Chris Nelder - Angel Publishing

Is the Commodity Boom Over?

The last few weeks have really had me scratching my head and wondering, "What the hell is going on here?" The markets have been behaving exactly the opposite of what any rational read of the facts might suggest.

As we have predicted repeatedly in these pages, the fallout from the mortgage crisis has continued for the top names in finance: USB, Merrill, JPMorgan, AIG, Goldman, Wachovia, Morgan Stanley, HSBC, Citigroup, and on and on. Not just writedowns, but buying back their crap securities, raising more capital, and generally fighting for their survival. Meanwhile, the losses of Fannie and Freddie have been socialized, with a massive taxpayer-funded bailout.

And how did the markets react to this terrible news? The financials boomed, rising about 15% since the bottom on July 15, with some players like Merrill Lynch rising 32% in the first five trading days of the rebound.

With a hallucination of confidence in the health of the US financial system restored, the dollar charged back up, while European and Asian markets took their hits.

The action in oil has been likewise counter-intuitive. The loss of approximately 1.5 million barrels a day of oil supply from the world market due to the conflict in Georgia caused a mild one-day uptick in its steady decline from a peak of $147 to $113.

In a normal world, such a cut in supply would be enough to pack another $20 or more onto the price of oil. If the Saudis were to suddenly cut 1.5 mbpd of production, you can bet it would have a huge impact on the price. But this isn't a normal world.

Upside-Down World

This is Upside-Down world, where everything does the opposite of what you expect. For a short while.

Is the renewable energy business so much worse this year than it was last year, such that the best names deserve to have their stocks whacked by 40%? No, not at all; in fact the business has grown substantially since last year.

Is the world suddenly losing its appetite for oil and natural gas? No, demand is still higher than ever before. Although the rate of growth is slowing somewhat due to record prices, demand in Asia and the Middle East is still red-hot and will continue to outweigh declining demand in the US and Europe.

Is demand for base metals, fertilizer, and food so much lower now than it was in the first half of this year? No, we still want more and more of everything.

So what's the deal?

The recovery of the dollar, however illusory, is the main factor taking down the price of gold, oil and other commodities. As I have said here more than once, the daily news about oil inventories, demand levels, even pipeline attacks isn't nearly as important as the valuation of the dollar. (And no, it's still not because of the evil speculators.) Consider this chart:

As the dollar (the lower red line) has recovered, oil (in blue) and agricultural commodities (DBA, in green) have fallen off. They are the mirror images of each other.

The reason is simply that when traders have lost confidence in the stock market, they fly to the safety of commodities, energy and gold. When confidence returns, they fly right back out and look for bargains in the carnage they just left behind.

Stay the Course

In short, what we have here is a trader's market. The fundamentals have been thrown out the window, and now it's all about herd mentality.

That makes it a particularly dangerous market for longs like you and me. If you're not a very active trader who's on top of every move, you're going to take some hits. And if you're not such a trader, you're going to get killed if you try to play it.

Your best strategy is to simply stay the course. I have no doubt that my long term theses are still solid. Energy, commodities—particularly agricultural commodities—and gold are still the right place to be for long investors, and I don't see that changing for several years...not until global peak oil is clearly behind us, and the consequent global recession sets in.

But you have to have a strong stomach in a market that has simply lost its mind. When chaos is happening all around you, there's nothing harder than standing your ground.

And times like these, when the trendlines have returned to their 200 dma's and the whole sector that you know is right for the long term has been sold off, are ripe for bargain hunting.

Just don't try to be a hero. Watch the important support levels closely and choose your buy points carefully. Be patient. Accumulate your favorite long positions-and a few shorts for good measure, like SKF and FXP-gradually. And then hold them and hold on.

The commodity boom is far from over, and the panic over energy supply and a fundamentally unsound US economy will always return after these bear market rallies. This Tuesday's selloff destroyed half the gains or more in the financial sector over the last three weeks. And today, the bears are out in force, driving the major indexes lower while the gold/commodities/energy complex charges back up. (See my past articles for stock picks in those sectors.)

Likewise, the correction in oil will overshoot, as it always does, and then it will overcorrect to the upside again. I thought the new floor was around $120, but it could be $110, or it might even dip lower for a short while. But it will be back. I expect to see $150 again before the year is out.

I also expect this wicked volatility to increase as we make our way into the heart of this beast. Vladimir Putin isn't done in his campaign to renationalize the resources of the former Soviet Union, oil and gas supply is still as tight as a drum, and there are still far too many mouths to feed. So take your Pepto-Bismol and hold on tight.

When the markets finally come to their senses again, your clearheadedness will be rewarded.

Until next time,

Chris

Will Arctic Oil, Natural Gas, MIT, Paris and Pickens Save the Day?

In my past life as a computer programmer, there were two classes of problems that particularly bedeviled me.

The first I called "ghosts," which are problems that don't exist. For example, I'd spend hours trying to find a bug in my code, not realizing that the reason it wasn't working was due to some bug in processes far outside my code. The wrong behavior would mysteriously appear and disappear, like a ghost, when I was running the exact same code.

The second I called "unicorns," which are solutions that don't exist. I'd spend hours or days attempting to devise a solution that ultimately could not work, for reasons that weren't apparent until I actually tried to build it, and realized it was a dead end.

Lately, evaluating our energy policy options has started to feel a lot like programming. It is getting increasingly difficult to determine which options are real, and which aren't, and when, and to what extent.

I have already addressed a few popular ghosts in recent columns, like those evil oil speculators, the non-existent Chinese oil drillers off the coast of Cuba, and the horrible Demmycrats who have stymied offshore drilling.

This week, we'll take a look at a few potential unicorns, and see if they're for real.

Arctic Oil Bonanza!

Two weeks ago, the USGS issued a press release titled "90 Billion Barrels of Oil and 1,670 Trillion Cubic Feet of Natural Gas Assessed in the Arctic," which claimed to be "the first publicly available petroleum resource estimate of the entire area north of the Arctic Circle."

Ever willing to jump at any bit of brightly-colored bait, the press swallowed it hook, line and sinker. "Enough supply to meet current world demand for almost three years," they gushed. "May hold one-fifth of the world's undiscovered, technically recoverable reserves of oil and natural gas," and "the race to claim territorial ownership of the resources already has begun."

Wahoo! Pack up the truck, Jed, we's a-goin' ta the North Pole!

More knowledgeable analysts who know how to dig for the details had quite a different view. When it comes to oil and gas production in the Great White North, my first call is J. David Hughes, a Canadian geoscientist with nearly forty years' experience. In this week's Peak Oil Review, he explicated the new study beautifully.

The real story is much more nuanced. Those of you who have read my book know that oil and gas reserves are estimated according to their probability. An "F95" estimate means that there is a 95% chance of the stated amount being found, and an "F5" estimate means there is only a 5% chance. (Sometimes a "P" is used instead of an "F.")

Detailed data stating the probabilities is only available on the USGS web site for 7 of the 25 assessment areas included in the Arctic report, which comprise about 32% of the oil and 17% of the natural gas in the whole. For those areas, Hughes calculated that the F95 estimate was 3 billion barrels, the F50 estimate was 11.8 billion, and the F5 estimate was 95.7 billion. Out of that, the USGS reported a "mean" estimate of 28.9 billion! It's not clear what their justification for that claim is, but that amount is clearly well above the F50 estimate.

Hughes cites the "West Greenland - East Canada" assessment as a particularly egregious example of fudging the numbers, where the "mean" estimate given had an actual probability of less than 10%!

Sadly, such shenanigans are common in oil data reporting. It takes a keen eye to sort out fact from fiction.

The real bottom line on the Arctic's resources will not be known until it is drilled. But it doesn't really matter that much. Even if it does turn out to contain three years' worth of oil and 16 years' worth of gas, those numbers are only useful as a rough way of estimating how much is ultimately recoverable. In reality, the production will be hardly noticeable, because it will take many decades to recover, at low flow rates, and it will be the most expensive oil and gas ever produced. And an unknown portion of it, perhaps 25%, might accrue to the U.S.

It might buy us a little more time to adjust to a post-peak world, but by that time I expect the world will either be panicking and disrupting normal commerce in oil and gas, or well on its way to switching over to renewables. Either way, the world's oil and gas markets will be very different from what they are today.

But you wouldn't know it from the breathless reports of "90 billion barrels!" in the press.

A 50% Increase in Natural Gas Reserves!

Next in our cavalcade of chicanery is the new report from the American Clean Skies Foundation, a natural gas industry organization founded by gas producer Chesapeake Energy (CHK).

The report claimed that the US has 2,247 Tcf (trillion cubic feet) of gas reserves in place, a 47% increase over the 1,530 Tcf estimate of 2006. They claimed that current technology and prices make it possible to recover much more gas than previous thought from domestic shales like the Haynesville, Marcellus, Barnett and Bakken formations.

"This study authoritatively refutes head-on the mistaken belief that we do not have sufficient supply," said Denise Bode, president of ACSF.

Again, the press jumped all over it. "Industry report says U.S. natural gas supply abundant," blared Reuters, and the rest of the press gang were quick to assert that the US now has enough gas "to last up to 118 years."

Chesapeake CEO Aubrey McClendon was all over the media in the wake of the announcement, and gave testimony before the House Select Committee on Energy Independence and Global Warming. Chairman Ed Markey asked him if natural gas supplies were adequate to reduce our electricity generation from coal to 35% from its current 50% share. "Today, I say yes," McClendon replied.

A closer look at the numbers reveals a slightly different story. A discussion thread on The Oil Drum pointed out that the 118 year estimate is based on our current production (not consumption) of gas, which is at the rate of about 19 Tcf per year. Our consumption is actually about 4 Tcf higher, at 23 Tcf, reflecting our continued reliance on imported natural gas.

So that 118-year assertion relies on several very questionable assumptions: 1) that we will not increase our current level of natural gas consumption for over 100 years; 2) that we will continue to be able to import about 20% of our current gas supply for over 100 years; 3) that the price of gas will remain near or above its current levels. With natural gas, price is a key determinant in whether or not a given gas deposit is considered "economically and technically recoverable."

If we intend to shift electricity generation toward natural gas and away from coal, then we can already toss out that first assumption.

Now, I don't want to sound too critical of Chesapeake. I think it's a good company and a good investment, and I have owned it and promoted it myself. Nor do I want to appear unduly pessimistic about the potential of the shale plays. After all, we have promoted them vigorously here in the pages of Energy and Capital. I am only trying to put them in a realistic, credible, big picture perspective.

Is there gas in them thar shales? You bet there is. Is it profitable? At today's prices, yes, absolutely, much of it is. But one has to look carefully at the numbers to guess exactly how much, and realize that ultimately, it's not the recoverable total, but the flow rates that really matter.

The same is true, by the way, for the oil potential of the Bakken Formation. Truly, it is an enormous and profitable formation, and the companies we have picked out for the $20 Trillion Report are well positioned to profit from it. But ask yourself: do you really know the difference between the 500 billion barrel and the 4.3 billion barrel estimates usually proffered for it? What's the probability of the 4.3 billion number? Will it bring down US gasoline prices? (If you can't answer those questions, you should probably read up on our past articles on the Bakken and check out the USGS survey reports.)

I hope this finally puts to rest the questions I keep getting along the lines of "But what about the Bakken?"

Boone's Wind Boom!

No doubt by now you have heard about the Pickens Plan, the initiative started by Texas oil billionaire T. Boone Pickens to promote his "bridge" solution to a post-peak oil future.

It's a reasonably straightforward and practical idea: take the 22% of our current electricity supply generated from natural gas, and replace it with wind over 10 years. Then we use the natural gas to run our vehicles, offsetting 38% of our demand for foreign oil. We could generate 22% of our electricity supply from wind with his plan, Pickens claims, and avoiding spending $266 billion a year on foreign oil. (If you haven't watched his presentation, check it out here. It's smart stuff.)

As usual, however, the crucial details remain to be explained. How and when will all those natural gas fired power plants, many of which were built in the last 10 years and are far from the end of their useful, fully amortized lives, be decommissioned? What is the cost and the time-to-market for millions of natural gas powered cars?

As I reported in my recent article on plug-in hybrids, the annual replacement rate for vehicles is slow, at somewhere between 3-6% percent. But that is with a normally functioning economy and a normal supply of cheap fuel and cheap steel, which is not an assumption we can necessarily make for the future.

Nor is the financing picture quite clear. On Larry King's show on Monday night, he claimed that the full $1 trillion cost of the program could be borne by private industry. But critics like Anthony Rubenstein, a sustainability consultant who was the force behind California's Proposition 87 in 2006, has raised questions about the $5 billion bond measure that Pickens has put on the November ballot in California to support his plan by providing incentives and rebates for natural gas vehicles.

There is another important question about the Pickens Plan: How does it square with the assertion that we have "118 years' worth of natural gas?" If we switch over to natural gas for vehicles, I think it's safe to say that we cannot make any of the assumptions that I discussed in the previous section. Our rate of consumption will almost certainly go up. Our natural gas imports are far from certain over the next 100 years, and our recently-built LNG import facilities are suffering badly from poor economics.

Nor can anybody predict what the plan would do to prices. Such a transition would almost certainly raise the price of natural gas to bring it into parity with oil, while at the same time depressing oil prices. Imported oil may continue to be attractively priced in such a scenario, making the possible offset of foreign oil less certain than Pickens claims.

Still, it's a reasonably good idea, and it deserves closer attention. It sure beats the pants off most of the ideas I've seen from Washington lately. But it could be a unicorn, if it's not done right.

MIT Hydrogen Breakthrough!

Finally, we must take a few minutes to take a closer look at the much-ballyhooed "breakthrough" announced by MIT last week, which made headlines like "MIT Scientists Unlock Nirvana of Solar Power Storage" and "'Major discovery' from MIT primed to unleash solar revolution."

The gushing press that issued from the announcement was enough to drown a sane man. "This is a major discovery with enormous implications for the future," enthused one analyst.

So what is this "major discovery?"

Remember when you studied electrolysis in school, hooking up a battery to a couple of probes in a glass of water to make hydrogen and oxygen?

Well, it's like that. Only the MIT design uses a catalyst made of cobalt and phosphate, so theirs is a "catalysis" process instead of a straight electrolysis. The advantages of the design are that it can run at room temperature in regular water, using materials that are abundant and cheap, and that it is apparently more efficient (note: I have not been able to verify these claims).

The hydrogen thus produced can be stored and then consumed in a fuel cell to generate electricity, so it opens a path to storing energy without batteries.

Thus, the technology has been billed as a breakthrough for solar, because it could store energy overnight, when the sun isn't shining. But that's really a hyped-up misdirection. It's not about solar, it's about hydrogen.

Unfortunately, the crucial details here are still unexplained. What's the net efficiency of using this catalyst to generate the hydrogen? I was able to turn up one reference stating that it might be 80%, vs. 70% for standard electrolysis, but I wasn't able to verify that by press time. If you have read my article on the hydrogen economy last year, you know that losses in storage reduce the net energy of any fuel cell based system. Finally, the efficiency of the fuel cell stack-typically cited as 50% but variable depending on the conditions-must be taken into account.

Because this is strictly a laboratory development, and has not yet become an application in the real world, we also know nothing about the relative cost of the proposed system.

We do know however, without consulting any numbers, that using solar PV to generate electricity to drive off hydrogen from water, then storing the hydrogen, then using it in a fuel cell stack to make electricity again, will incur far more losses than simply collecting the original solar-generated electricity and storing it in a battery. According to the Second Law of Thermodynamics, every time you convert energy from one form to another, you lose a little, usually in the form of heat.

Without knowing the relative costs of each approach to storing energy, or being able to calculate how many such systems could be built and deployed, and when, it's impossible to say whether the MIT "breakthrough" is even interesting.

We can already deploy regular solar PV systems with battery backup in the field as fast as we can build them, which isn't nearly fast enough. And those systems are simpler, stabler, and have been proved in the field for over 30 years. For applications where more storage is needed than is economical with batteries, there are other technologies also under intensive R&D that might prove more efficient and economical than hydrogen, including thermal systems, flywheels, and hydraulics.

This new approach to the hydrogen fuel cell is unlikely to become commercial for at least another decade, and even then it will still be a more "lossy" approach to energy storage. It may work some day as small residential-sized energy storage system, but leaping from this process to fantasies about hydrogen powered vehicles makes no sense at all, when the efficiency of straight electric vehicles is practically and theoretically much higher.

Professor Daniel Nocera, who led the MIT project, dismissed the obstacles ahead blithely: "The basic science is done," he said, "now it's engineering."

That reminds me of another old saw from my software engineering days. We rolled our eyes when some marketing type breezed in with an impossible-to-build idea, and then dumped it on us with the standard line, "Implementation is left as an exercise for engineering."

Lots of great ideas never made it off the shop floor, because in the real world, they turned out to be impractical or uneconomical. It's far too early to say if this MIT development is a unicorn or not, but I think I see a bump on its forehead.

Paris' Latest Score

On a lighter note, one of the most sensible energy proposals I have heard yet came out of the mouth of the unlikeliest of sources: Paris Hilton. If you're one of the six people who haven't seen it yet, you can watch it here.

If only our political leaders had as much sense as Paris does.

Until next time,

Chris

A Story Nobody Wants To Hear

As we prepared to tape the final segment of my interview with Aaron Task on the Yahoo Finance "Tech Ticker" podcast at their Times Square studio on Monday morning, the producer asked: If there is no hope of increasing the supply of oil from here, and prices are going to just keep going up, what changes did I expect in the future?

Watch Chris Nelder
on Tech Ticker

Part 1: 'Sky's the Limit' for Crude, says Peak Oil Advocate: Buy Drillers, Avoid Majors

Part 2: No Relief from $120 Oil Anytime Soon — or Ever, says Energy Expert

Part 3: The End Is Nigh: Peak Oil Proponent Forecasts Grim Future

We both laughed. Aaron flashed me a knowing grin. "Does she really want to know?" I asked him. Yes, yes she did. The tape rolled, and I tried to tell it straight.

Not only does it mean the end of personal transportation using internal combustion engines, I told him, but much, much more. It means the end of cheap air travel. It means we won't be able to keep living in the suburbs and commuting to cities. It means the end of globalization, such that we will have to relocalize our production of manufactured goods and food. Eventually, it might even mean that if you didn't grow it yourself, you won't have anything to eat!

Being an old friend of mine (we used to work together at Microsoft, 11 years ago), Aaron has heard it all before from me, and has read my book, so he accepted my perspective with a certain panache. But when we encountered the producer again after the taping, he asked if she found it shocking.

Yes she did, she said, "but by the time it happens, I'll be dead."

Oh, if I had a dollar for every time I've heard that reaction...

Afterward, I retired to my hotel room and flipped through CNN, CNBC, and the other business news shows. I shook my head as I watched the pundits worry over the future of energy, and bemoan the impasse in Congress right now over the energy bill. If you've been following the news, you know the score: The Republicans want to open the remaining federal lands to drilling, and the Democrats want the oil companies to drill on the leases they already have.

If you have read my previous articles, you know that both sides of that debate are wrong if they think their proposals can alleviate high oil prices. If we started drilling ANWR and the OCS now, it would take on the order of 10 years-about 7 years after the global peak of oil production—to begin producing a very modest flow of new oil, at which point it will be too little to make much of a difference in prices at the pump. And the oil companies don't drill on their existing leases because they know there isn't enough oil there to make it worth their while!

It seems we are still firmly stuck in denial about the future of oil. (See "Peak Oil: Living on the Banks of Denial.") The buzz over the new USGS report on Arctic oil is just the latest example. I read that report, such as it was, along with whatever additional analysis I could find, and found absolutely nothing there to get excited about. If and when that oil does arrive on the world market, it will probably be another modest flow of the most expensive and difficult-to-get oil the world has ever produced...and that will be decades from now.

The truth, as best as I can make it out, is an ugly story. If you're still alive in 10 years, you will see the end of life as we know it, and the beginning of a long transformation in which we learn to live within an energy budget that shrinks ever year. No amount of new drilling can change that fact. And the long-term trend will be toward higher and higher prices for oil, at least until a global depression sets in and reduces demand.

I know it's a story nobody wants to hear, but I tell it because I have always tried to tell the truth as I see it. I could be wrong, and I hope I am, but I have seen nothing yet to convince me otherwise.

We can blame each other until the cows come home for failing to plan for this day, but that will get us nowhere. All of the solutions are on the demand side now. Instead of crossing our fingers for some new supply of oil, we should be driving less, driving more efficient vehicles, and investing in renewable energy and electric transportation. That is truly the only way forward, as far as I can see.

A side note: Since I am a big believer in rail as part of the solution to the peak oil crisis, it was a great pleasure for me to take my very first inter-city train ride in America after the interview, from New York City to Baltimore. (I have spent most of my life on the West Coast, where there is so little inter-city train service that it almost never makes sense.) It was clean, quiet, comfortable, and cheaper than driving. Here's hoping that the rest of the country can have such an option as soon as possible!

I may have a story to tell that nobody wants to hear, but those who long for sweet assurances can always flip on the TV and find some commentator to put their minds at ease, like the one I heard on TV the morning of my interview, claiming that oil would soon be back at $80 a barrel. There will always be analysts out there willing to tell you whatever you want to hear-that Arctic oil will prove the peakers wrong, or that drilling the OCS will bring gasoline back down to a buck a gallon, or that Saudi Arabia will always ride to our rescue.

No doubt they will be much more popular than me, too. But I'm not here to be popular. I value credibility above all else.

Maybe that's why I had an old Shel Silverstein poem titled "The Perfect High" stuck in my head all day, in which a thrillseeker named Roy seeks out a guru named Baba Fats who was said to know the secret to the perfect high. But the guru tells him that he must find it within himself. This makes Roy furious, and he insists that the guru tell him the secret. So Baba Fats makes up a wild story about a mythical magical flower, and Roy goes off in search of it. The poem ends:

"It seems, Lord", says Fats, "it's always the same, old men or bright-eyed youth,
It's always easier to sell them some sh*t than it is to tell them the truth."

Until next time,

Chris

P.S. Although I do not believe that there are any supply-side silver bullets that might solve the peak energy problem, I do believe that oil, gas and coal producers will continue to see high demand for their hydrocarbons. That's why we created the $20 Trillion Report—to find the best plays and alert you to them. Check it out today and take your share of the profits while you still can.

Who's Afraid of the Big Bad Three?

As I wandered the Plug-in 2008 Conference this week in downtown San Jose, California, I had an un-original but startling thought: Is Silicon Valley the new Detroit?

For a trade show and conference that is essentially about cars, this one looked nothing like any car show I've ever seen. In fact it looked like a typical computer trade show. The place was swarming with smart, well-dressed 20-somethings and gray hairs were few. Only a handful of cars were on display in the exhibit hall. And the sessions were decidedly technical, preferring performance curve charts and hard data over flashy videos.

These attendees weren't interested in body styling or macho demonstrations of horsepower. They had an entirely different set of things on their minds, like peak oil, climate change, and the uncertain future of transportation.

From the presentations I saw, one thing was clear: These young technologists aren't waiting for the Big Three to lead us into a new era of personal transportation. They're unafraid to admit that we have some serious problems, and they know that we have very little time to accomplish an unprecedented technological revolution. They aren't beholden to the gas-burning technologies of the past. And they're accustomed to working at light-speed, compared to the glacial speed of innovation that characterizes the lumbering old automakers.

Step On It!

Andy Grove, former CEO of Intel, kicked off the conference with a bold challenge to convert 10 million existing gas guzzlers to plug-in hybrids within four years. By comparison, Toyota has only built one million Priuses to date. But for a computer company chairman like Grove, such a challenge is just the thing that gets his juices flowing.

He didn't just issue the challenge, though. He's got plenty of ideas on how to pull it off: A federal tax credit to offset half the cost of the conversion, paid for by licensing fees on all cars, boats, and planes. Give the electricity away for free for the first two years. Harness open source collaboration to speed development. And call on the venture capitalists of Silicon Valley to fund the innovations that are needed.

Transforming our rolling stock so that it can run on mostly electricity is, as another famous computer industry mogul likes to say, a "no-brainer." Peak oil means we have a looming shortage of liquid fuels, but all renewable energy technologies make electricity, not liquid fuels.

With the latest battery technology, most PHEVs can run 40-60 miles on electricity alone. According to Anant Vyas of the Argonne National Laboratory, a 60 mile electric range is enough to offset 75% of vehicle miles traveled.

That could take a hell of a bite out of our consumption of petroleum.

James Winebrake, an expert with the Rochester Institute of Technology and Department of Energy alum, noted that the $500 billion [more like $700 billion now] that we spend on foreign oil is enough to buy every American driver a "neighborhood electric vehicle" over a four-year period.

He calculates that hybrid electric vehicles (HEVs) and plug-in hybrid electric vehicles (PHEVs) could replace 40% of our existing fleet by 2030. In the process American households would save $316 million dollars a year, even after accounting for the increased electrical demand, since electrically-powered miles costs a fraction of gas-powered miles. (A typical The economic benefits of the shift, he says, extend across the entire economy as more jobs are created and more discretionary income is freed up.

And that doesn't even include the benefits to public health, transport outside the household sector, and general economic development and capital costs.

A Great Race to Save Society

Dr. Andy Frank, a professor of mechanical and aeronautical engineering at UC Davis who is credited as being the father of the plug-in hybrid, broke the numbers down in his keynote address.

We have 200 million cars on the road today, but we only make 15 million new cars each year. So at best, if the country's entire auto manufacturing capacity were to build nothing but PHEVs, in 10 years we could only replace about 50% of the fleet. (Other speakers suggested the replacement rate might run as high as 7-8% per year, but did not cite details.) [This section has been corrected from the original version; please see note at the end of this article.]

Peak oil and rising prices, along with global warming, are such urgent and serious challenges that we simply have to move faster than that. "We are in a great race to save society," he said, and offered his prescription on how to accelerate the transformation to a transportation fleet 90% powered by renewable energy:

Replace and modify vehicles, because replacement alone is too slow. We might replace 1-5% of the fleet per year, but we could modify 10-15% (20-30 million) per year. (That makes Grove's call to modify 10 million in four years seem slow!)
Offer government subsidies to help drivers buy PHEVs, to overcome the initial higher cost of the vehicles and create the surge in demand that will drive innovation and more rapid production. He observed incisively that the subsidy would be justified by the future cost of diminishing oil, which nobody seems to take into account.
Add plug-in outlets everywhere, to overcome the chicken-and-egg problem of having a PHEV but nowhere to plug it in. This is hardly a radical idea, he said, noting that outlets are already a ubiquitous feature of parking spaces in Canada, where drivers plug in during the winter to run heaters that keep their engine blocks from freezing. We already have parking meters with electric power supply in many places, he asserted, so adding plugs to them would be trivial and relatively cheap.

Frank has founded a company called Efficient Drivetrains, Inc. (EDI) to make an end-run around the big car companies and deploy PHEVs much more quickly. "GM and Ford are in the business of never buying or licensing anybody's technology," he said, and if they violate your patents, they'll say "so sue me," and you'll lose. So instead of even trying to talk sense into their thick skulls, he's focusing on the 400 other car companies in the world, supplying them with drivetrains and components, licenses to existing technology, and an open approach to collaboration.

His objective is bold and clear: "To see that the world moves toward electrification of the entire society in an integrated fashion to enable greater energy efficiency for higher improvement in productivity and lifestyle with a zero CO2 footprint."

He's not afraid of the Big Bad Three. And neither are we.

What's Hot—and Not

The Plug-in 2008 Conference concluded yesterday, the same day that Ford announced yet another sweeping restructuring as it staggered under an $8.7 billion loss for the quarter. CEO Alan Mulally, who's been struggling at the helm of the company for two years to turn its fortunes around, acted decisively. He issued new marching orders to retool three of its pickup and SUV factories to produce six models of the smaller, more efficient cars it currently makes in Europe. It's a good move for Ford, but for the moment, they're so Not hot.

But PHEVs? Nothin' but hot.

Jeff Siegel has long been in hot pursuit of the companies with the best designs for lithium ion batteries, the power pack of choice for the new generation of PHEVs, and has recommended several of them for Green Chip Stocks subscribers. The rest of the components that will enable the PHEV revolution, like new high-efficiency electric motors, innovative transmissions, and software control systems, are also on his radar.

PHEV technology has been around for 15 years, and all-electric cars have existed for over 30 years. It's mainly Detroit that has stood in the way of its progress, as many have learned from the documentary film Who Killed the Electric Car? But now, thanks to their own myopia, they're on the ropes.

Silicon Valley is about to snatch their crown. With a fertile ground of fresh ideas, plenty of VC, and a $130-a-barrel wind at their backs, the question is not if you will ever drive a PHEV or EV, but when.

Based on the presentations I saw at the conference, I'm expecting to be able to buy PHEV technology for myself within the next two years. Perhaps it will be a conversion from EDI, a standard production line Mitsubishi, the Prius "2.0," or a sleek all-electric Tesla.

But I don't think it will be a Chevy Volt.

Until next time,

Chris

P.S. Bridging the gap to using clean, efficient energy isn't going to happen overnight. That means investors like us now have a perfect opportunity to take advantage of the burgeoning interest in clean technology. If you're interested in learning more on how you can profit from these trends, feel free to take a look at the Alternative Energy Speculator.

Correction - July 26

Thanks to the readers who pointed out the incorrect numbers in the section on Dr. Andy Frank's talk. I'm not sure what happened there, but I suspect it was a typo in my notes. Unfortunately I was unable to find data that precisely matched what I thought he said. Running the calculations again and using data I located online, I made the smallest possible edit, to correct the replacement figure to 50% over 10 year. Here is a sample of the data I found:

According to the OICA, there were about 247 million registered highway cars and light trucks in the U.S. as of 2005. The U.S. makes about 11 million per year (a 4% per year replacement rate), but sales run about 17 million per year, according to the Automotive News Data Center. The definitions of what constitutes a "car" or "light truck" vary from source to source, and the numbers vary from year to year, so it's difficult to rationalize all the data. For example, according to ANDC, sales in the first half of 2008 were 834,000 lower than the first half of 2007, which when annualized would mean a 1.6 million decline. For the purpose of comparison to Dr. Frank's assertions, I assume he was working with slightly outdated data to come up with 200 M existing vehicles and a 15 M per year replacement rate, and that he assumed growth to about 300 million total within 10 years, resulting in a 50% replacement. So my original "in 10 years we could only replace about 5%" was probably a typo I made while taking notes during his keynote, which should have been 50%.

Looking at cars only: In 2005, OICA says the U.S. produced 4.3 M cars, where the total number of cars was about 136 M according to the Bureau of Transportation Statistics. This amounts to a 3% per year replacement rate, replacing 43 M cars over 10 years, or about 32% of the existing inventory.

—Chris

Shadowboxing the Apocalypse

(An homage to John Perry Barlow)

If it weren't such a desperately serious situation, watching our fearless leaders trying to grapple with the energy and financial crises would be hilarious.

Anyone with more than $100,000 in their bank accounts must be having some sleepless nights right about now, as the failure of overextended financial institutions continues its brutal cascade. The federal seizure of IndyMac, and the potential federal intervention into Fannie and Freddie, have somewhat dampened the fallout, but Congress' response on Monday to Sec. Paulson's plan was tepid. As I have discussed in previous articles, by the numbers there is still a long way to fall before we hit bottom.

Merrill Lynch warned yesterday that the flagging faith in US financial institutions may hasten that long-dreaded day when Asia, Russia and the Middle East start dumping dollars and refuse to continue buying $700 billion of our debt every year to keep our listing ship afloat.

According to Brian Bethune, the chief financial economist at Global Insight, the situation is even worse: If the US Treasury does not push through a rescue of Fannie and Freddie within a mere two or three days, he said, it risks a financial crisis that spirals out of control. "We can't dither," he warned. "The markets can be brutal. We have to break the chain of contagion before confidence is destroyed."

Free-market champions like Larry Kudlow have argued that a $1.4 trillion Fannie and Freddie bailout would only increase the "moral hazard" risk, by allowing an unsound mortgage business to go even deeper into a hole of lending to try to rescue itself. Far too few of their holdings could be called a piece of moral land, they say, and I am inclined to agree on that. On the other hand, I don't think the economy can tolerate the risk of letting them fail.

In response to the crisis, Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson have been vigorously waving their magic wands before a weary band of bankers, but the Street seems unconvinced. The Dow Jones U.S. Financials Index has fallen 15% over the last week alone. (Of course, if you have been buying SKF, as I have recommended several times this year, you're up 30% over the same week, and using that to hedge your losses elsewhere in your portfolio.)

Meanwhile, President Bush continues to complain that he doesn't have a magic wand to make gas prices go down. I don't know who advised him to keep hammering on that talking point, but every time he says it, it just sounds dumber. We don't need magic wands, or for that matter bloody and costly attempts to secure by military means our access to foreign oil. What we urgently need is a sensible energy policy for the long run, and by that I mean a 100 year plan.

Unfortunately, I see very little of the kind offered from our energy cretins on the Hill. For your amusement and horror, I offer this little selection of their vast, bipartisan failure to come to grips with reality.

A Parade of Bad Ideas

I begin with Newt Gingrich's soft-money PAC, American Solutions for Winning the Future, which is largely funded by Las Vegas billionaire Sheldon Adelson, a major Republican donor and fundraiser. Their flashy new web site panders to the patriotic breast shamelessly, while promoting a "Drill Here, Drill Now, Pay Less" message. Apparently, they have gathered over a million signatures in short order on their petition to Congress, asking them to "act immediately to lower gasoline prices" by "authorizing the exploration of proven energy reserves" off our coasts.

Nice try, Newt. I assume that none of my readers were among your signatories. They know that any new drilling off our coasts could not produce any significant new stream of oil for at least 10 years, and would only slightly affect prices at the pump. Even the EIA has acknowledged that "any impact on average wellhead prices" would be "insignificant" after 2030.

For his part, President Bush lifted the moratorium his father placed on offshore drilling, saying that "as the Democratically controlled Congress sat idle, gas prices have continued to increase. The failure to act is unacceptable." Apparently he has forgotten that the Republican controlled Congresses that preceded this one, on his watch, also watched gas prices increase without actually doing anything about it.

Since Congress has its own moratorium in place, Bush knows that the gesture is purely symbolic, just as he knows that new offshore drilling would have no effect on prices until well after his successors are out of office. But it might reassure the gullible that he's trying to do something about oil supply, and score a few political points.

Seeking to score some points of her own on the issue, Senator Barbara Boxer (D-CA) expressed her "outrage" over the presidential reprieve, saying that the oil companies should drill on the leases they've already got. (We'll discuss the energy illiteracy of that claim in a minute.)

Next we have a strange and oft-repeated claim by a handful of Republican senators (and Dick Cheney) that we must start drilling in offshore Florida because the Chinese are already drilling off the coast of Cuba, and taking "American oil." In fact, there are no Chinese firms drilling off Cuba's coast, but according to the Washington Post, the claim is "just too juicy not to repeat."

The hype about oil shale must also grace our list. Bush and other boosters are trying to whip up public support for a new run at turning low-grade shale into liquid fuel (the fifth such attempt in our nation's history), touting the deposits as being three times the size of Saudi Arabia's reserves. As my readers know, such assertions are extreme exaggerations. The oil shale resource, while large, has never proved to be commercially viable and is unlikely to ever deliver more than a trickle of very expensive, synthetic fuel, which will have very little impact on American supply or prices while incurring as-yet-unknown environmental damage. Unfortunately, the appalling ignorance about energy that burdens most of America makes such wild claims useful political fodder.

On the other side of the aisle, House Speaker Nancy Pelosi struck her own pandering pose, claiming that the current economic "emergency" justified releasing oil from the SPR. Clearly, Pelosi is no more up to speed about the realities of the oil business than anyone else on the Hill. As I have explained before, the SPR is already far too small an emergency reserve, and should only be tapped in the event of severely disruptive actual shortages. It's bad enough that the Democrats were able to stop the filling of the SPR some months ago. Anyone who isn't in total denial about peak oil knows that trying to use the SPR to moderate prices is a terrible idea.

The Democrats, of course, have a growing list of terrible ideas on how to address the energy crisis. I'm sure it scores political points with angry voters to say they'll crack down on oil price "gouging" and excess speculation, but as I have written repeatedly, I don't believe either of those things are a significant factor in today's prices, if they're happening at all.

But the crowning idiocy of Democratic suggestions must remain the legislation that makes it possible for Congress to sue OPEC for price gouging, an idea so stupid that whoever conceived it should win a Darwin Award. In a way, I hope they actually try that some day. Maybe the blowback will slap some sense into them.

And so the shadowboxing continues, with both sides of the aisle feinting and jabbing against straw men, and getting us exactly nowhere in terms of real solutions. Each side blames the other for being in this predicament, while none dare whisper the one word that ought to be the first on the list: conservation. Our addiction to oil is too great to even talk about.

A silent war rages within the very breast of America. Will we continue to insist, with the mentality of a two-year old, that all the oil we want should be ours, that we have some birthright to endless growth and cheap energy? Or will we grow up, and realize that we're neither immortal nor wise, and that the world has real limits we have to live within?

Enough, Already!

While politicians do their level best to ensure that America is as confused as possible about energy, spreading their spins and racking up pander points, there are at least a few experts in the energy industry who are telling the story straight.

John Hoffmeister, former CEO and president of Shell Oil's US operations, told CNBC yesterday why he supported lifting the ban on drilling the outer continental shelf (OCS). Recognizing that OCS production is "not gonna make any material difference" in the short term, he noted that America has resisted developing those areas for 30 years, and that we're now "paying the price" for that.

He went on to explain that all of our options—including drilling for more oil and gas domestically, swapping out 200 million liquid-fuel burning cars for ones that run on electricity, and growing the 2% share of renewably generated energy up to a much more significant level—will take decades to achieve. But politicians, with their short term motivations, simply can't grapple with the long time horizons of the energy business.

Our 30-year failure to develop a sensible long-term energy policy, a period that has seen both Republican and Democratic presidents and majorities in Congress and a long history of shortsighted solutions, is ample demonstration of his point.

Regarding the Democratic assertion that the oil industry isn't using its existing leases, Hoffmeister remarked, "The industry is pursuing the leases it has, but to be blunt, the prospective nature of many of those leases is very low. And you don't go drill oil where you know it doesn't exist." That, I believe, is a true statement.

Hoffmeister explained why he chose to leave the oil business and found a nonprofit group called Citizens for Affordable Energy: to start "doing what's right in America." "Doing what's right in America is listening to the citizens that are in great pain," he said, "making the tough political choices to go after more oil and gas, and—and, as T. Boone Pickens would say, all those other forms of energy that are out there, and do it all."

That has been my position all along, because the way I tally the numbers, even if we do it all, and do it well, we're still likely to come up quite a bit short.

Decrying the "politics of partisan paralysis," Hoffmeister said "It's not helping the American consumer or the American economy one iota. We really have to look at this as an American problem. It's not a Republican problem, a Democratic problem...It's an American problem, and I wish the two branches of government would work together." He went on to say, "The great American public has said ‘enough, let's quit the political rhetoric, and get on with solutions.'"

I only hope that's what we're saying.

(To those of you who caught the references: hey now!)

Until next time,

Chris

Peak Oil Confusion - A Game Whose Time Is Up

Pain at the pump is finally putting energy on the front burner in this election season, but media coverage of the issue has been fraught with misinformation.

I hate to say it, but I am beginning to think some of the confusion is intentional. From the news that Cheney's office has interfered with reporting on climate change science (what a shocker!), to the assertions of some pundits that there are 12 trillion barrels of oil yet to recover out there, to assertions by politicians that we can drill our way to energy independence, it's tough for the average person to get a real grip on the issues.

Confusion breeds apathy, and that's not something we can afford anymore. I believe that the impending energy crisis is too urgent to allow misinformation about peak oil to go unanswered.

So I am attempting to set the record straight.

For this week's Energy and Capital column, I am publishing a formal rebuttal to a May editorial on peak oil in Investor's Business Daily, which got the facts about peak oil-as I understand them-badly wrong.

It refers to a companion piece which has just been published, a "Peak Oil Media Guide" that I developed for the Association for the Study of Peak Oil - USA.

I hope my readers will find these two pieces helpful in separating fact from fiction about peak oil.

Until next time,

Chris

To the editors of Investor's Business Daily:

I feel compelled to respond to your editorial of May 28, 2008, entitled "Peak Oil: An Idea Whose Time Is Up." For a respected financial publication such as yours, I found your coverage reprehensible and rife with errors. I have to wonder if it was deliberately designed to confuse the public, or if the authors were merely deeply misinformed.

Our nation urgently needs to get up to speed on the realities of energy before we can have any sort of intelligent conversation about reforming energy policy. Articles such as yours do the public a grave disservice.

First, peak oil is a study, not a "theory." That is why the name of the world's top authority on peak oil is the Association for the Study of Peak Oil (ASPO), not the Association for the Theory of Peak Oil. The peak oil study is simply a scientific analysis and modeling of available data. More data might correct existing models, but there is no theory to prove or disprove. Likewise, politics plays no role in the scientific assessment of the ASPO's respected petroleum geologists.

Second, peak oil is not about "running out of crude," it's about the rate of oil production. You are correct "that one day the crude supply will effectively dry up," but that day, perhaps 100 years in the future, is not what the study of peak oil is about.

I will refer to the "Peak Oil Media Guide" as I address your remaining statements.

To begin with item 1, "It's not the size of the tank which matters, but the size of the tap."

Talking only about the number of barrels of oil that might exist somewhere, without also talking about the rate at which that oil can be produced, and when, is utterly meaningless.

You stated:

U.S. production is trending down again, but it's not because there's no oil. It's due to shortsighted policies that prevent the industry from drilling for the almost 100 billion barrels of crude known to be under Alaska's Arctic National Wildlife Refuge and beneath the oceans just off of America's coasts. It's because politics and political correctness block the development of Big Sky state oil shale fields, where as much as 2 trillion barrels of crude, by some estimates, sit idle.

Here's the reality.

Right now, the world is producing between 86 and 87 million barrels per day (mbpd) of oil, just 2 mbpd more than it did in 2005. The world has reached a bumpy production plateau, and will likely continue on it for another three to six years before beginning the terminal decline of global oil production.

Your numbers on oil are also questionable:

But the impact of those nations on crude prices in recent months is suspect. Global oil consumption grew 2% in the first quarter of this year over the first quarter of 2007, while production increased 2.5% over the same period. On a daily basis, roughly 85 million barrels of oil are consumed across the world, almost exactly matching the amount produced each day.

You don't state your sources, but according to the IEA Oil Market Report of May 13, the most recent publicly available global data I am aware of, the numbers are quite different:

Global oil consumption grew 0.81%, not 2%, from 85.9 mbpd in Q1 2007 to 86.6 mbpd in Q1 2008.
Global oil supply in the grew 1.81%, from 85.6 in Q1 2007 to 87.2 mbpd in Q2 2008. However, April supply fell 0.4 mbpd to 86.8 mbpd, due to declining output from OPEC and the FSU, plus North Sea outages.
Average demand in 2008 is projected to be 1.2% higher than 2007.
According to this data, supply is a scant 0.6 mbpd higher than demand.

If you will refer to "Figure 3 - US Oil Production 1900-2005," which shows the historical peaking of U.S. oil production, perhaps you can explain why you would dismiss the U.S. peak with a comment like "Yes, domestic output has peaked. But it peaked at a level 13% above what Hubbert predicted. And the peak wasn't followed by a falling-off-the-table decline. Output rose after a temporary slide."

Yes it did...and then resumed its downward course on a relentless, 38-year history of decline, as the chart clearly shows. Who are you trying to fool?

As for the fact that U.S. production peaked 13% above Hubbert's prediction, I say, "close enough." Hubbert also found that if the recoverable amount of oil in the U.S. were increased by one-third, it would only delay the Lower 48 production peak by five years. A similar calculation for world production would produce similar results. Again, when it comes to the question of peaking, flow rates are far more important than reserves.

The decline of U.S. oil production was not the result of politics, nor can any political decisions now significantly alter its future course. It is simply the nature of petroleum extraction that it ramps up to a peak and then declines, in a rough bell-curve shape. This observation has been made in thousands of oil fields (and oil producing nations) worldwide, which is why Hubbert's model continues to be respected.

If you will refer to item 2, "We are now at, or ‘close enough' to the peak," you will note that global oil production has plateaued. It may continue to rise at a negligible rate for the next couple of years, but no major increases are possible.

You seem to be among those who are laboring under the mistaken belief that the U.S. can somehow drill its way out of dependency on foreign oil, and that increased domestic production could the relieve today's "high" prices.

Nothing could be further from the truth.

In fact, the U.S. uses about 20 mbpd of petroleum, and produces about 7 of that. The other two-thirds is imported because there is no possible way that we could produce another 13 mbpd domestically, even if we drilled every single place that might have oil.

Regarding the potential of oil shale, please refer to item 4, "Oil shale: the fuel of the future...and it always will be." After four decades of fully authorized, commercial, even subsidized attempts to develop oil shale into a usable fuel, no one has ever been able to make it economically feasible. Part of the reason for that is that it's not even really oil-it's kerogen, an immature precursor to oil, and it takes an enormous amount of energy to turn it into something usable.

It remains to be seen if the energy returned on the energy invested (EROEI) for oil shale is high enough to even make its production worthwhile. Even if it does prove to be viable, it is unlikely to ever produce more than a modest flow (though perhaps a very long-lived one) of extremely expensive, synthetic oil. It is not some quickly available "two trillion barrels" of "crude," as you asserted, and it will require an enormous amount of energy, probably from coal, to produce.

As for the oil reserves of ANWR and the continental shelf, please refer to item 5, "ANWR and the continental shelf are no panacea." The flow rates from these resources cannot be known until they are produced, but we can make ballpark estimates.

Preliminary estimates by the USGS indicate that ANWR would likely only produce around 750,000 barrels per day at peak. More importantly, it would take 10-20 years to achieve that peak production level.

If all limits on domestic drilling were removed, including ANWR, it could only increase US oil production by a maximum of 2-3 mbpd. It would come online slowly, and given the loss in global oil production by the time it arrives, the additional production from these remaining domestic reserves will be underwhelming. Together, they could amount to perhaps 12-15% of our daily usage today, or about 3% of world production.

However, if we are currently on the peak/plateau of global oil production, and production starts to fall within the next five years, then 10 years from now, at a reasonable average 2.0% rate of net depletion, world oil production will be down 11 mbpd-about 12%-from where it stands today. Therefore any additional domestic production could only offset perhaps one-quarter of the global production that will be lost!

It should be obvious, after a close look at the data, that at the rate that the U.S. currently uses oil, the chance of producing all of our own needs domestically is zero.

The potential impact of increased domestic drilling on oil prices is also minimal. Since oil is traded globally, and the U.S. imports about two-thirds of the oil it consumes, the price of the oil we produce will always maintain parity with global prices. With the global supply and demand balance as tight as it is for oil, natural gas, and coal, increased production in the U.S. would make a negligible difference in U.S. gasoline prices.

The U.S. Department of Energy estimates that drilling in ANWR would only reduce the price of gasoline by less than four pennies per gallon-20 years from now!

The slight declines in petroleum consumption over the past year in the U.S. and Europe have been more than offset by the increasing consumption of countries in Asia, South America, Russia, and the Middle East. Net global consumption is expected to increase another 1 mbpd this year.

Indeed, we should recognize, as the Saudis have, that the oil we still have will only become more valuable as time goes on, and it makes sense to save some for future generations. Oil is incredibly useful and energy dense, and we use it altogether too profligately today. Burning every last bit of what remains as quickly as we can makes no sense at all. I further submit that it is irresponsible and immoral to attempt it.

One of the most glaring errors in your analysis was in misunderstanding depletion. I refer your attention to item 7, "Depletion is relentless."

The concept is simple: Oil production first must make up for the depletion of mature fields before any net additional oil can be counted. It's like pouring water into a bucket with a hole in it. The background global decline rate is generally accepted to be 4.5 - 5%.

Anyone familiar with a balance sheet should understand this concept, but you missed it when you said:

Production over the next two quarters is projected to continue rising (3.3% and 4.1%, according to estimates from Citigroup), while demand is expected to grow at a slower 1.6% pace over the next six months.

A net global production increase of 3-4% has not occurred in several decades, nor is it conceivably possible in the future, let alone the next six months, given what we know about the projects that are under way.

Clearly, you confused "production" with net production. The world's net production over the next six months would be lucky to manage a 0.6% increase, after accounting for the background decline rate.

You point out: "World output is expected to rise from 85 million barrels a day today to 110 million barrels by 2015, according to the International Energy Agency," but your information is out of date.

Surely you are aware of the Wall Street Journal's article, "Energy Watchdog Warns of Oil-Production Crunch," published on May 23, 2008, about a week before yours? It previewed the IEA's upcoming report in November, which will announce the results of their first detailed study of the depletion rates of the world's top 400 oil fields. That study has prompted them to reduce their estimate to 100 mbpd by 2015.

I should also point out that the IEA has lagged well behind other knowledgeable analysts who have consistently demonstrated why the IEA's past projections could not be obtained, and who are now of the opinion that global oil production is unlikely to ever exceed 90 mbpd.

I must emphasize that no political considerations, or faith-based economics, are needed to understand the available data and the models. The mathematics are quite clear.

Finally, I must address your quote from Peter Jackson of CERA, who said, "The 'peak oil' argument is based on faulty analysis which could, if accepted, distort critical policy and investment decisions and cloud the debate over the energy future."

I respond that CERA's projections of future oil production have been far off the mark for about the last five years straight. If anyone's analysis is faulty, it is theirs. The ASPO's has come much closer to reality. ASPO-USA has directly challenged CERA to back their projections with real money; so far, they have declined to respond.

CERA is correct, however, that faulty analysis could "distort critical policy and investment decisions and cloud the debate over the energy future." I beg you to consult more reliable authorities than CERA for that very reason. They have a lovely story to tell; unfortunately, it's wrong.

I hope you will explore the information I have provided here, and avoid making such fundamental errors in your future coverage of the oil markets, and of the study of peak oil.

Sincerely,

Chris Nelder
Energy Journalist

A New Paradigm

It was a wicked, wretched June for the Dow, which posted its worst performance for the month since the Great Depression.

Oil prices setting record high after record high, while the dollar sinks ever lower, have put the hurts on the whole economy—except for commodities and energy, which are the only two asset classes I have promoted in these pages.

It's not that I'm a genius investor or anything—I assure you, I'm not. All I do is read the writing on the wall, and tell you what I think. It's a surprisingly rare thing to do among Wall Street pundits, who seem to prefer the safety of historical patterns and chart analysis to actually looking around them.

So you have to look past the talk about how all those beaten down stocks in tech, retail, and luxury items are good buys.

They sure are: Good bye house, good bye car...

What we have here is a new paradigm. It's time to throw out the old investing playbook and make a new one.

Rather than being safe ways to play the market, index funds, diversified portfolios, momentum trading strategies, and technical chart analysis are now more likely to lose you money than increase it.

Want some proof? Here are the top-performing diversified U.S. stock-fund categories, according to MarketWatch:

Category	Q2 Avg. Return	YTD Avg. Return
Midcap Growth	5.2%	- 8.3%
Small-Cap Growth	4.2	- 11.3
Midcap Core	4.1	- 6.0
Multicap Growth	2.0	- 10.5
Large-Cap Growth	1.8	- 10.0
U.S. Diversified	0.6	- 9.7

Yes, that's right, the top performing stock funds are down 6-11% on the year. As for the major averages, they're down 12-14% this year.

A typical Wall Street pundit, trying to paint a happy face on an abysmal market, might write up the headline as "Funds beat the indexes in 2008!"

But that's not the kind of gruel we serve around here.

A Perfect Storm

Regular readers of my column know the real score: We've got a perfect storm on our hands.

As more and more of one's income is eaten up by the basic needs of food and energy, it leads to further dependency on credit, which increases the likelihood of credit and mortgage default, which further hurts the financial sector, taking down the broader markets and putting the economy in an increasingly worse position.

Oil prices are causing inflation across the board, from food to everyday goods, and by "inflation" I mean prices for everything going up, not some geeky Austrian-school definition of it.

Part of the reason oil keeps going up (apart from simple supply and demand) is that the Fed has devalued the dollar in order to stave off a financial crisis resulting from the subprime meltdown. But if the Fed tries to prop up the dollar now, and raise rates, it could bring an already-down economy to a standstill. So by averting a crisis of confidence in the banks, they brought on a crisis of stagflation for the entire economy. As the old saying goes, if the only tool you have is a hammer, the whole world looks like a nail.

The fact is, the Fed is whistling past the graveyard. Or sticking their finger in a leaky dike. Or whatever metaphor you like.

While most investors are shaking their heads in confusion and dismay over a recession that just won't go away, it all makes perfect sense to those who really understand the implications of peak oil.

I hold a very simple thesis: Without an ever-growing supply of cheap and plentiful energy, the old investing strategies simply don't work anymore, because the markets don't behave as they should.

In fact, record high oil prices have clearly failed to bring adequate new supply to market. Consequently, oil and commodity prices stubbornly refuse to revert back to the mean, as a technical analysis says they should.

A Very Nasty Period

The trends should be clear enough to anybody who reads the news.

Transportation is on the ropes. The Big Three automakers are posting huge losses after being asleep at the wheel for years, continuing to pin their futures on big trucks and SUVs even as global oil production flattened out and the peak oil story started to unfold. Now new and used car dealerships are saddled with row upon row of gas guzzlers nobody wants, and American-made vehicles with European fuel economy are nowhere to be found. It's no surprise to me that Chrysler just shut down an assembly plant, and I expect more bad news yet from the American automakers.

The airline sector is going down in flames, with fuel prices destroying the bottom line. (See my article of last month, "Peak Oil and the Rail Revolution - Say Goodbye to Cheap Air Travel.")

Truckers are trying to strike their way out of losses due to skyrocketing fuel costs, but if they can't pass on the higher cost of their fuel to the buyers of the goods they haul, which is hard to do in a declining economy, then they're going to simply run out of road.

The financial sector is down 20% on the year, and it ain't over yet, not even hardly. Hedge fund manager John Paulson believes that we're only $360 billion of the way through a $1.3 trillion writedown from the credit crisis.

Oh, yes. The subprime mess was just the beginning. Now we're getting into the option ARM resets, where borrowers have a choice about how much to pay off each month. Merrill Lynch estimates that the losses from option ARMs could add another $100 billion to the $400 billion in mortgage and subprime related losses. And after that, we'll likely see another wave of personal credit defaults, leading to yet another fat writedown for the banks.

On June 18, the credit strategist for the Royal Bank of Scotland said, "A very nasty period is soon to be upon us - be prepared," and warned that the S&P 500 could tank to 1050 by September—a 28% drop since the beginning of the year. That means that all of the gains made by the index's component companies since the end of 2003 would be wiped out.

Retail, luxury goods, tech, travel, entertainment...all in the dumper. Want a good way to hedge against recession? Pick the weak companies in any of those sectors, and short them.

Yesterday, the Dollar Thrifty car rental company blamed its poor 2008 performance on "tough operating conditions" as if this were some unexpected, nasty bump in the road, but I call it an entirely predictable result of peak oil.

Likewise, it should have been no surprise to anyone who's paying attention when Starbucks announced that it will close 600 stores, cut 12,000 jobs, and halve its expansion plans. When people can't afford to fill their tanks just to get to work, a $4 cup of frothed coffee-flavored milk just doesn't rank on the priority list.

But energy and commodities? Ahh...now there's a different story.

Energy Stocks: The Only Way to Make Any Money

In a CNBC interview on May 29, Matthew Simmons, one of the world's top energy investment bankers and a proponent of the peak oil study, explained his investing strategy. "I have a very significant portfolio that I've built up over the last 25-30 years in energy stocks," he said, "because I think it's the only way that anyone's going to make any money."

I couldn't agree more.

The investing game has changed, and those who realize it now have an opportunity to jump on the greatest investment event of the century. The growth potential for renewable energy in particular, and the associated technologies of the future, seems nearly limitless. After decades of investment and research into renewable energy, it currently accounts for only about 1% of the global energy mix, but by the end of the century, it will have to be closer to 100%.

We should expect prices for our most basic of needs, food and energy, to continue to rise until the supply and demand equations are back into balance. And it looks to me like that will be achieved mainly by demand destruction, which could take years to play out. This bear is going nowhere.

Meanwhile, energy and commodities, including agricultural commodity ETFs, are doing very well this year even as the rest of the market goes south. (For my previous recommendations in these sectors, see the Related Articles section at the bottom.) Along with traditional safe havens like gold and silver, bonds, T-bills and the like, they're really the only place to be right now.

But if you want to do really well, then you need to have a stake in some of the choice energy picks we have selected for the $20 Trillion Report.

Until next time,

Chris

Energy and Capital

The Big Picture on Q2 2008, Part 2

In part 1 of this series, we reviewed the trends in financials, fossil fuels and electricity. This week, we take a look at renewables, food and fertilizer.

Renewable Energy

The picture for renewable energy just keeps getting better, as more of the world begins to realize that we are having a real problem maintaining our traditional energy supplies. I have no doubt now that a big revolution in energy has begun. Mark my words: This is the time to go long on renewable energy, for the long term.

Consider this chart of a few of my favorite renewable stocks against the S&P 500:

After being beaten down harshly in the first quarter, along with just about everything else, renewable energy shares bounced up like spring flowers, handily beating the indexes by 20% or better.

Meanwhile, the chatter about controlling carbon emissions has only gotten louder, particularly as bad weather hits everywhere (which we'll get to in a moment). I expect this trend to continue, and would not be at all surprised to see some sort of binding legislation passed within the next year.

As I have detailed in my book, I favor a carbon tax over cap-and-trade schemes, for a variety of reasons, but I would be happy to see any sort of binding controls established. When that happens, you will definitely want to be holding some solid, reputable renewable energy companies in your portfolio, because it's going to put new fire under the whole sector, even as it puts the hurts on oil and coal.

Agriculture

Food production has come about even with energy as the world's top concern since my review of the first quarter. Riots, hoarding, and intermittent shortages became more common, and everyone from the UN to the Saudis put it on the front burner.

My observation was borne out in an unexpectedly harsh way:

Not only are food and energy closely interrelated, but weather is right in the mix too. The increasing use of fossil fuels contributes to global warming, which reduces food production, as was the case with the Australian wheat harvest. At the same time, weather impacts our ability to produce energy...and back around the wheel we go.

Flooding in the Midwest this spring has ruined an estimate 5 million acres of land, and harvests have been delayed because the fields were too wet to work. While parts of the West like California had the driest spring on record, parts of southern Indiana, Illinois and Missouri have endured the wettest spring on record. (Inversely, China's agriculture ministry instructed wheat and rice farmers in southern China a few weeks ago to harvest as much of their crop as possible before another wave of rains arrived.)

With fields too wet to sow corn, many farmers opted to plant soy this year instead of corn. The corn harvest this year is expected to be 10% lower than last year, and soybean plantings are running about 16% behind last year.

Consequently, corn shot from $5.82 at the end of Q1 to a record $7.92 last week. The spike in corn prices was due to the torrential rains that soaked the Midwest starting in late May, and in a mere two and a half weeks, corn prices went up 28%.

Ethanol production is expected to increase 25% over last year, and consume about 4 billion bushels of corn out of the 86 billion that will be sown this year. In the face of record corn prices, the cattle and poultry industries have been lobbying the EPA to cut the nation's ethanol production mandate in half.

They're not the only ones. Policymakers are realizing that corn is a very inefficient way of trying to produce biofuel, and might not be worth it. (That has been my position on corn ethanol since the beginning.) The corn ethanol plays have suffered the fallout:

The one bit of good news for grains is the worldwide wheat harvest, which is expected to be about 8% higher this year than last. The expectation brought the price of wheat down from a record $13.50 per bushel on Feb. 27 to $8.70 today, about where it started the year. Still, wheat remains about 50% higher than it was a year ago, and the harvest below average levels.

The big picture for agriculture is clear enough: demand is higher than ever, and supply is faltering. (Reminds you of anything?)

The flooding of the Mississippi had another unexpected consequence: The levee breaks shut down transport on the river, stranding 100 barges. Mississippi barges are the primary mode of transport to get grain from the Midwest to export terminals in the Gulf of Mexico. Grain giant Cargill alone had 200,000 bushels of corn sitting on the dock, unable to get a barge.

If you took my recommendations on fertilizer at the beginning of Q2, you are smiling now:

FEED has clearly sold off a speculative bubble, so I wouldn't touch that one now (and I hope you got out with some nice gains, as I did). But Mosaic and Potash Corp. are still good bets to hold, because I don't see any reason to think the food supply situation is going to radically improve any time soon. In fact, this looks like a nice little buying opportunity.

As one would expect for a diversified play, the more general agriculture ETFs I suggested have performed more modestly than the fertilizer plays, but who would complain about a 10-30% gain in a quarter, especially when the S&P actually fell a few percent?

I remain bullish on the ag ETFs, at least until we get a significant change in the supply and demand balance.

Metals

The metals group I suggested hasn't done quite as well, but if you picked the better stocks over the ETFs, you made out alright:

My read of the metals group is that it's probably ripe for a recovery, as the last couple of weeks are showing. Considering that the building boom is still going strong in Asia and the Middle East, and that shortages of basic building materials like iron are still happening regularly, I think this is a good time to jump into metals if you're not in already.

On the whole, as bad as the news has been in energy, agriculture, finance, and the economy in general for the past quarter, I have to say I saw it all coming. I banked on it, and I'm still banking on it.

With an economy on the ropes, the financial sector going down in flames, food prices skyrocketing, oil prices causing widespread inflation and the Fed helpless to do anything about it, a lot of investors will end this year with a lot less money than they started it.

But not us. In fact, we expect to turn some nice gains, by reading the signs rightly and playing them smartly.

Gains like the ones you'll make from our energy picks, when you sign up for the $20 Trillion Report.

Until next time,

Chris

Energy and Capital