands of linked, detailed spreadsheets, employing all sorts of advanced mathematical functions to tease coherence out of chaos.

And you'd most definitely ring the alarm bell that we've got a serious energy supply problem on our hands and we'd better do something about it, fast.

You'd probably point out that moving aggressively to renewables could solve the climate change problem, and do it without a global agreement on emissions.

But then, you're not working for the EIA.

Anatomy of an Illusion

If you were, you'd do something like this...

You'd get out your crayons and your graph paper, and starting with your most recent data, you'd plot a nice, steady 1.5% global growth rate for energy demand over the next 25 years.

You'd do something similar for supply so that it matches demand at prices that also climb at a nice steady rate. For oil prices, call it, oh, how about 0.4% per year? That sounds pretty good.

You'd draw basically flat lines into the future for all the fuels dominant today, since you know they have serious challenges ahead, and then draw sharply rising lines for the latest and greatest technology, projecting enormous growth rates for things like shale gas and enhanced oil recovery.

You'd be sure to count all possible supply from new sources — like a new gas pipeline from Alaska — even if those projects don't yet exist. Hey, it could happen!

You would not, however, factor in any CO2 reduction, because policies to control it don't exist.

Naturally, you'd assume that the next 25 years would show gradual economic growth, so there wouldn't be any troublesome issues like credit availability or depressed consumer demand to worry about.

You'd wind up with a chart like this:

AEO 2010, Figure 1: U.S. Primary Energy Consumption. Source

In sum, you'd present a picture of the future that looks like a continuation of the best parts of the past, with none of the bad parts.

You'd assert that the declining trend of U.S. oil production would be reversed by the miracle of technology, and grow from 5 million barrels per day (mbpd) in 2008 to over 6 mbpd in 2027, then flatten out for decades to come. You certainly wouldn't try to explain how that would happen while mature fields continue to decline — in fact, you wouldn't mention decline rates at all.

You'd explain that, even though domestic biofuels will fail to meet their 2022 renewable fuels target, they'll exceed it by 2035 as new sources that don't exist commercially today, like biomass-to-liquids and cellulosic ethanol, suddenly bloom.

To that you'd add some major gains from efficiency and "structural changes" like switching to hybrid cars — hey, what if the fleet of alternative vehicles tripled in the next five years? — eliminating about 90% of the new energy demand that would otherwise result from a constantly growing economy.

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You'd do away with the problem that much of the U.S. nuclear fleet has to be rebuilt in the next 25 years because the reactors are past their expiration dates and living on extended operating licenses already, by assuming that they'll get another extension to operate beyond 60 years. So you won't have to worry about any loss in nuclear capacity.

Finally, you'd toss in a scenario for electricity production where renewables grow modestly then flatten out, while the use of cheap biomass suddenly explodes for unknown reasons.

You won't explain where that biomass comes from, or the net energy of using it, or any difficult details like that.

You'd continue the recent sharp growth curve for wind for a few years then flatten it out, perhaps because you don't think a storage solution will be found to address the intermittency issue. After all, it's not your job to know about emerging technologies like flywheel storage systems or V2G — it's your job to make the future look kinda like the past, only better.

That would give you a chart like this:

AEO 2010, Figure 5: Projection of U.S. non-hydropower electricity sources. Source

And voilá! You'd be able to claim that U.S. oil demand peaked in 2005, and would remain flat around 19 mbpd for the next 25 years — even while the economy continued to grow. It's like magic!

Just Doing Your Job

It wouldn't bother you in the least that none of your projections use the best available information on these complex matters.

You'd be completely untroubled by the fact that oil prices averaged $74 in 2007, $100 in 2008, and $59 in 2009, but you drew straight lines into the future. Presumably, all that volatility owed to noise outside your sphere of consideration, and won't happen again.

You'd sleep just fine at night despite the obvious vapidity, in retrospect, of the oil price predictions in your 2004 annual outlook... nor would you be perturbed if I overlaid your 2010 prediction on it in chart form:

Three AEO 2004 oil price projections, plus AEO 2010 Reference Case. Chart by Chris Nelder.

You'd be careful to follow the lead the IEA set in its recent annual report and arrive at basically the same prediction they did for future oil supply, while trying not to piss off your bosses.

You'd be sustaining the illusions that everybody around you believes in and supporting their religious beliefs about endless growth rates, American ingenuity, and so on. Nobody would fault you for that!

You could do all this secure in the knowledge that, apart from a few snarky financial bloggers out there who nobody reads anyway, you'll never be challenged on any of it. The press will dutifully report your projections verbatim, and won't ask you any difficult questions.

And when the business and policy leaders of America drive the whole enterprise off the net energy cliff because they relied on your expert opinion and neglected to invest in the renewable energy solutions of the future in time, you wouldn't worry your pretty little head about it.

After all, that's not your job.

[Author's note: This is based on the "early release" of the EIA's 2010 Annual Energy Outlook which offered only a summary press release, a slide deck of charts and some data, without the main text. Perhaps when the final report is released in March 2010 they will explain themselves better, but I doubt it. The EIA does an excellent job of collating and reporting historical energy data, but they should be statutorily barred from making projections.]

Until next time,

Chris

P.S. While the EIA may rule the data roost in the U.S., my colleagues Nick Hodge and Sam Hopkins scour a world's worth of energy info to bring Green Chip International readers top global clean energy stocks. To learn why more and more of the clean energy investment action is taking place beyond American shores, read Nick and Sam's new report: Racing to Build the Perfect City.

Real Solutions to the Energy and Climate Crises

As my regular readers know, I've spent much of this year contemplating big themes, like the long-term picture for energy, energy and monetary policy, black swans and the human penchant for valuing the present more than the future, the problems of complex systems like the energy-food-water nexus, sustainability, and the relationship between climate change and peak oil.

As this year draws to a close and I review my work, the biggest question that emerges is about why it is so incredibly difficult to reach people on these subjects.

It's more than the usual culprits. Yes, the corporate media and the ad-supported business model are problems — like when I was called a "peak freak" on television and given no opportunity to respond to my opponent's disinformation.

Yes, the overweening influence of corporate lobbyists has effectively neutralized policy and confused the public debate on our most serious problems. Yes, the capitalistic system favors short-term concentrated profits over long-term public good. And yes, the simple human preference for happy talk over sad stories plays a role in our denial.

The real problem is much more pervasive. Those actors cannot explain more fundamental questions:

Why has our economic theory failed us?
Why is the reality of climate change so hard to accept?
Why does climate change dominate public dialogue while the more proximate threat of peak oil remains far off the radar?
Why do we have such resistance to change?
Why would anyone ever think Dubai World was a good idea?
Why is talking about population control — arguably the only real way out of our predicament — taboo?

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For over 40 years, our public dialogue has gotten progressively dumber and more polarized. The one "town hall meeting" I attended on health care was a horrifying display of tribal theater, with both sides screaming at the other and drowning out the elected official. It did not even remotely resemble intelligent discussion of issues.

Our news media have substituted entertainment for information and sponsor-endorsed opinion for neutral reportage, while the literacy of the public and the capacity for critical thought have progressively declined. Orwell, Huxley, Bradbury, Vonnegut, Chomsky, and a long line of others have decried it all along.

Yet it persists, and grows. Why?

Addicted to Fantasy

I discovered a partial answer to this question in the terrific new book, Empire of Illusion: The End of Literacy and the Triumph of Spectacle by veteran journalist Chris Hedges. He argues that America has been slowly transformed into a nation entranced by Horatio Alger-wrapped fantasies of personal wealth, fame, and power. Our culture has been utterly subsumed by a fantasy world, he says, in which celebrity worship, dumbed-down "news," and consumer messaging form an impenetrable veil of manipulated reality.

Hedges offers some compelling evidence: Nearly a third of the population is almost or fully illiterate. A third of high school graduates, and 42% of college graduates, never read another book for the rest of their lives. Eighty percent of U.S. families didn't buy or read one book in 2007. We did, however, watch 28 hours a week of television. Each.

Television, where we have hundreds of channels but nothing is on... nothing but unimaginative, formulaic entertainment packages for highly crafted messages designed to make you buy, buy, buy.

Jon Stewart offered a great example this week in his takedown of Fox News anchor Gretchen Carlson — a high school class valedictorian, Stanford honors graduate, and former Miss America with classical violin chops — who pretended to resort to the dictionary to find out what the words "ignoramus," "double-dip recession," and "czar" meant.

Instead of discussing the content or import of the leaked "Climategate" emails, Carlson cited a poll asking if global warming research had been falsified... a poll which added up to 120%. Public opinion, however dumb, is now more important than facts.

I had to sort though dozens of articles and hours of radio and television that merely repeated the corruption allegations before discovering two decent articles (at New Scientist and Real Climate) that described what the "scandalous" e-mails said and what they meant.

What I found was... nothing interesting. Just scientists, doing their regular jobs of sorting through and correcting the errors in data.

But a few words, made in private conversation and taken out of context, is all Sen. James Inhofe and his tribe of right-wing activists needed to renew their assault on climate change legislation. His effort is no doubt enabled by the fact that only 11 of the 538 members of the Senate and House have backgrounds in science or engineering, and most are functionally illiterate about energy or climate science.

In fact, the deniers have no alternate scientific theory for global warming, nor do they care to formulate one. They only need to cast doubt on the existing research and claim that the scientific process has been corrupted.

The actual significance of the science, or lack thereof, in Climategate was quickly rendered irrelevant; that irrelevance was then seized and gloriously amplified in the media. The spectacle is more exciting than the dull facts about the science, so the media only care to perpetuate the spectacle. It's entertainment, not news.

The "climate change is bunk" message was sent, but how many Americans who heard it then spent any effort trying to figure out what the e-mail leak actually meant, as I did? I'm guessing very few.

Perhaps a third of the public now believes that there is some sort of conspiracy to destroy the economy by taking action on climate change. The obvious lack of any conspirators is irrelevant. Merely saying there is a conspiracy is enough.

Global media king Rupert Murdoch pounded the final nail into the Fourth Estate's coffin this week in a Wall Street Journal editorial where he argued passionately that media should only give consumers what they want. Government help, non-profit status, or any other mechanism that would support journalism without a profit motive is insidiously evil in his view. Yet he asserts that merely giving customers what they want — even if they only want illusions and circuses, and have no patience for thoughtful discussion of matters like policy or science — produces a free and informed citizenry.

This seems an utterly indefensible stance. The Fourth Estate is much wider, but also considerably shallower now than it was in 1888 when Oscar Wilde wrote: "The Lords Temporal say nothing, the Lords Spiritual have nothing to say, and the House of Commons has nothing to say and says it. We are dominated by Journalism."

Our appetite for illusion has made us, as Aldous Huxley feared, a nation of passive, self-centered consumer idiots, endlessly distracted by trivia and irrelevance, embedded in a alternate reality matrix, saturated with information we don't comprehend, easily confused, and easily led down paths we would never choose if we were informed and thinking clearly.

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Peter Pan Meets Financial Truck Bomb

If you think I'm off on a tangential rant here, let me bring it home, for it has everything to do with our utter failure to respond in a meaningful way to our impending challenges, and with investing in general.

An outstanding and extremely important recent white paper by an oil and gas exploration consultant, "The Tragedy of 21 Darts," confirmed the worst of what I have come to understand about the game of projecting oil and gas reserves. Reserve calculations are essentially mathematical simulations, which are regularly distorted and misrepresented by the companies that claim them. As a hedge fund manager and oil and gas producer friend of mine commented on the paper, "The oil and gas business is a bunch of holes in the ground with liars on top."

To understand what you're buying as an oil and gas investor, you'd have to spend many hours digging through technical papers full of unfamiliar jargon. You'd have to be able to read critically and understand probability distributions. I've done it, and it's hard work. Harder than most people are willing to do.

The regulators and policymakers won't read that paper, nor will most of the industry's investors. As a result of this ignorance, the author warns, new SEC regulations will set off "a financial truck bomb that's going to blow away ‘proved reserves' as a meaningful metric of oil company assets" in January. The liars will get away with it... at least until the wells run dry.

This is why peddlers of absurd fantasies about the future of oil production, like Phil Flynn and Dan Yergin, are in the press and on the TV every day, while the people like me — patiently and diligently sorting through the facts and the fictions in search of reality — are continually marginalized.

This is why wingnuts like Sen. Inhofe get more airtime than those who could explain what the science on climate change really says.

This is why simple, rational solutions to our tangle of developing crises — like resource scarcity planning, or carbon taxes, or population control — are immediately disregarded as unworkable.

And it's why we elect leaders who massage our egos and assure us that everything will be fine, when it clearly won't.

If it doesn't conform to our fantasies and the people don't want it, then men like Murdoch will ensure we don't get it. But they'll happily sell us snake oil like space-based solar power for as long as we keep buying it.

We are not only lost in our illusions... we're in love with them.

We desperately want to believe that there are no physical limits to our insatiable desires, even on a finite planet. We'd rather poke holes in the multiplying signs that humanity on Planet Earth is fundamentally in overshoot than face the hard work of figuring out how to adapt and survive.

We're clinging to 17^th Century remnants of the Age of Enlightenment, still trying to believe that humanity has a special elevated place above Nature when it's becoming increasingly obvious that it does not. Our models of the future, our economic theory, our educational regimen, our personal and cultural ambitions, our national identity, even our very conception of Man's place in Creation have been rendered intellectually bankrupt. But we refuse to see it.

Our emotional progress is even worse. We've barely budged from total nihilism to tribalism... "The American way of life is non-negotiable," and all that rot.

We can't afford to go on this way because, as James Baldwin put it in the prologue to Hedges' book: "People who shut their eyes to reality simply invite their own destruction, and anyone who insists on remaining in a state of innocence long after that innocence is dead turns himself into a monster."

It's Up to You Now

In the absence of rational leadership, neutral journalism for the public good, or a free and informed citizenry, the task of meeting the challenges ahead falls to each of us, individually. There is no "them" who are going to sort all this out. There is only "us."

We have to own the problems of energy, food, water, climate change, population, and investments that don't go sour. They're ours.

So will be the solutions. Fortunately, there is much we can do.

Concentrate on efficiency first: Insulate your house. Get a more efficient vehicle and more efficient appliances. When an opportunity like Cash for Clunkers/Caulkers comes around, jump on it. Try to limit your driving and use public transit. Move closer to work, or vice versa.

Then do something on the supply side: Add solar PV and solar hot water to your house. Tear up your lawn and plant a vegetable garden, even if it means paying a fine to your HOA.

Rebalance your investment portfolio with a view toward long-term sustainability. Limit your exposure to dollar-denominated assets and invest in hard assets. Do your own due diligence. Eliminate your debt as quickly as possible.

Instead of hoping that your fantasies of wealth will be restored when the economy recovers, think about how you can live within your means if it never does.

And finally, don't wait for leadership in Washington. Be a leader, wherever you are. Work toward sustainable solutions, not at town hall meetings — but with your family, neighbors, friends, and local governments.

Until next time,

Chris

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Dubai and Masdar City: A Study in Contrasts

Looking at the world through the lens of energy investing and peak oil, it's hard to imagine a starker contrast than Dubai World and Masdar City.

Both will rise out of a barren wasteland of sand in less than three decades, but only one was designed to survive the future.

Dubai World was built to serve up the ultimate in luxury and decadence: Indoor ski slopes in one of the hottest places in the world. Architecture straight out of a sci-fi novel on three artificial archipelagos built into the sea. Refrigerated beach sand. Floating tennis courts. The world's largest shopping mall, featuring luxury goods, and entertainment. The world's tallest building. Hotels featuring independently rotating floors, or underwater views, or rooms with eight attendants each. And so on, ad nauseam.

Suffice it to say there's a reason why after Never Land, Dubai was the one place in the world that Michael Jackson wanted to call home.

Lacking a significant endowment of oil, Dubai sought to be the financial hub and the Las Vegas of the Middle East. Its revenue is almost entirely derived from high-rent tourism and servicing the enormous flow of petroleum capital generated by its neighbors.

But the gleaming glitter hides a dark underbelly. Those fantasy buildings were constructed on the back of slave labor from places like Ethiopia, Bangladesh, and the Philippines. While Western ex-pats live the high life drinking Moët on the beach and being waited on hand and foot, laborers do backbreaking work in the desert heat, making $5 a day... their passports confiscated, their liberty denied. Subsisting on meager rations and insufficiently desalinated water, they're forced to live in stinking, cramped, unventilated concrete ghettos an hour's bus ride away, conveniently out of sight of the rich patrons.

Convoys of trucks haul sewage out of Dubai every night because the sewer system cannot handle the load. Much of the excess gets dumped illegally into the sea, leading to unsafe, contaminated waters at the very beaches of its ultra-luxury hotels.

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In the long history of empire and the excesses of the rich, there is nothing unusual about any of that of course. All great empires were built on the backs of slaves at one time or another and all committed their eco-sins. My point here is the utter unsustainability of the strategy.

Predictably, the bursting of the global real estate and financial bubbles took the air out of Dubai as well.

An empty villa on Palm Jumeirah. Source: New York Times

Dubai's new flagship hotel, the Atlantis, stands unfinished — its roof leaking and its rooms unwanted — on an enormously expensive artificial island. Its structured financial products, supposedly compliant with Shariah law forbidding the charging of interest, were discovered to be — surprise — not so clean. It's like an echo of the SEC's and rating agencies' complicity in enabling the subprime debacle.

Now Dubai faces sovereign default as collateral damage of the global hallucinated wealth meltdown. The news that Dubai had asked its creditors for a six-month freeze of interest payments on $26 billion in debt related to Dubai World ripped through the financial world, temporarily raising the specter of a domino effect. (The markets quickly shrugged off that fear however, realizing that the damage would be mostly contained and local.)

Masdar: City of the Future

Less than 100 miles away from the broken dream of Dubai World, a new city based on a very different dream is rising in Abu Dhabi. Masdar City aspires to be the world's first carbon-neutral, zero-waste city, a happy oasis six kilometers square with its own micro-climate, supporting 50,000 people in renewably powered harmony with nature.

Masdar City birds eye view conception. Source: Masdar City

Built from the ground up with sustainable living in mind, it will bring together the best-of-breed clean technologies: building-integrated solar photovoltaics and solar glass, solar hot water systems, smart grid technology, electric transportation, power storage, sustainable agriculture and vertical farming, water recycling and desalination, low-energy HVAC, green building materials, waste-to-energy systems... essentially everything but wind energy.

The first phase of the project is already under way. Construction of the Masdar Institute, a higher learning institution that will explore new green technologies and shepherd the best ones into commercial development, is slated for completion next year; its courtship of the world's top cleantech companies and investors has commenced. The Institute aims to be a world-class research and development hub for the solutions of the future.

Ironically, Masdar City is the dream of Sheik Mohamed bin Zayed Al Nahyan — the Crown Prince of Abu Dhabi, one of the most oil-rich emirates in the UAE. Abu Dhabi claims 92 billion barrels of oil reserves, and produces 2.7 million barrels per day of oil — 85% of the UAE's total output. That's a $1.5 billion-a-week revenue stream, and the reason why Abu Dhabi has the world's richest sovereign wealth fund, worth over $700 billion.

But rather than spend it on lavish amusements and trifles as its sister did, Abu Dhabi intends to use its vast oil wealth to invest in the future. The royal family knows better than most that the punch is running low, and the oil party will be over in 30-50 years. Accordingly, it has committed $14 billion — with another $8 billion expected from outside investors — to build Masdar City as part of a 20-30 year effort to transform itself into a high-tech industrial and knowledge economy.

While the world's oil addicts continue to line up for another hit of its dwindling stash, Abu Dhabi will be weaning itself off hydrocarbons, building a semiconductor industry and turning out some of the most advanced renewable and efficiency technologies in the world. In sha' Allah.

Of course there is no guarantee that Masdar City will prove economically viable, particularly amidst a real estate collapse. And there is an exceptionally high risk of technology failure. It could turn out to be a supersized 21^st Century equivalent of the failed Biosphere project — mankind's last serious attempt at maintaining an artificial, zero-footprint environment.

Yet, it's almost unimportant whether Masdar City succeeds as the model city of a sustainable future or fails as an expensive boondoggle. As the world's first comprehensive experiment in integrating the whole spectrum of green technologies at a city scale, the results will be invaluably instructive to the reengineering of the rest of the world.

We'll have a much better idea of exactly what technology can (and can't) do. The winners that emerge from the proving ground of Masdar City will be overnight sensations and turn more than a few penny stocks into green chips.

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The Past and The Future

In reality, the men behind both Dubai World and Masdar City are closely related and their investment objectives intertwined. At the very least they share a common interest in securing for themselves a prosperous future as the twilight of oil fades to black.

I have contrasted the two cities sharply to make a larger, and perhaps a moral point.

When one thinks of Dubai today, one conjures Rome... Icarus... Easter Island... the frothy head on a just-poured beer. She is the very image of the Age of Oil, in which the value of every dollar "made" was ultimately derived from cheap and easy petroleum. As oil peaked, her lavish beauty wilted. Now, the wrinkles have appeared, the plastic surgery has become a ghoulish mask, and the enticing sway of her hips has been replaced by a halting limp. Her day is gone.

Whereas Masdar City is like a phoenix, rising from the soot of the fossil fuel age and the ashes of a consumptive, wasteful way of life. She's hot, young, and sexy, and she wants to dance. She stands atop the very heart of the world's remaining oil reserves, offering the hope of a sustainable age after oil. She is the future.

As the excesses of the first half of the Age of Oil gives way to the deprivations of the second half, Masdar City represents humanity's best shot at renewal. May she live long and prosper.

Until next time,

Chris

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Investing in Hard Assets

One key to being a successful investor is knowing where the big money is going.

And this year, that money has been going into hard assets.

Of particular interest are the in-the-ground oil and gas assets that China has targeted, and farmland.

For legendary investors like Jim Rogers and Julian Robertson, the reason is simple. The unprecedented expansion of the money supply that enabled "bailout nation" eventually must result in the destruction of the dollar. Inflation is now the Fed's only way out of the mess it's in, because we're certainly not going to grow our way out of it.

In my view, this anti-dollar sentiment has largely driven the commodity trade this year, because the fundamental case for commodity demand has been much harder to make.

Over the last three months, however, I have noted a shift in focus from general commodities to hard assets. While most commodities and energy equities have been flat or slightly positive, gold (NYSE: GDX) and silver (NYSE: SLV) have staged an impressive rally.

Warren Buffett's decision to buy up Burlington Northern (NYSE: BNI) for $34 billion earlier this month is a sterling example. Buying a railroad is the very definition of going long — very long — on hard assets. Indeed, in May 2008 I called it the longest safe bet you can make. Those who thought he overpaid for it at $100 a share when it had been trading around $80 simply didn't understand the rationale.

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One must grasp the implications of peak oil, the long decline of fossil fuels, the slow process of substituting renewables, and the long-term effects of quantitative easing to see that buying rail during a depression is very, very smart.

History will show that even at $100 a share, Buffett got those assets on the cheap. It was a typically shrewd move, in part because there so few opportunities to invest in real assets that are not directly (and negatively) correlated with oil prices and credit growth.

Profits are Un-American

As my readers are well aware, there are more risk factors at work than the dollar. In fact, the dollar could remain flat, or even strengthen a bit, and hard assets would continue to appreciate.

The risk list is a long one. I covered the ones related to peak oil in August, including the problems of sustaining energy and food supply, the likely failure of the air travel industry, and the ineffectiveness of carbon pricing.

But there are others, which are more related to the long-term outlook for the U.S. economy. There is a good case to be made that it will go down hard in a currency panic after the money-printing games are over, sending gold skyrocketing.

Martin Armstrong, former Chairman of Princeton Economics International, recently speculated that gold could explode starting in October-November 2010, eventually reaching $5,000 an ounce in 2016 — not in reaction to inflation, but due to a general loss of confidence in the U.S. Government.

That aside, I do see a dicey situation for the U.S. next year. The unemployment rate will stay stubbornly above 10%. State tax revenues will stay down. Neither the real estate bubble nor the financial bubble can be reflated without utterly destroying the dollar, and there isn't another growth story waiting in the wings. It's probably going to be a long, hard slog.

For all the good intentions of investments into energy and climate change mitigation, those areas actually constitute a fairly small part of the federal stimulus program. As such, they will prove to have all the impact of a pea-shooter on an economy that spent the last 30 years sending its manufacturing capacity — that is, the portion of GDP related to creating real value — overseas.

America is quickly learning that a purely service economy is simply not sustainable. And the final pillar that the dollar stands on — its role as the world's reserve currency, and the primary oil trading currency — is slowly eroding. Whether you argue it on the basis of money supply or fundamental value, the dollar is going to remain weak and under attack.

The smart money is responding by seeking hard assets that are either not denominated in dollars, or not correlated to them. Resource-rich countries like Brazil, Australia, and Norway have been the beneficiaries.

While U.S. equities spent the last 12 months clawing their way back to 2005 levels, look what happened to some of Brazil's resource plays over the same time period: Petrobras (NYSE: PBR), up 138%; the iShares MSCI Brazil Index ETF (NYSE: EWZ), up 121%; and the Market Vectors Brazil Small-Cap ETF (NYSE: BRF), up 218%. That performance isn't just about the upcoming World Cup and Olympics Games; it's based in the fundamental appreciation of Brazil's natural resources, and how the revenues they bring in are driving its rapidly developing economy.

If the U.S. economy remains stagnant or worse, as I think it will, the developing world will more than make up for the lost demand for minerals and fossil fuels. And if the U.S. economy recovers (at least before oil's decline pulls the rug out from under it) it will only add more demand pressure, driving commodity prices higher.

Looking farther into the future, one must consider what will happen when capital tries to exit government bonds. This week's $44 billion auction of two-year debt drew a yield of 0.802%, the lowest ever according to Bloomberg. A mere 1% slide in the dollar would be enough to put those investments underwater. After bonds and overvalued equities, I submit that hard assets are where capital must go to find yield.

Compared to a potentially loss-making $44 billion in 2-year debt, Buffett's $34 billion buy of an entire railroad looks downright brilliant. Once the rest of the big capital world realizes that, they will find even fewer opportunities to follow suit, creating intense demand.

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Bargain Hunting

Aside from a select few foreign equities, MLPs and ETFs, it's hard for an American retail investor to play hard assets. Buying resources in the ground, or entire railroads, is strictly a game for big money with long investing horizons.

It's not impossible though. The trick is to identify the companies with substantial reserves in the ground and little debt who have seen their stocks whacked mainly because they couldn't raise the capital to continue drilling and mining during a credit market lockup, not because they didn't have a profitable business.

The best part is that my readers are taking full advantage of these opportunities. Just look at the situation developing in Greenland. In a few weeks, Greenland's mineral rights will be up for grabs, making one particular chunk of land too good to pass up. Naturally, that has opened the door for one company to control it all. You can read our full report here.

As demand picks up, those companies will either be acquired by deeper domestic pockets, or sucked into China's blood funnel. Either way, those resources will be developed... and whoever owns them will reap the profits.

This is where investors must get out their pencils and examine the financial statements carefully. It's possible to buy barrels of oil in the ground for under $5, and natural gas for under $1. But you have to know what you're looking for. You have to know how to distinguish possible from proven reserves, and know your netbacks (the profits obtained after production costs are subtracted).

Choosing carefully according to those criteria can mean the difference between struggling to trade a volatile and often senseless market (and making more money for your broker than you do for yourself), and kicking back for years just watching your investments grow.

This year has been like an eye in the storm of "peak everything," offering an incredible opportunity to buy natural resources at low and relatively stable prices, mainly thanks to the excesses of the financial sector.

So let there be no mistake about where commodity prices are going next: all signs point higher. Take your positions and buckle up now, because the wild ride is about to resume.

Until next time,

Chris

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What Peak Oil Can Do for Climate Change

With all eyes focused on the Copenhagen climate summit in less than three weeks, perhaps its time for the peakists to find a new purpose.

The reason is simple. Money isn't interested in problems; it's only interested in solutions. And wherever capital goes is where the changes will be made.

The public also has little appetite for unpleasant stories, even true ones. The message is: Don't tell us what we can't consume — tell us what we can consume. Tell us our grid power costs are going to go up because of climate change and we'll fight it. But help us buy efficiency improvements and renewables that will pay for themselves in fuel savings, and we'll support it all the way.

A new Pew study on "apocalypse fatigue" highlights the problem nicely. The public's confidence in the global warming problem has fallen sharply this year, even as momentum built toward Copenhagen.

Guilt and deprivation simply don't sell like opportunity does.

That's why trillions of dollars are pouring into cleantech annually, while the peak oil community continues to go begging for a few dollars to staff a small office and keep a web server running, all while battling a constant onslaught of misinformation placed in the top mainstream media by very deep-pocketed vested interests.

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That's why I said last week that the IEA was shrewd to turn its annual World Energy Outlook into a stalking horse, masquerading its alarm about peak oil as an earnest appeal to address climate change.

It's also why I applaud Chevron's new commitment to offer mentoring, resources, and financial support to the Cleantech Open through its $240 million venture capital arm. Chevron has long held the lead among its peers, I think, for engaging with the public on the energy challenges ahead with their "Will You Join Us?" campaign.

Oil industry, take note: That's how you bridge the great divide between the Greens and the Browns — by putting some oil industry profits into the solutions for a world after cheap and easy oil.

Here are a few key concepts from the peak oil study that should inform climate policy.

All of the Above

First, solving the energy crisis isn't an either Green or Brown proposition, but all of the above. There is a dangerous paradox here that the peakists can help the world avoid.

Climate activists need to realize that the renewable energy revolution can only be built on the back of fossil fuels. It will take vast amounts of oil, gas, and coal to mine raw ores, crush them, transport them, smelt them down and turn them into stock, transport them again, and turn them into end-products. . . then transport them again. We have no idea how to do all that without petroleum fuels, gas, and coking coal.

Therefore, in order to build a vast new infrastructure of solar and wind generation, ubiquitous rail transport, plug-in and natural gas vehicles, the next-generation grid, and so on, and do it at a reasonable price, we'll have to ensure that fossil fuels receive vigorous and sustained investment.

Here's a rough, rule-of-thumb way of expressing the supply dilemma: We have to fill a 25% gap in 25 years, a 50% gap in 50 years, and we need to be off fossil fuels completely by the end of the century.

Here's another rule of thumb: Starting two to four years from now, the world will need to build the equivalent of all the world's existing renewable energy capacity every year just to compensate for the decline of oil.

Meeting that challenge with renewables and efficiency would solve the emissions problem as a side effect, only it would do so by harnessing the profit motive — not by penalizing production. That's how capitalism works best.

If we allow climate policy to pour cold water on the fire of fossil fuels, we would extinguish the growth in renewables too. Failing to maintain a steady supply of fossil fuels, even as they peak and decline, their prices rise, and their availability shrinks, would subject the cleantech industry to devastating boom and bust cycles.

Count on Less Fuel. . . and Less CO2

It's fairly astonishing, but none of the climate change models take the peaking of any fossil fuels into account. They all project — over a period of 30 years or more! — fairly simple growth curves for population and the global economy, assuming that sufficient oil, gas and coal will be available to satisfy demand at historically normal prices.

As the peakists know, nothing could be further from the truth.

If my current understanding of the situation is even close to correct — peak oil circa 2005-2012; peak gas 2015-2020 and peak coal 2025-2030 — then the climate models are not accurately modeling 78% of the global energy supply over the next 30 years.

Accordingly, the CO2 projections must be wrong. Ultimately, the population-based forecasts must also be wrong. The peak oil study can help correct these glaring flaws by offering better data to the CO2 emissions models.

Easier to Switch than Fight

Resisting the policy focus on climate change, and resisting the truth about peak oil, the fossil fuel industry has become its own worst enemy.

By perceiving these issues as threats, the Browns have created a vicious cycle. Fighting the renewable energy revolution sows public opposition, adds cost, and delays the deployment of renewables, which makes the CO2 problem worse. The worse the CO2 problem gets, the more it costs them.

If instead the Browns acknowledged that the future of fossil fuels will be increasingly difficult and expensive, and that CO2 is a problem they need to own, it would feed a virtuous cycle.

Peak-adjusted fuel models would lower the projected CO2 emissions, reducing the cost of mitigation and buying a bit more time for the transition to renewables. It would give the energy industry a clear mandate to invest more in renewables, and do so in a measured, less disruptive way. In turn, the accelerated adoption of renewables would reduce CO2 projections and feed further investment, reducing CO2 even more.

Hopefully, the peakists can help the fossil fuel industry come to terms with a decarbonized future, and in so doing, ensure its long term survival.

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Incentivize, Don't Penalize

Perhaps the most important way that the peakists can help the climate change cause is by changing the focus to what goes into the engine, instead of what comes out of the tailpipe.

As I have argued, incentivizing renewable energy solutions would be far more effective than penalizing fossil fuel producers. As an example, consider carbon capture and sequestration (CCS).

CCS remains an infant technology. As a recent article in Scientific American pointed out, there is currently only one project in the world that does CCS (the 1,300 megawatt coal-fired Mountaineer Power Plant in West Virginia), and it captures a lousy 1.5% percent of its emissions.

Before CCS can be scaled up, there are also significant issues to be solved in finding sufficient storage capacity, transporting the CO2 to the storage sinks, and doing it all at an acceptable price.

Worse, if CCS is ever deployed at scale, the cap-and-trade approach to CO2 emissions would push the technology toward cement factories and natural gas-fired power plants before coal-fired plants, because of the additional cost and complexity of filtering out CO2 from coal plant effluent.

The CCS process alone will consume an estimated 30% of the energy a "clean coal" plant produces, and add up to 78% to the cost of the produced power. Should the technology catch on, its added costs and reduction in output would likely arrive at the worst time: just as oil goes into its long decline.

Emphasizing CO2 emissions in policy, therefore, has several undesirable outcomes: It doesn't address coal plants satisfactorily; it raises costs substantially; it reduces overall power output; and it engenders resistance from the energy industry.

By contrast, focusing on the renewable generation side — what goes into the engine — results in increasing amounts of power that was clean to begin with, at ever-declining costs, and could create a long-term growth opportunity for the energy industry.

Follow The Yellow Brick Road

One needs to look no further than the backpedaling in anticipation of the Copenhagen summit to see the fundamental problem. The meeting is now essentially pre-programmed for failure, thanks to a continuing deadlock between developed and developing nations over who will shoulder the responsibility for future emissions.

It doesn't help that President Obama has refused to commit to binding emissions targets internationally before Congress passes domestic emissions legislation, and that the U.S. Senate has now decided not act on its bills until the spring.

Commenting on the climate bill, Sen. Claire McCaskill (D., MO) said, "It's really big, really, really hard, and is going to make a lot of people mad."

I think that's true, and it should tell us something: It's a whole lot easier to find the financing and business support to roll out millions of little solar systems and insulation upgrades and more efficient vehicles, and so on, than it is to get a world full of politicians to agree on anything. Even after you get that agreement, you still have to build the solar systems and cars and install the insulation.

At best, the summit will probably result in non-binding political agreements. But I prefer to take a longer view of the climate change movement.

It doesn't really matter if Copenhagen is deemed a failure or a success. And it doesn't really matter if we take a backwards approach to the renewable energy revolution.

The only thing that matters is that the world continues to make progress in the right direction. Here, the peakists have an important role to play.

Somewhere over the rainbow, down a long and winding Yellow Brick Road, is energy's Emerald City, and we'll need the pragmatic peakists to lead us there. With their help, the Greens can get their heads out of the clouds, the Browns can move their rusting limbs again and learn some compassion for the earth, and the policymakers can find some courage.

Until next time,

Chris

China The Vampire Squid of Commodities

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For my final report on the 2009 ASPO peak oil conference, I must address the world's new prime mover of commodity demand: China.

With flat-to-declining economic growth rates in most of the rest of the world, the Red Dragon has emerged as the dominant force driving global demand for natural resources.

Adam Robinson, a Vice President at RBS Sempra Commodities who gave an excellent talk on the oil trade and its relationship with the recession, noted that China's willing to buy oil in size at $55 a barrel for its strategic stocks, providing a natural floor for global prices.

Steven Kopits, the managing director of Douglas-Westwood LLC, said China will overtake the U.S. as the world's top consumer of oil by 2018. In fact if supply is available, he thinks it could double U.S. consumption by 2025.

Tom Petrie, Vice Chairman of Bank of America Merrill Lynch, essentially agreed. In his model, all of the growth in oil demand through 2030 comes from non-OECD countries, with China accounting for fully 43%. The IEA anticipates that absolute oil consumption in the OECD will fall over next 20 years by about 3 mbpd, while China's increases by 9 mbpd.

Investors are looking at the convergence between falling OECD oil demand and rising demand in non-OECD, Robinson explained, and after taking monetary policy into account, the see commodities winning either way.

His reasoning is astute: Even if the Fed's fiscal stimulus turns to drag, and we don't get the recovery, then where does the dollar go? Down - which will be bullish for commodities. And if we have a V-shaped recovery, demand and prices will rise - again, bullish for commodities.

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Voracious Demand

In his presentation on China's oil and gas balance, Michael Rodgers of PFC Energy made one thing abundantly clear: China's domestic oil production has nearly peaked, while its demand for oil is only going up.

China currently accounts for about half the total oil production of South Asia, Southeast Asia, and Australia combined:

Source: PFC Energy

The crude oil reserve balance for Asia went negative in the early 1980s, when the region began producing more oil than it was discovering. Like the rest of the world, most of its current production is from large reserves discovered in the 1960s and 1970s, supplemented by smaller discoveries since. The region's current deficit is about 1.5-2 billion barrels per year.

Source: PFC Energy

After years of continuous increase, China's oil production base is now in decline with overall depletion levels of 60%. Fields producing prior to 2000 are generally declining at rates of 5-7% per year, but mature fields are declining by as much as 16-20%. China expects enhanced oil recovery (EOR) technology to bring the overall decline rate to 6.7%.

New fields should allow it to maintain a production plateau around 3.6-4 mbpd for another 8-10 years in the PFC forecast. But then China will see a "catastrophic" drop in production as mature fields, accounting for 3 mbpd of production now, fall to about 1 mbpd by 2020.

Against a GDP growth rate of 8-8.5%, the stagnant supply picture means that China's demand for oil imports will grow from 4 mbpd today to over 10 mbpd by 2020. China now constitutes 7.5% of global GDP and 9% of global oil demand, which will soon grow into the teens.

An appetite like that, Rodgers said, means China must do exactly as it has been doing: aggressively compete with the rest of the world to secure reserves, and export workers.

The picture for natural gas is slightly better, but also points to sharply increasing imports. China's gas consumption is expected to rise from 7.6 billion cubic feet per day (Bcfd) in 2008 to over 30 Bcfd by 2030. Domestic production should keep up with demand until around 2014 — at which point imports will have to pick up the slack - and peak around 2020.

China is already building pipelines from every possible direction to import gas. I'm sure I'm not the only one who, looking at the following map, thinks "vampire squid."

Source: PFC Energy

China's demand for coal is just as astonishing: In just the last four years, Kopits observed, its increase in demand for coal was equivalent to the total U.S. coal demand.

Vince Matthews, director of the Colorado Geological Survey, rounded out the picture with some stunning facts on the demand for minerals and other commodities. China is:

The #1, #2 or #3 producer in the world for 15 of the most important commodities;
The #1 importer of copper, accounting for more than 40% of world demand;
Both the #1 producer in the world of iron ore and the top importer;
The #1 car manufacturer in the world, and the #1 car market. (Petrie later made a similar point: China is now second only to the U.S. in first-class interstate highways.)

Consider this little factoid: China built 70,000 new supermarkets in 2005 alone. For a little perspective on that number, the 2002 census counted about 150,000 "food and beverage stores" in the United States.

That voracious demand drove up prices across the board. Matthews ran down a list of price increases from various months in 2003 to the present:

Copper up 307%
Scrap iron up 559%
Molybdenum up 997%. Exports from the U.S. doubled, most of which went to China.
The average price increase of major metals was 379%, and the average price increase was 746% for 15 other industrial metals.

Although prices for many of the metals fell sharply in the commodity crash last year, they're now staging a comeback, driven by Chinese demand.

Worse, most of these metals are bought via long term contracts, not on the spot market. When those contracts expire, Matthews expects spot prices to spike again.

Even cement demand was disrupted when China when began importing it in 2003, resulting quickly in price spikes and shortages in the U.S. China now consumes half of all the cement in the world.

The resources causing the most consternation, though, are the rare earth elements. As I discussed a few weeks ago, China has a virtual corner on the world supply of these crucial elements, which are used in wind turbines, solar equipment, parts for hybrid cars, and many of the other solutions for a post-peak oil future.

The U.S. now imports between half and all of its supply of the rare earths, putting it at China's mercy for some of the raw materials that would be needed for a "Made in the U.S.A." renewable energy revolution.

Indeed, Matthews believes that China intends to take advantage of its position by clamping down on its exports of rare earths, to bring world manufacturing to them.

But perhaps this should not unduly alarm us.

If China is clear-headed and deep-pocketed enough to invest in the energy solutions of the future while we are not, and they can build them faster and more cheaply than us, then maybe it's time to stop worrying and learn to love our new Chinese overlords.

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Outmaneuvering America

Rodgers has no doubt that China understands peak oil and expects future supply disruptions, which is why it's accumulating foreign assets and diversifying its import options.

Peter Dea, the president of oil and gas exploration and production company Cirque Resources LP, made the same point a bit more obliquely, rhetorically asking if China had no doubts about the future of oil, why would they have recently outbid Exxon Mobil for new drilling in Ghana?

Putting a finer point the difference between the strategies of the U.S. and China, Dea wryly observed that the U.S. has potential for offshore drilling for natural gas, but "it won't be developed until the U.S. takes energy resource planning as seriously as China does."

That doesn't appear to be in the offing any time soon. Washington doesn't seem to understand the commodity markets at all, Matthews said, nor the shrewd moves that China is making. While Japan already has a strategic mineral stockpile, and China is quickly amassing one, the U.S. is selling off its key minerals: "The lack of knowledge and concern over it in Washington is horrifying, and I can't explain it," he moaned.

Well, I have explained it: America has no energy plan, and we won't have one until we give up our fantasies about energy independence or drilling our way out, admit that oil is peaking, and get serious about planning accordingly.

While America was busy with its hallucinated wealth meltdown and trying to raise some cash by selling assets at garage sale prices, just one of China's three major oil companies, CNPC, secured 75 resource projects in 29 countries.

Another of the three, energy giant China National Offshore Oil Corporation (CNOOC), just bought oil assets in the US for the first time. The size of the deal for four deepwater exploration licenses in the Gulf of Mexico was undisclosed, but Norway's Statoil, the seller, characterized it as "small."

Still, the purchase is bound to make it more difficult for China to maintain a low profile as it snaps up resources.

Perhaps that's why it has begun trying to cover its tracks: China OGP, an oil industry newsletter issued by Xinhua news agency, recently announced that it would no longer publish data on China's stockpiles of crude oil, gasoline, and diesel. (As if that data weren't hard enough to get already! Killin' me.)

The lesson on China for retail investors should be clear: Buy domestic reserves while they're cheap, and hold ‘em, hold ‘em, hold ‘em.

Until next time,

Chris

Editor's Note: This article is the final part of Chris's six reports from the 2009 ASPO Peak Oil Conference. See also Part 1, Part 2, Part 3, Part 4, and Part 5.

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No Plan for Oil Shortages in North America

On Halloween day this year, I killed part of a beautiful afternoon at a local shooting range with a buddy. It had been quite a while since I did that, and I needed the practice.

[I know some of my gentle readers might find it a little shocking that a peace lovin' hippie like me would do target practice, but I was raised with it. My parents put us boys through the NRA's gun safety program at a fairly early age, before agreeing to take us hunting. Later I was certified to carry a weapon in the line of duty as a security officer. I've always had a healthy respect, if not real love, for guns.]

I was taken aback when I walked in the door at the nondescript, low industrial building. The place was packed. I could hardly find a place to stand and I waited about 15 minutes just to speak to a clerk. The registers were ringing constantly, taking in $100-$300 totals at a whack. Where I come from, we call that a gonga business.

The gun business has been strong this year, without a doubt. Guns have been flying off the shelves and ammo shortages have been common (and surrounded by conspiracy theories).

Unfortunately, most gun makers are small private companies that make high specification steel, leaving Smith & Wesson (NASDAQ: SWHC) as one of the few good tradeable stocks in the sector. And it has done nicely: up 62% YTD after declining from a huge rally in the spring.

Clearly, the general public has had an increased appetite for guns. And let's not kid ourselves — they're not planning to go deer hunting. It's about fear in an increasingly chaotic world and demand for better personal defense.

From an energy standpoint, that fear is certainly justified.

No Plan for Oil Shortages

At the 2009 ASPO Peak Oil Conference, the security outlook for North America was given a surprising twist by Rick Munroe, a Canadian farmer who learned about peak oil some years ago and decided to find out if the military or the government was doing any planning to address the problem.

His efforts turned up three good studies: Alan Smart (ACIL Tasman, 2004); Kathy Leotta (PB, 2004); and Helen Peck (Defence Academy, 2006). But within the actual gears of government, he found naught but denial.

One government official assured him that because Canada is a member of the IEA and has 200 years of oil supply in the tar sands, people should relax. (If you don't immediately realize what a cretinous statement that is, see "The IEA'S Come-to-Jesus Moment" and "Tar Sands: The Oil Junkie's Last Fix," Part 1 and Part 2.)

Munroe found numerous studies about peak oil by the GAO (U.S. Government Accountability Office), which were apparently dropped from any further consideration. As early as 1981 the GAO wrote: "It is questionable whether an adequate organizational structure exists which could effectively manage a crisis."

The IEA's messaging has been clearer. In 2005 it warned that pre-planning is critical, and that the public must be primed and well informed in advance. Yet their strategies for dealing with the impending oil crisis are laughable, boiling down to a short term "surge" in production, and drawing down emergency reserves-at most, a 90-day solution.

Munroe offered a quote by Dr. Helen Peck, a lecturer at Cranfield University in the UK and an expert in complex systems, energy security, and national emergency planning, that highlighted the relationship between food and energy I wrote about in my last article: "The fundamental problem is that it is the very efficiency of the nation's food and drink supply chains, under normal circumstances, that make them so vulnerable under abnormal ones."

Those who try to plan for such emergencies know that in the absence of a plan, the public usually responds to shortages with panic buying and hoarding. Preventing such an outcome requires top-to-bottom pre-planning.

Yet those who have tried it found that mandatory measures are hard to implement. Energy expert and veteran government researcher Roger Bezdek explained at the 2007 peak oil conference that he worked on an oil rationing program in the 1970s, and it was "a nightmare." The team found that they could not improve upon the market, and indeed, he now believes that many of the problems we had in the 70s were due to government interference in the markets.

In his research, Munroe found a confidential report by the IEA explicitly stating that in the event of a crisis, the market should be left alone and allow price spikes to pass through to all consumers. And as recently as 1996, he says, the GAO expressed its faith in the principle by writing "physical shortages. . . are virtually impossible in a market economy."

We know something about what the market does when supplies run short. It caused oil prices to triple up through last July. In fact that outcome was actually anticipated by a 2005 intelligence exercise called "Oil Shockwave," in which nine former White House cabinet officials convened to simulate what would happen if 4 mbpd of global oil supply were suddenly lost. The predicted result was a near-tripling of the world oil price.

U.S. Secretary of Defense Robert Gates was one of the participants in the exercise, and commented afterward, "The threat is real and urgent, requiring immediate and sustained attention at the highest levels of government."

Yet, four years later, not one city, state, or federal government in North America has a plan to deal with the effects of an oil shortage. The official plan is to have no plan.

We can rest assured that the government won't be on our backs the next time there is a supply interruption. As long as we can pay — even if gas is $7 a gallon — there simply cannot be physical shortages! Hurrah!

Grid Security

The U.S. electrical grid has its own peculiar security issues, as Scott Pugh testified in his presentation at the conference. Pugh is a former captain of the U.S. Navy and now serves with the Department of Homeland Security (DHS).

Few people know this (I certainly didn't), but our national grid has three parts: East, West, and Texas. A major grid fault can take down the entire western or eastern halves of the country without affecting Texas, so, Pugh quipped, "Texas can secede from the union any time they think they should."

It's a good option to have. U.S. grid power is generated by over 1,400 power plants and passes through some 25,000 substations in a network of transmission and distribution lines, all of it privately owned by hundreds of transmission utilities & generating companies. A shutdown at any one of those points can take down large segments of the grid.

In an effort to assess the grid's vulnerability, DHS and DOE staged a cyber attack test in 2007 to see if they could shut down a substation by damaging it with a cyber attack. They succeeded. Subsequent war game scenarios produced frightful results.

Yet, as it now stands, the agencies are primarily working on alternative ways to respond to an attack, and praying for a rapid smart grid transformation which should make more fine-tuned grid control possible. In any case, their hands are somewhat tied, said Pugh, because the government doesn't see fit to interfere too much with the privately owned grid infrastructure.

Laissez Faire or a Dereliction of Duty?

It may be the most heinous dereliction of duty ever witnessed in the history of democracy, but that's where we stand in North America. While the UK, Australia, and New Zealand continue to work hard on contingency plans for an oil emergency, we remain in widespread institutional denial, complacent that our fuel supply will be assured by the wise hand of Mr. Market.

We don't need no stinking plans. Panic buying and hoarding — pshaw! We're going to do the job the free market way, through voluntary demand reduction and switching fuels! Remember how the financial markets worked so much better after the Phil Gramm era of deregulation?

If a supply interruption event should happen, and farmers can't get fuel to plant their crops when the seasons dictate. . . well, the resulting food shortages and price spikes will simply have to be the cost of doing business in a free market system. And if oil and gas companies, airlines, trucking companies, farmers (and, well, just about everybody), can't swing with increasingly frequent fuel price spikes and crashes — then I guess we don't need them.

Our government's blithe laissez faire attitude toward the threats of fuel shortages and grid attacks may be intellectually comforting to free market champions, but I'm willing to bet that should such events seriously compromise national security, they'd turn authoritarian in a heartbeat. . . and that includes me.

After seeing these presentations my first thought was: This is utter insanity. We need to nationalize the grid and prepare for deliberate fuel rationing ASAP.

It's not that the government doesn't know about peak oil. Some of the most important studies on the subject and on its likely effects have been produced there. Indeed, Pugh asserted that the military definitely gets peak oil because "they're paying for fuel in money and blood daily." Their primary focus is on using it more efficiently, he said, but they don't worry about shortages because "there's always going to be enough oil for the military."

I'm sure that's true. But I'm not at all sure it's something we want to test.

Failing to plan is planning to fail. The government's weak, bumbling federal response to Katrina is still relatively fresh in the national psyche. And there is a growing awareness among the rank and file that the free market's ability to govern itself failed miserably in the financial meltdown of 2008, and laid a heavy burden of debt on the next several generations of citizens.

Is it any wonder that people are starting to think about personal defense? About being able to generate and store their own electrical power? About growing their own food and putting up some extra canned goods, water, and batteries in the basement, "just in case?"

Until next time,

Chris

The 2009 IEA Oil Report & World Energy Outlook

The International Energy Agency (IEA) released its annual World Energy Outlook (WEO) this week — a report I always anticipate eagerly. Hey, it's like Christmas for energy geeks.

The IEA found coal in its stocking though, after a report the previous evening in the UK's Guardian newspaper cited unnamed whistleblowers alleging the agency had been distorting its true view on peak oil in order to prevent public panic.

The internal sources claimed its analysts did not really believe that global oil supply could rise to the level in the official forecast, but that the agency had bowed to U.S. pressure to paint a rosier picture.

The quotes were unquestionably damning:

The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this. . .

Many inside the organisation believe that maintaining oil supplies at even 90m to 95m barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further. And the Americans fear the end of oil supremacy because it would threaten their power over access to oil resources. . .

We have [already] entered the 'peak oil' zone. I think that the situation is really bad. . .

. . . imperative not to anger the Americans. . .

Peak oil analysts nodded their heads in agreement. It was hardly a revelation.

John Hemming, the MP for Britain's all-party parliamentary group on peak oil and gas (yes, they actually have one — jealous?) was gruff: "Reliance on IEA reports has been used to justify claims that oil and gas supplies will not peak before 2030. It is clear now that this will not be the case and the IEA figures cannot be relied on."

I've critiqued the reports of the Energy Information Administration (EIA) and the IEA many times over the years (here, here and here), and concluded that both agencies understood the reality of peak oil well enough, but somehow had been pressured to spin the story in the most optimistic way possible. Either that or they had some seriously schizophrenic people.

I have no doubt that a cohort of government and industry representatives from the U.S. and other OECD countries (at whose pleasure the IEA serves), have made their preferences known to the IEA leadership, and possibly reminded them who's their daddy. After all, the agency was created after the 1974 oil crisis for a fundamentally political purpose: to safeguard the West's energy supplies.

To be clear, my analysis of the agency's data supports the allegations. Uncertainty has always been used to put an optimistic spin on the reports.

Several years back, it was the uncertainty around enhanced oil recovery and new discoveries, and the potential for higher prices to increase recoverable reserves

When conventional crude flatlined at 74 mbpd in 2005, despite a tripling of prices afterward, the emphasis shifted to the unrealized potential for non-OPEC supply.

When that didn't pan out, the potential for unconventional sources such as natural gas liquids, tar sands production, extra heavy oil, coal-to-liquids, and biofuels defined the optimistic gray zone.

There were also a few disturbing discontinuities along the way in which report summaries didn't quite match up with the details in the later chapters. Various kinds of unconventional fuels began creeping into the "conventional crude" category.

The spin was absolutely detectable to a sharp eye.

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Concealed Clues

At the same time, another transformation was taking place.

The edges between the solid data and the gray zone gradually became sharper. Over the last few years, the agency's estimates for peak oil production fell from 120 mpbd to 105 mbpd. . . but oddly, their forecast for the date of the peak remained stubbornly around 2030. Curves were gradually flattened, but reached the same point. Simple head-scratchers like that.

The language of the reports also grew in clarity and intensity, alarming critics. By last year, it had become downright shrill: "The world's energy system is at a crossroads" . . . "global trends. . . are patently unsustainable". . . "the era of cheap oil is over". . . "Time is running out and the time to act is now."

This year, they admitted what many of us had already figured out: non-OPEC supply has basically peaked, yet forecasted that global oil supply would still rise from 84.6 mbpd in 2008 to 105.2 mbpd in 2030.

They then devoted fully half the report to a "450 Scenario" in which a vigorous global investment in efficiency, renewables, carbon capture, and nuclear power averts global disaster by keeping atmospheric CO2 concentration below 450 ppm, with a price tag of $26.5 trillion (in 2008 dollars).

The good news now is the situation isn't quite as dire as we thought it was last year. Their cost forecast has come down from $35 trillion, and they now think the world will only need to come up with 45 mbpd in additional crude capacity (another four Saudi Arabias) not 64 mbpd (another six).

Indeed, the divisions between reality and fantasy in this report grew sharper still.

They worry at length about the effect of the global financial crisis on investment in new energy supply, yet still imagine the world will spend about $1.5 trillion a year on new supply infrastructure.

While envisioning a massive investment in efficiency and renewables in the 450 Scenario, they observed that low oil prices, receding investment in cleantech in 2009, and general economic malaise could mean slower growth rates for the solutions.

They forecast that OPEC alone would come up with 17.5 mbpd in new supply — 85% of the global increase — but expect the Middle East to spend only $1.9 trillion out of a global total of $25.5 trillion.

In an extremely dubious scenario, they see global natural gas supply growing faster than demand, eventually resulting in a massive glut. At the same time, they published for the first time a detailed, field-by-field analysis of nearly 600 major gas fields, accounting for 55% of global production. It showed an average 5.3% post-peak decline rate for the world's largest gas fields, and a global production-weighted decline rate of 7.5% for all post-peak fields — very similar to the decline rates they published (again, for the first time) last year on oil fields.

While noting that nearly all of the growth in global energy demand will come from the developing world, and that much of the investment capital needed to obtain their 450 scenario will need to be invested there, they also expressed significant uncertainty about those prospects.

Most telling, however, were the comments made in the press conference at the report's unveiling.

When a reporter asked why they're still sending a signal that the world will come up with another four Saudi Arabias of supply in their reference scenario, when no one believes that is possible, IEA chief economist Fatih Birol tipped his hand:

This is not the scenario we think is — first of all — likely; this is not the scenario that we want to happen. . . This is the scenario that, if it happens, we are going to have an accident in terms of climate, in terms of energy security, and other things, and it is the reason why we are pushing the 450. . . We push the 450 not only for the climate change reasons. . . it is also for the energy security reasons. And it is the reason why our ministers in October have endorsed our work in general. . . We think this [report] is a driver for [policies developing around climate change].

Essentially, he admitted that they deliberately tilted the report toward climate change with an expressly political purpose: to motivate capital and policy in the direction of a decarbonized energy supply. And they did that because it was politically expedient, with all eyes now on the upcoming Copenhagen summit on climate change.

Finally, the agency's highly-nuanced, limp denial of the whistleblower allegations was well salted with impassioned pleas to reckon with their 450 Scenario, reiterating that "the era of cheap oil is over." Birol even emphasized that the IEA had decided to make their data on oil depletion available on its web site for the world's free and transparent examination — a clue that was not concealed, but painted in fluorescent orange.

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The Climate Change Stalking Horse

I have considerable sympathy for the IEA. It's not easy to follow your heart and tell the truth for the benefit of humanity while the boss man is glaring at you and pulling a finger across his throat. Of course their report is politically distorted.

Yet, as I highlighted the key points in the report's executive summary and mentally ticked off the articles I've written on each one over the last few years, I realized how far the IEA has really come. They may have no choice but to walk a tightrope in an intense global spotlight, but they're backing into the truth as quickly as they think they can. For that fact alone, despite its flaws, this report gets my thumbs-up.

Regarding the IEA's Reference Scenario, my view remains basically unchanged from what I said this time last year: "Here's my prediction: their 2010 report will state that the new peak is only 95 mbpd, at a cost of over $30 trillion. And by 2012, they'll admit that the peak was in fact in June of this year, at 87 mbpd. By 2030, fully 20 years past the peak, world oil production will likely be under 70 mbpd."

As for the 450 Scenario, I continue to believe that climate change is a backwards approach to the problem. I have seen no serious rebuttals to the studies by Kjell Aleklett and David Rutledge calling into question whether the world can even get to 450 ppm when peak oil, and then peak gas and peak coal, are properly considered. (Currently, no climate change scenarios have any cognizance of fossil fuel peaking whatsoever.) In e-mail correspondence this week, Aleklett told me that he will soon have two new newspaper articles published in his native Sweden (which will be translated to English) that demonstrate on scientific bases that all of the IPCC scenarios are wrong.

But even that is not important.

Climate change is merely a stalking horse for the IEA. Whether we focus on energy or on climate, the ends are largely the same. And the IEA has astutely recognized that there's a whole lot more public momentum and investment money to be focused on climate change than there is on dour old peak oil.

What the 2009 WEO Really Means

I could go on for pages and pages, as I have in the past, pointing out the discrepancies and critiquing the scenarios. But that's not really what this report is about.

Never mind the outlandishly optimistic oil and gas production scenarios. We can throw out the 450 Scenario, as well. They're wrong, and we all know it — wink wink, nudge nudge.

The IEA doesn't believe either one of its scenarios any more than they believe humans roamed the earth with dinosaurs. Some stories are meant to be read as parables.

The internal message of the 2009 WEO is clear: The world is facing an energy crisis of epic proportions. The path we're on is precarious and unsustainable. (The word "sustainable" occurs 18 times in the report, which I'm sure is a record, and Birol repeatedly emphasized the phrase "energy revolution" in his comments.)

There is a way to avert disaster, but it's going to require the world to commit an incredible amount of capital to the energy sector for many decades to come. And if we fail to rise to the challenge, we'll be dead in the ever-rising water.

That, of course, is our entire raison d'être here. To motivate capital, rise to that challenge — and make some cheese in the process.

And making cheese is exactly what people who see the forest for the trees have been able to do — not just by questioning what is fed to them via sugarcoated goverment reports. . . but also by following the guidance of experts.

My work gives me the pleasure of working with people who know how to surpass the cold feet many investors have these days and invest with success. My colleague Ian Cooper is one such person. Members of his Pure Asset Trader have been having nothing but success, in spite of the market's volatility. In fact, they're trading with a 94.2% success rate. You can read more about Ian's service here.

Until next time,

Chris

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How To Invest in the New Energy Paradigm

One of the more interesting themes that emerged from this year's ASPO peak oil conference was the problems of maintaining complex systems, and the role that energy plays in them.

Dr. Jason Bradford, the biology brains behind Farmland LP (more on that here), ticked off a few of the key vulnerabilities of the U.S. food system in his presentation on sustainable agriculture:

Commercial agriculture consumes 10.3 quads (quadrillion BTUs) of primary energy in order to produce 1.4 quads of food energy. The inputs are mainly fossil fuels used in running tractors, producing artificial fertilizers, producing seeds, trucking, refrigeration, processing, freezing and cooking.
Commercial agriculture not only depletes non-renewable resources and degrades soil, air, and water, but it also releases 5 billion pounds of harmful chemicals and massive amounts of greenhouse gas emissions into the environment per year.
Animal waste provides critically important fertilizer to small distributed farms, but in the modern massive feedlots of concentrated animal populations it becomes an environmental hazard. All the feed transported to the feedlots uses petroleum fuels, and the hay is grown using ancient "fossil water" pumped from deep, essentially non-renewable aquifers.
Over the last four decades or so, runoff from commercial agriculture has resulted in massive "dead zones" near our shorelines caused by algae blooms that suck the oxygen out of the water and create anoxic environments where nothing can live. (The dead zone in the Gulf of Mexico has grown to an estimated 8,500 square miles.)
Just three crops comprise 71% of U.S. crop acres: corn, soybean, and wheat.
Monsanto, Pioneer, and Syngenta —all basically chemical companies — dominate the seed industry with patented GMO seeds. Those seeds are finely tuned to the temperature, rainfall, and so on of the recent past, making climate change a major threat to the whole food regime (more on that here).
Likewise, a handful of giant companies now control the vast majority of the food supply system — a stark contrast to the millions of small family farmers who dominated it prior to the 1960s.
Nearly all of the food delivery system uses just-in-time inventory methods, so there is only one to three days' supply at any point in the distribution chain.

In short, Bradford explained, we have built a complex food supply system with very low diversity and strong connectivity. Yet in nature, those characteristics lead to instability. Stable systems are highly diverse with weak connectivity. The very complexity and interconnectedness of our food web is, in itself, a dangerous vulnerability.

Bradford aptly compared our blithe faith in the food supply system to "the hubris of Wile E. Coyote" just before he realizes he's about to plunge into the canyon.

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The Energy-Water Nexus

A presentation by Michael Webber of the University of Texas at Austin emphasized another important interrelationship: We use water for energy, and energy for water.

Nearly all power plants are thermoelectric heat engines — they use heat to produce electricity (the notable exceptions to this are hydro power and solar photovoltaics). Although there are many variations of the process, here's a simple explanation: A source of heat is applied to one side of the engine, which causes the expansion of a gas. The expansion of the gas makes a turbine spin, generating electrical power. The heat is then dumped by the cold side of the engine, which causes the gas to condense again.

Water is typically used to remove the heat on the cold side. Air-cooled plants are also possible, but they are less efficient because they're less cold, and so water-cooled plants are far more common.

It should come as no surprise, then, that the largest user of water in the U.S. is the thermoelectric power sector, accounting for 48% of the total water withdrawal and 39% of freshwater withdrawals.

The first vulnerability of the energy-water relationship is what happens when insufficient (or insufficiently cold) water is available: It forces power plants to scale back, or shut down altogether, which has happened at numerous coal- and nuclear-fired plants around the world over the last few years.

Webber believes that droughts could even close nuclear power plants in the Southeast permanently due to limited water.

On the flip side, Webber noted that roughly 10% of electricity in the U.S. is used for waste and wastewater, including end uses. But in denser, larger states the energy load can be much higher. According to a 2005 study by the California Energy Commission, fully 19% of the state's energy use is related to pumping, treating, transporting, heating, cooling, and recycling water.

The energy-water nexus includes liquid fuels as well as electricity. Net energy researcher David Murphy noted at the conference that the EROWI (energy returned on water invested) is 228 for petroleum diesel, but only 0.024 for corn ethanol, because making it requires massive amounts of water.

Producing liquid fuels from low-grade resources like tar sands and oil shale also requires enormous amounts of water to produce steam and fracture shale. Vince Matthews, the director of the Colorado Geological Survey, expressed his doubts at the conference that his state's shale resources would be developed because of the water dependency. The "head" of the state's water supply is dropping by about 30 feet per year, he said, and has been falling for 20 years. He expects it to hit the aquifer around 2011.

Finally, we must not forget that most of the Middle East is investing heavily in the desalination of seawater to provide adequate fresh water for its burgeoning population (and of course, its indoor ski slopes). Desalination requires over 9,800 kWh per million gallons, according to Webber. I can easily imagine desalination becoming a major factor in the declining oil exports from the Middle East.

On the energy-water nexus, Webber made two important conclusions: first, we need to rethink transportation; and second, water conservation and energy conservation are synonymous.

Peak Credit = Peak Oil

Gail Tverberg, energy analyst and editor of The Oil Drum, discussed the financial side of complexity in her presentation, describing the economy as a highly-networked system of great interdependence: manufacturing depends on international trade; businesses depend on credit, manufactured goods, and electricity; electric utilities depend on credit and on replacements parts, and so on.

There is a systemic risk in highly-networked, interdependent systems she said, like a computer crash: one thing stops working, and everything else stops working. International trade and finance and credit, for example, are closely linked with oil extraction. It's not coincidental that consumer credit peaked in July 2008, just as oil production peaked. . .

Credit enables oil production, and also enables demand for oil, by allowing consumers to buy things made with and from oil. Conversely, shrinking oil supplies limit economic growth, leading to the kind of defaults we saw this past year. When banks cut back on lending, it leads to less supply and less demand.

The net impact of credit on oil is that it provides positive reinforcement for oil extraction when it's growing, and negative reinforcement on the way down. Peak oil equals peak credit, and peak credit equals peak oil.

Therefore, Tverberg concluded, our complex systems' vulnerabilities to peak oil extend far beyond mere fuel supply. Our current model of food production may cease to work. Our current model of transportation may cease to work. Globalization will fail without ample cheap liquid fuels, making re-localization a necessity. And ultimately, without all complex systems we take for granted today, we will likely be forced to accept a much lower standard of living.

Simplify, Simplify

Simon Ratcliffe, an energy advisor for the UK government and an expert on energy and security in Africa and South Africa, offered this graphical depiction of some of the interconnected risks he has studied in those nations:

Source

Just reading a chart like that makes you want to turn away and latch onto a simpler view, doesn't it? Well, keep that in mind and we'll return to it in a moment.

The problem with complex systems of course is that they're. . . well, complex.

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No one can model demand accurately, and no one predicted that oil would hit $147 and $33 in a span of six months last year.

No one has a good model for the feedback loop from GDP to oil demand, oil demand to price, price to supply, and supply to GDP — let alone the influence of new Frankenstein financial instruments and monetary policy.

No one has a good model for how much fossil fuel we'll need to build the renewably-powered infrastructure of the future, let alone how we'll procure it in a scenario of shrinking global supply. (In fact, hardly any models even contemplate the reality of depletion.)

No one seems to recognize that although the population growth curve led the energy curve on the way up, energy will lead population on the way down.

Even the historical data is all from an era of constantly growing energy supply, making it a poor guide to the future.

A quick aside: In a presentation to the World Future Society annual conference this year, David Pearce Snyder, an editor of The Futurist magazine, argued that schools are not equipping students with the necessary skills to deal with complexity, and that new curricula are essential to surviving the modern world. I agree completely.

So how can retail investors navigate this increasingly complex and chaotic world?

My guiding lights here include the likes of E. F. Schumacher, Paul Erlich, Paul Hawken, and Thomas Malthus — they were right, if a little (or a lot) early. And of course Henry David Thoreau, who exhorted us to simplify.

They would tell us to focus on simplicity in our investing strategies: Think locally, not globally. Small and distributed is more resilient (and more beautiful) than big and centralized. Using less energy to accomplish the same thing will succeed over trying to produce more energy. Imitating nature's low-energy, low-impact, non-toxic methods in our industrial activities — a study now known as biomimicry — will succeed over inventing wacky new chemicals that nature has never seen before.

From now on, we should let the K.I.S.S. principle be our guide: Keep It Simple, Stupid.

Until next time,

Chris

P.S. As you may know, Green Chip's Nick Hodge has been making a killing by following a simple investment strategy. By focusing only on cleantech stocks, he's been able to close a winner for his readers every single week this year. In fact, he's even taken several double-digit gains from the very sectors I discussed today: water and energy efficiency. And he thinks his next pick — a tiny Chinese lithium-ion battery play — could be one of his biggest yet!

Editor's Note: This article is Part 4 of a series of Chris's reports from the 2009 ASPO Peak Oil Conference. See also Part 1, Part 2, and Part 3.

Energy Sector Outlook

With peak oil already upon us, sustaining oil supply is akin to running up the down escalator.

Or, as Nate Hagens put it at the ASPO peak oil conference earlier this month, "Technology is in a race with depletion and is losing (so far)."

The urgent question then is: Can renewables fill the gap of oil depletion?

Mind the Gap

The most recent global data summarized by fuel available from the EIA is, unfortunately, for 2006 and only preliminary (I know they're trying to improve their reporting, but seriously — they need to do better than that). But we'll use what we've got. . .

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In 2006, the total amount of energy the world consumed was 469 quadrillion BTUs, or quads.* Charted in percentage terms, the global fuel mix looks like this:

World Primary Fuel Mix, 2008. Chart by Chris Nelder. Data source: EIA Annual Energy Review 2008 (released June 2009)

If the latest information I gathered at the ASPO peak oil conference is correct (and I think it is, or at least as close to, correct as anybody is going to come at this point), then we should expect oil to begin declining at about 5% per year, starting around 2012-2014.

Of the 157 quads provided by oil, a 5% decline rate will give way to 7.85 quads lost per year, or 1.7% of the world's primary energy supply.

The "Geothermal and Other" category — supplying 1.6% of the world's primary energy — represents all the renewable sources combined: geothermal, solar, wind, biomass, and so on.

Since 1.7% is very close to 1.6%, we can put the challenge of substituting renewables for oil this way: Starting around 2012-2014, we will need to build the equivalent of the entire world's existing renewable energy capacity every year just to replace the lost BTUs from oil.

Fortunately, renewable energy of all kinds is enjoying a massive growth spurt, attracting trillions of dollars in investment capital. On average, the sector seems to be growing at about 30% per year, which is phenomenal. . . but it's not 100%.

In terms of BTU substitution, then, it seems unlikely that renewables can grow at the necessary rate.

Not Just BTUs

However, the challenge is more complex than mere BTU substitution.

Replacing the infrastructure, particularly transportation, that's based on oil with one based on renewably generated electricity will in itself require energy — and lots of it. As Vail pointed out, between 80% and 90% of the energy inputs for renewables must be made up front, before they start to pay any energy out.

Even if renewables were able to make up all of the lost energy from oil, still more would be needed to afford any economic growth.

In all, it seems a fair bet that it will take at least a decade for renewables to merely catch up with the annual toll of oil depletion. The gap will likely manifest as fuel shortages in the OECD, when the developing world outbids it for oil, and a long economic recession or depression. . . unless efficiency comes to the rescue.

To that point, Jeff Vail, an associate with Davis Graham & Stubbs LLP, said at the conference that population increase alone could offset as much as 30% of the improvement in conservation and efficiency. He noted that despite the recession, car sales are up 29% in India as people buy their very first cars.

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Falling Net Energy

Another driver of the down escalator is that the net energy (EROI, or energy returned on energy invested), of nearly all fossil fuel production is falling.

Dr. Cutler Cleveland at Boston University has observed that the net energy of oil and gas extraction in the U.S. has decreased from 100:1 in the 1930s; to 30:1 in the 1970s; to roughly 11:1 as of 2000.

Simply put: As the quality of the remaining fossil fuels declines, and they become more difficult to extract, it takes more energy to continue producing energy.

This begs the question: What EROI must the replacements have to compensate for oil depletion?

Vail presented several models attempting to answer it. In his optimistic scenario, assuming a 5% rate of net energy decline and an EROI of 20 for the renewables, the "renewables gap" was filled in year 3. In his pessimistic scenario, assuming a 10% rate of net energy decline and an EROI of 4 for the renewables, the gap wasn't filled until year 7.

For a sense of how reasonable those assumptions are, we must turn to the academic literature — since no business or government agency has yet shown any particular interest in EROI studies (much to my dismay).

Studies assembled by David Murphy put the average EROI of wind at 18 (Kubiszewski, Cleveland, and Endres, 2009); solar at 6.8 (Battisti and Corrado, 2005), and nuclear at 5 to 15 (Lenzen, 2008; Hall, 2008). No data is available for geothermal or marine energy. All the biofuels are under 2, making them non-solutions if the minimum EROI for a society is indeed 3 (Hall, Balogh and Murphy, 2009).

[A quick aside: The huge range of the nuclear estimate is one indication of how difficult it is to accurately assess the costs of nuclear, which is part of the reason I still haven't written the article I know many of you are hoping to see some day. I'm working on it, and still looking for current research with appropriately inclusive boundaries and updated numbers. Nearly everyone is still using cost estimates that predate the commodities bull run, not even realizing how it distorts their analysis. So far, I have found nothing to change my outlook that the nuclear share of global supply will stay roughly the same for several decades.]

I am not aware of any studies on the EROI of biomass not made into liquid fuels. For example, methane digesters using waste, landfill gas, and so on. . . but its sources and uses are so varied that if the numbers were available, they probably wouldn't be very useful. While such applications are generally good, they're not very scalable: They work where they work, and don't where they don't.

Theorem of Renewables Substitution

Where EROI analysis leaves us is unclear; it needs more research and a great deal more data. There are some useful clues in it, though.

First, we know that biofuels — at least the ones we have today — won't help much, other than providing an alternate source of liquid fuels while we're making the transition to electric.

Second, we know that solar tends toward Vail's pessimistic scenario, and wind fits the bill for his optimistic scenario.

But here's the rub: The lowest EROI source, biofuels, is the easiest to do, with the vigorous support of a huge lobby and Energy Secretary Chu himself. Rooftop solar is the next-easiest to do. . . but making up the lost BTUs takes longer, due to its moderate EROI. And the source with the highest EROI, wind, is the hardest. (I explained why solar is easier here.)

Therefore I propose the following, slightly snarky Theorem of Renewables Substitution: The easier it is to produce a source of renewable energy, the less it helps.

The Winner: Efficiency

All of these factors — the declining supply, the pressures of the developing world on demand, the renewables gap, and the theorem of renewables substitution — underscore how crucial efficiency is to addressing the energy crisis.

They also underscore how profitable the entire energy sector will be for many years to come.

With supply maxed out, and demand at the mercy of a developing world, the name of the game now is doing more with less. More efficient vehicles and appliances, building insulation, co-generation. . . and all the other ways to eliminate waste.

I know it doesn't have the sex appeal of oh, say, space based solar power. . . but it's where the real gains will be made.

Until next time,

Chris

P.S. Regardless of how the renewables solution plays out, one thing has become blatantly obvious to traders: the longer you sit out, the more you stand to lose. However, trading in today's market can get downright frustrating. . . unless, of course, you're following Ian Cooper's advice.

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Editor's Note: This article is Part 3 of a series of Chris's reports from the 2009 ASPO Peak Oil Conference. See also Part 1 and Part 2.

* The thermal values (heat content) of various fossil fuels are typically measured in BTUs. One BTU is roughly equivalent to the heat produced by burning a wooden kitchen match. One cubic foot of dry natural gas contains approximately 1,031 BTUs. For those who prefer their data measured in joules, 1 quad = 1.055 exajoules (EJ, or 10¹⁸ joules). Renewable energy, however, is typically measured in kilowatt-hours (kWh), or the amount of energy delivered by a one-kilowatt source over the course of an hour. 1 kWh = 3412 BTUs.

Our First Peak Oil Recession

One of the most bedeviling problems for oil producers (and oil investors) is knowing when it's too cheap to keep producing, and when it's too expensive to sell.

Last year gave us new boundaries: $147 a barrel was too expensive, and $33 was too cheap. But those aren't terribly useful numbers in the real world.

We now know that $147 was extra-inflated by too much money sloshing into the sector, and $33 was extra-deflated by the fear and confusion that dominated all markets in December of last year. It's likely that tighter regulation of the oil futures market will tamp down the former, and the latter will not be seen again. . . so long as the world banking system continues to beg, borrow, and steal its way to stability and "full faith and credit."

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If you're a Chevron trying to decide if you should plunk down another $5 billion for a big new deepwater platform, or a marginal producer of oil from unconventional sources where the production cost is high, you'll find it hard to commit to new projects with price volatility like that.

One way to get a handle on the question is to look at the supply side costs. As I wrote in March, the current cost of new production in the few places in the world where oil production can still be increased ranges from $60-$75 a barrel, and the average minimum is around $65. The more extreme and marginal projects we'll be eyeing in ten years' time will need closer to $100 a barrel to pay off.

But prices on the demand side of the equation are harder to gauge.

Our First Peak Oil Recession

Several presenters at the Association for the Study of Peak Oil (ASPO) conference two weeks ago used measures of GDP to express the economy's tolerance limit for high oil prices.

David Murphy, a pioneer in net energy (EROI) research at SUNY, noted that major recessions are always associated with petroleum and offered this chart, suggesting that that oil expenditures over 5.5% of GDP lead to major recessions:

Source

Murphy changed the time scale from years to months at the end of the chart to demonstrate how the portion of GDP paying for oil last year spiked and crashed as much in 12 months as it did in 4-5 years during the most recent recessions.

Steven Kopits, Managing Director of Douglas-Westwood LLC, came to similar conclusions in his presentation. He noted how oil stopped responding to price signals in 2004, with production remaining basically flat even as prices tripled. The global oil supply only expanded by 2% while global GDP grew 17%, causing prices to increase by about 25% per year from 2003 on.

By 2008, when crude expenditures reached 4% of GDP, the U.S. fell into recession. In fact, said Kopits, oil over $80 would have been enough on its own to cause what he called "our first peak oil recession."

Former head of exploration and production for Saudi Aramco Sadad al-Husseini opined similarly in his interview with ASPO, saying that the spending ceiling is between 5% and 6% of global GPD. Accordingly, he thinks alternatives to petroleum like Arctic oil, coal- and gas-to-liquids, and so on may not be economical to develop because their costs are too high.

In essence, OECD countries are simply getting squeezed out of the market as the global drivers of demand shift to the developing world. When the cost of filling the tank on an SUV goes from $60 to $100, it really takes a bite out of consumption in America. But your average resident of, say, India or the Philippines can shrug off a 50-cent increase in the cost of filling the tank on his scooter, because he gets so much more economic value from the transportation.

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Kopits believes that $70 oil is enough to effectively lock out the EU from the oil market, and $75 locks out the U.S. This begins to explain how, as independent oil producer Jeffrey Brown observed in his presentation, the U.S. was outbid by Kenya for oil last year.

On a related note, ASPO analyst Dave Cohen made a convincing argument that economic fundamentals will not support increased oil demand — even from China — for years to come, ensuring that global GDP growth remains weak.

In counterpoint, Matthew Simmons asserted that we don't yet know the economy's tolerance point, and thought it could be as high as $500-$700 a barrel.

This is where I must make my departure from Simmons' camp. The data presented on GDP and price at the conference have forced me to reconsider my longstanding belief that peak oil will bring much higher prices. Although prices 5 to 10 years from now, when we're well past the peak and into decline, remain an open question. . . I now doubt that we'll see oil over $150 anytime soon.

A Narrow Ledge

If these analyses are correct, then we are on what Kopits called "a narrow ledge": Houston needs $75 oil to keep drilling, but the economy goes into recession with oil at $80.

Two editors of "The Oil Drum" generally concurred. Nate Hagens put the boundaries a bit wider at $60 to keep drilling and $80-$100 as the economic pain tolerance point, and Gail Tverberg observed that oil at $75-$80 seems to kick off a recession.

If the stability of oil production relies on oil spending staying within roughly 4% and 5% of GDP, it's going to be dicey. But if the oil price ledge is only $5 wide, then it's not clear to me whether the global GDP can manage to stay on it.

In short, the world may not be able to continue executing the expensive oil projects of the future at all. The tension between the price of new production and the pain tolerance of the global economy may be resolved not by stable prices, but by a failure to bring new supply online.

This is indeed a crisis — but it's also a hint that it's time to focus on how we're going to replace oil.

Take it from Sadad al-Husseini: "The hidden opportunity may be efficiency and conservation."

The investment community has already heard that message. At the ASPO conference this year, I estimate that not one of the roughly 400 attendees represented development capital, while at a typical Cleantech Forum in San Francisco, at least half of the 1,500 or so attendees are with banks, VCs, and big hedge funds. Granted, the ASPO conferences are about information, not deal-making. . . Still, investors seem to prefer theses based on abundance to those based on scarcity.

It only makes sense. If you had a large chunk of capital to deploy in the energy space, would you rather try to balance on a narrow ledge, or jump into a sector that's growing at 30% per year — with no ceiling in sight — and the wind of oil depletion at its back?

Efficiency and conservation may not be as sexy as solar and wind, but for the next several decades they will be the only real way to survive a future of volatile oil and gas prices and declining supply. It takes a long time to rebuild an infrastructure. . . and in the meantime, we're going to have to make do with what we've got.

In the pursuit of investment capital, cleantech clearly has the edge over oil now.

Until next time,

Chris

P.S. Chris continues this article as Part 2 of a series of reports from the 2009 ASPO Peak Oil Conference. See also Part 1.

P.P.S. It's no surprise that the bulk of new efficiency dollars is going to the smart grid. Indeed, CEOs of both GE and Cisco have each said its development will rival the Internet in size, scope. . . and profit. As economic pressures weigh on the development of new oil. . . there's no limit to how high conservation stocks could climb. In fact, this report has all the details on three that could easily double.

High Speed Railroad

Chris Nelder recently wrote a fantastic piece about high speed rail in our sister publication Energy and Capital. I found the article to be on point and completely relevant for Green Chip readers, so I've decided to send it to you today.

I think you'll really enjoy it.

Jeff

_ _ _

"'Boondoggle‘, 'Loss-making whim‘, ‘Monument to bad territorial planning'. . .

Such are the arguments of high speed rail critics, as the United States finally gets on board the passenger rail revolution that is sweeping the world.

But that quote wasn't about the U.S., and it wasn't about today's debate.

It came from an essay by José Blanco López, Spain's minister of transport and public works, which was published in a new pamphlet from SERA, a sustainability activist organization within the government Labour party. He was talking about the two decades of opposition that conservatives had mounted against the country's progress in building a high speed rail system.

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Starting with a line from Madrid to Seville in 1989, Spain pursued an aggressive and determined commitment to high speed rail that, by 2012, will produce the longest system in Europe. This year alone, most of the country's €19 billion development budget will be invested in high speed rail. By 2020, López says, more than 90% of the country's total population will be within 31 miles of a high speed train station.

Here he put his country's achievement in perspective:

Shielded behind overly simple, short sighted cost-benefit analysis, critics complained with those arguments against high speed projects over years, until the success of each one of the new corridors proved them wrong and showed that in troubled economic times, the best investments for a society are the ones which improve equality.

History has proved rail's critics wrong in Spain, as economic development and rider enthusiasm followed it everywhere it went.

Cretinous Shortsightedness

Even so, ever unwilling to learn from the successes of the rest of the world, the U.S. is now starting the same effort at about the same place as Spain was 20 years ago.

The president of the U.S. High Speed Rail Association, Andy Kunz, appeared on Fox Business last Friday to make his pitch. And what argument did the show's overcoiffed co-host raise? "Amtrak has been in the red for years and years and years, and nobody in charge over there seems to be able to turn a profit, despite the fact that everybody I know takes the train from New York to Washington D.C., the Acela. It's just not working though financially," she whined.

After Kunz explained that that the Acela leg (with a maximum speed of only about 100 mph) was in fact profitable, and that the rest of the system needed to be upgraded so that it was equally attractive and profitable and capable of speeds over 200 mph, the host pressed on: "How do you get people to ride it?" Kunz patiently explained his point again, and pointed out that when Europe opened its new high speed lines, they filled up with riders immediately. The hosts then tossed off a quick wisecrack about the Chunnel and muttered about the need for profitability, but assured the audience that "Nobody more than Fox Business wants to see new ventures succeed."

Be that as it may, one wonders why Europe's success would not convince them that high speed rail would be a good thing for this country. A projection from rail proponents FourBillion.com indicates that building the 9,000 miles of high speed corridors identified by the U.S. Department of Transportation would create 4.5 million permanent jobs and 1.6 million construction jobs, save 125 million barrels of oil, eliminate 20 million pounds of CO2 per mile per year, reinvigorate U.S. manufacturing, and generate $23 billion in economic benefits in the Midwest alone — all alongside a long list of intangible side benefits.

Putting aside the cretinous shortsightedness and obstinacy of conservative media, let's take a look at what the rest of the world is doing.

A Global High Speed Rail Explosion

The UK's Labour party is also pursuing an expansion of high speed rail, having commissioned a study on building a new line from London to the West Midlands and extensions to the north. Currently, Britain has only one high speed line, the 69-mile-long "High Speed 1" link from London to the aforementioned Channel Tunnel ("Chunnel") to France. The Tories have offered their own £15.6 billion plan, so it seems likely that Britain will soon have a new high speed project.

France, as I mentioned last year, already has the wonderful 200 mph high speed TGV network, with 1,100 miles of track, more than 400 trains, and the third-highest ranking of rail passengers per year, behind Switzerland and Japan. Personally, I found it to be the most enjoyable travel experience I have ever had.

Bombardier's ZEFIRO 380

This week, the Chinese government awarded a $4 billion contract to build 80 high speed (236 mph maximum) electric train sets for the new 3,700-mile-long high speed train network it is building. Half of the contract went to Bombardier Sifang, a Chinese joint venture with Berlin-based rail giant Bombardier Transportation (TSE: BBD.A). The company will begin delivering the trains in 2012 and finish by 2014— boom, done.

Bombardier is already building 20 sleeper trains for China and another 20 passenger trains, in addition to the 500 high-power electric freight locomotives that it contracted to build for China in 2007.

Russia is taking the plunge into high speed rail as well, spending nearly $1.5 billion to upgrade 401 miles of track between Moscow and downtown St. Petersburg, and buy eight electric Sapsan trains made by German conglomerate Siemens (ETR: SIE) with a top operating speed of 217 mph. Four runs a day will make the trip in less than four hours, compared with an average five hours to make the trip by airplane, including the time wasted getting to and from the airport and running the check-in and security gauntlets.

Meanwhile, Back in the States. . .

Calling the U.S. "a developing country in terms of rail," a Siemens representative told the New York Times last week that his company was a candidate for a proposed high speed link between San Francisco and Los Angeles, along with Bombardier and Japanese bullet train manufacturer Hitachi.

The California line is on the short list of high speed rail priorities prepared by the America 2050 group, ranking it fifth nationally in terms of ridership demand behind four other lines for the Northeast.

High Speed Rail Phasing Map by America 2050. Source.

SCNF, the French company that runs the TGV network, has submitted its own plan to the U.S. Federal Railroad Administration (FRA) for four 220 mph corridors in California, Florida, Texas, and the Chicago-Midwest area. The company believes it could open the first line from Milwaukee to Detroit by 2018 and be in full operation by 2023. The costs would be recouped quickly, according to SNCF, returning triple the $69 billion cost of the Midwest corridor within 15 years in environmental and other benefits.

All Costs Considered

Building America's high speed rail network will be expensive — about that, there is no disagreement. The $8 billion appropriated for high speed rail in the stimulus plan was dwarfed by the $103 billion in applications the FRA received for the funds, and is a small fraction of what the total network will cost. The California run alone will probably cost over $40 billion to construct, and that's after the state's existing commitments to building support networks and light rail links.

On the other hand, as the director of the BART light rail system pointed out this week in his testimony to San Francisco city supervisors with the city's Peak Oil Preparedness Task Force, the U.S. currently spends as much on parking as it does on national defense. I haven't run the numbers, but it seems within reason that if that is the case, spending that money instead on high speed and light rail would cover a very large part of the total cost.

Indeed, all of the cost arguments I have heard against rail are incomplete and wrong.

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The true costs of remaining committed to our current road and air infrastructure are never taken into full account. . . like the health care costs of polluted air; the cost of continuously maintaining roads, bridges and tunnels; the availability of materials (remember, several cities in America literally could not buy asphalt during the oil frenzy of last year, because refiners were cracking every last lighter molecule they could from the crude); the trillions of dollars we are spending on oil imports and defense operations in oil producing regions of the world; the billions' worth of damage that our current ways do to the environment; the insurance costs of keeping up 240 million cars and light trucks; the damage and death that those millions of drivers cause; and so on, ad infinitum.

Rail is cheaper, safer, and better on every single count.

When the boundaries are properly defined, the entire transformation of transportation from liquid fuels to renewable electricity would create millions of permanent jobs, and could probably pay for itself.

But the cost isn't really the point anyway.

The Future: A No-Fly Zone

America still has no energy plan, let alone a plan to address the looming threat of peak oil. With the decline of global oil production starting around 2012 already "baked in," due to a lack of sufficient oil megaprojects, we desperately need to start making tracks toward a high speed rail infrastructure. . . or face a painful future of fuel shortages and economic dislocation (at best).

No part of our transportation system is as vulnerable to volatile fuel prices as the airline industry. It was built on the expectation that oil would rarely cost more than $40 a barrel, and it is completely dead if oil stays over $100 a barrel. Last year's oil price spikes put many smaller carriers out of business and cost the major carriers billions. Then the operators who had the largest hedges against rising prices last year got whacked again as prices plummeted.

For my money, the airline industry may as well be dead. Not just because of the damage that oil price volatility has done and will continue to do — and not just because the experience of air travel has become a painful routine of delays and personal insults — but because it's so inferior in every way to high speed rail travel for distances under 500 miles. The TGV line from Paris and Lyons virtually eliminated air travel between those cities, and the high speed line from Madrid to Barcelona cut air travel in half in the first year of its operation.

Forward-looking investors would be wise to accumulate long positions in some of the major players in high speed rail, which have enjoyed a very nice rally over the last three months, as the next wave of investments in it began to hit the press:

I continue to believe that rail — particularly high speed rail — is the longest safe bet one can possibly make. As I have explained in this column over the last several years, we simply cannot replace enough gasoline- and diesel-burning cars with ones that run on electricity to address the peak oil challenge in the time we have left.

Like compressed natural gas vehicles, PHEVs and EVs are "silver BBs" that will help cushion the blow, but in the long term and for the majority of miles traveled, rail is truly the only answer. Rail is by far the cheapest and most fuel-efficient form of transport, requiring about a third less fuel than air for personal travel, and as little as 3% of the energy for freight.

The serious pursuit of high speed rail would also make a real and significant dent in CO2 emissions, and enable part of the urgent transformation we must accomplish from liquid fuels to renewably generated electricity. As Lord Andrew Adonis, Britain's transport secretary, put it in the SERA publication: "High speed rail is now pretty well a ‘no-brainer' transport strategy for the 21st century."

The rest of the world is already kicking our butts in deploying renewable energy. China is running circles around us in long term resource planning and buying up every hard asset under the sun. And compared with the rest of the developed (and developing) world, we're bringing up the rear in rail.

But it doesn't have to be that way.

It's Go Time

If you've watched any of the new Ken Burns series on America's national parks, you know that protecting the common good has always been a struggle against vested interests and conservatives resistant to change. It took strong-willed men of vision like Teddy Roosevelt, John Muir, and Stephen Mather to override the opposition and do the right thing for the future. We need that kind of leadership now.

If I were President Obama, I would direct the Department of Transportation to immediately begin transforming America's infrastructure to one based on electric rail, regardless of the long-term cost, starting with the highest potential traffic and fuel savings and working our way down the list from there. I would do as the French did when they created the TGV: Declare eminent domain and lay in the high speed rails where they make the most sense. I would restrict federal funding for roads and bridges to critical maintenance projects where rail can't take over the load in time — with not a penny more spent on new car-based infrastructure. I would forbid any subsidies for cars and trucks with a fuel economy of less than 30 mpg. I would move all subsidies for fossil fuels into renewable energy — then double or triple them — to ensure that we can run that new electric infrastructure cleanly. I would bind Congress to my purpose and ride roughshod over the objectors, making it my number-one priority.

I know it may seem hard to believe, with oil holding steady around $70 and gasoline around $3. . . but if you haven't studied the data, then take the word of a guy who has: We're in serious trouble, folks. The Armageddon of transportation is dead ahead and we need to move aggressively and determinedly to head off the peak oil challenge. Rail is hands-down our best and biggest shot.

Until next time,

Chris

Oil and Gas Outlook

I have just returned from the annual conference sponsored by the U.S. contingent of the Association for the Study of Peak Oil (ASPO-USA) with a wealth of new information and perspective to share, so this will be the first of a series of reports.

I look forward to the ASPO-USA conferences all year, because they consistently deliver good, solid data on the state of energy and afford an opportunity for vigorous and stimulating discussion with some of smartest and up-to-date experts in the world-particularly over dinner and drinks late into the night. This year was typically outstanding.

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As usual I took detailed notes, which will be uploaded in the weeks to come. But I'll begin with some high-level updates on the key aspects of the peak oil study.

Past the Peak?

Perhaps the thing that struck me most was how much the outlook on peak oil has changed since the first conference in 2005.

Those who thought conventional oil had probably peaked back then were considered extremely pessimistic, where the consensus view saw the peak another 5-10 years off, and the optimists put it 20 years away or more. Some thought the peak rate of "all liquids" would be around 100 million barrels per day (mbpd), up from 85 mbpd at the time. Most thought non-OPEC production would increase up through 2010. Biofuel boosters were sunny about their future.

Four years later, the view on oil and biofuel has grown considerably worse.

We now know that conventional crude did in fact hit its peak-plateau in 2005, having remained around the 74 mbpd level ever since. The expected growth from non-OPEC mostly failed to materialize, as depletion of mature fields took its toll and the cost of new projects soared—especially for deepwater and production from marginal sources. More pessimistic observers now think the 87 mbpd all liquids peak recorded at the height of the 2008 boom was the peak, and the more optimistic ones have cut their expectations to under 100 mbpd, with 90 mbpd looking more likely.

Biofuels now have a black eye from the corn ethanol frenzy of 2007-2008, which has all but collapsed. Ethanol from algae and cellulose still looks about as far in the distance as it did in 2005, as no one has figured out how to produce either one at commercial scale or with an acceptable net energy return. And biodiesel has remained a minor player, with little expectation for it to scale up any time soon.

But the most surprising change has been the outlook for North American natural gas. In 2005, the majority of observers seemed to think it had peaked for good, and saw gas prices remaining in a high range of $11-15/Mcf. I don't think any of them expected the recent boom in North American shale gas, and there was certainly no suggestion that gas prices would crash to nearly $2 this year.

In fact the main worry about gas now seems to be that the shale gas boom will prove to be short-lived, and sucker us into building more vehicles and infrastructure to use it just as it sputters out. We only have a couple of years of data to work with on shale gas wells, and the only good data is from the Barnett Shale.

Running down the depletion numbers on shale gas, analyst Arthur Berman found that in the first year of production decline rates have been in excess of 50% for Barnett wells, and 90-95% for Haynesville Shale wells. The average well in the Fayetteville Shale is "profoundly non-commercial" he said, and predicted that most shale gas wells will be abandoned in less than five years after their first production because the output will be so low.

There is also a fear, which I have articulated previously, that with an average production cost of $7-8/Mcf for shale gas and prices through most of 2009 staying around $4 or less, new wells simply haven't been getting drilled. The effects of that lapse should show up next year and cause our "glut" to disappear quickly, taking prices much higher.

Supply Decline Rates

With the end of growth in the rate of global oil production now either in the past or looming in the next few years, attention is progressively focused on the depletion rates of mature oil fields and the rate and date of overall decline.

Most observers believe the globally averaged depletion rate has risen from 4.5% per year in 2007 to about 5 - 5.5% now, which will accelerate to around 6.5% per year by 2014. This is more or less in line with the average rates from IEA's report last year. Petroleum geologist Chris Skrebowski pointed out that a 5% per year decline rate means a loss of 4 mbpd per year, equivalent to all the volume of biofuels, tar sands and heavy oil combined, or losing the entire North Sea in about 14 months, and that it would be a huge challenge to replace those lost volumes.

Analysts using the Megaprojects database (of large oil projects started up after 2005) generally agree that production will peak in the 2009 - 2010 time frame. Net new supply each year is expect to begin declining around 2014 - 2015 as depletion overwhelms new projects. Supply may reach as high as 92 mbpd in 2010, then plateau to around 89 mbpd in 2014, then decline to 84 mbpd in 2020 and 78 mbpd in 2030.

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That view was generally in line with comments from oil consultant and former head of exploration and production for Saudi Aramco, Sadad al-Husseini, in a video interview clip. Seeing insufficient large new projects in the next 5 - 6 years to compensate for decline rates of 6.5% in non-OPEC and 3 - 4.5% for OPEC, he expects a shortage of capacity in the next 2 - 3 years.

The poster child for decline rates is, of course, Mexico with its crashing Cantarell field. Matthew Simmons projected that its decline would end Mexico's long era as an oil exporter in 18 - 36 months. David Shields, an author and expert on Mexican oil production, delivered a devastating indictment of the country's political leaders and its oil company Pemex, asserting that Pemex officials knew exactly what Cantarell was going to do as far back as 2002, but said exactly the opposite in public. A chart that Pemex shared with the Mexican Senate showed that production from its largest fields would fall to 1 mbpd by 2017, a full 1.8 mbpd lower than the official forecast of about 3 mbpd. If political manipulation is distorting the public impression of Mexico's near-term oil potential (and I believe Shields on this point) then it could be very bad news for the U.S., for which Mexico is the #3 source of oil imports.

Demand Growth Rates

On the whole, I would say there is now a strong consensus (at least among analysts who prefer data to faith) that global oil production will begin to decline in the 2012 - 2015 time frame. The later-dated estimate is based on the notion that the global recession of the last two years has probably given us that much longer before terminal decline sets in.

Peak oil deniers who have projected continued growth for many decades hence and ultimate peak rates of 120 mbpd or more have obliquely capitulated in the face of the recent evidence and switched to a "peak demand" argument: It's not that supply couldn't keep up for geological reasons, it's that demand wasn't strong enough to support high enough prices to raise supply further.

It's a classic tactic to try to change the game if you can't win it, but the peakers aren't buying it. As Skrebowski pointed out, the peak demand argument only really holds for the OECD, where demand is off a few percent from the peak.

The real demand story is shifting quickly to the developing world, particularly China. Analyst Steven Koptis projected that China would overtake the U.S. as the top consumer of oil by 2018, and if supply is available, would double U.S. consumption by 2025.

Indeed, as petroleum geologist Jeffrey Brown pointed out in his presentation of the Export Land Model, the U.S. has already been outbid by Kenya for oil. According to the model he developed with Dr. Samuel Foucher, the top five oil exporters in 2005 will in aggregate reach zero net exports by 2032, and most of that will be shipped early on. In just three years, they shipped 1/5 of their total expected net exports after 2005.

Petrobras' Promise

As a counterpoint to the generally gloomy data on global oil supply and demand, a razzle-dazzle keynote was given by Dr. Marcio Rocha Mello, president of HRT Petroleum and a 24-year veteran of Brazil's oil company Petrobras (NYSE: PBR). He asserted that the recent pre-salt finds in very deep formations off the shore of Brazil, like the much-hyped Tupi field, indicated that there was a great deal more oil in the pre-salt layers—we just need to drill deeper.

In an extremely animated presentation that at times seemed more like a carnival sideshow than a serious analysis, Dr. Mello served up combination of stratigraphic charts and contrarian theory to make the case that between the pre-salt of Brazil, West Africa, the Congo basin and the Gulf of Mexico, there are another 500 billion barrels yet to find.

While entertaining and humorous, I don't think Dr. Mello made too many converts in the room. As former BP oil exploration chief Jeremy Gilbert pointed out the following morning, none of the alleged pre-salt oil is yet proved, and in fact he'd be surprised if there were 5 billion barrels of proved oil there. "Don't confuse passion with precision" he warned, and noted that it would take 20 - 30 years to prove the resource. In short, it doesn't change the peak oil story at all. By the time pre-salt barrels come online, we'll be well down the back side of the production curve. Rising resource nationalism in Brazil also bodes poorly for very many of those new barrels to make it to foreign markets.

I'll conclude this report with a brief comment on oil prices. As I mentioned in my update three weeks ago, the outlook for oil prices has been murky for months as they traded in a $60 to $75 range. I was long oil but cautiously bearish, and watching for signs of a new signal. This week, that signal came as oil breached the $75 level and touched $78 this morning. It's a decidedly bullish move and I think it portends higher prices to come, at least in the near term.

I took the opportunity to beef up my oil exposure with positions in EOG Resources (NYSE: EOG) and, naturally, Petrobras. Even if Dr. Mello is wrong about the pre-salt, Petrobras is one of the most sophisticated and aggressive oil companies in the developing world, and they are positioned better than most to mint money for years to come. And if he's right...well, it will be a great position to hold long term.

Stay tuned to this space for much, much more from the cutting edge of peak oil analysis in the coming weeks.

Until next time,

Chris

Energy and Capital

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