More than once lately we have commented that if we really knew what was going to happen to the price of oil, we could place all our chips on one bet—oil up or down. There really wouldn’t be much need to do much else. But so far it has never been that easy.

I have personally been following the goings-on in the oil patch since 1984 and it has never been easy to decipher the truth about oil supplies, and therefore future pricing. Besides oil has always been the stuff of politics, embargos and wars as well. That has added all the more intrigue and guess work to solving the puzzle.

Lately oil prices have been going pretty much one way—UP! Given the news lately it is easy to think that they will just keep going up. But that never really happens. If the price of oil is going to continue to rise it will do so in the same zig-zag-saw-toothed manner that all stock and commodity prices rise or fall.

But after more than 21 years of reading; 21 years of oil related politics; 21 years of bluffing by OPEC; 21 years of wars; and 21 years of guesswork; something is finally becoming clear to me. The world has just about squandered away the chance to bring prices back down substantially.

The truth seems to be that we are pumping about all we’ve got, all around the planet. Believe it or not production in the USA has been declining since 1970. Bet you didn’t know that.

Even if we aren’t pumping all we’ve got; we certainly are refining about all we can. Anyone recall any new refineries being built lately? You bet you can’t. The last one built in the U.S. was back in 1976. The truth is we’ve actually closed up a bunch since then, and we have approximately 60 percent of the refining capacity in this country that we had 20 years ago.

Don’t get me wrong. I am not setting you up to make the case that oil prices are going straight up. There is a lot of speculation, and possibly some fear, built into the current pricing structure of oil. It is still possible that we could see prices back down in the $40’s before we see $80. But I’ve got a distinct feeling that we will see $80, and possibly higher. Earlier this year one lonely analyst at Goldman-Sachs speculated that oil could be priced at $100 per barrel by the end of the year. Most other Wall Street mavens laughed and ridiculed him. I suspect those smiles are a little tighter on people’s faces right now.

Let me get down to explaining the problem and why I am more and more concerned that prices will zig-zag their way up, and not down.

It seems that we use about 84 million barrels of oil per day throughout the world right now. Approximately 21 to 22 million are used right here in the good ole USA. The good news seems to be that if we continue to use oil at that pace, by everybody’s best reckoning, we probably have a 40 year supply of oil left on the planet. The bad news is that is probably a lie! The worse news is that doesn’t help to have a 40 year supply of something that you can’t deliver today-when it is needed. It isn’t a matter of how much we’ve got left. It is a matter of how much can be delivered to the market place each and every day—refined that is! You remember that little relationship of supply vs. demand don’t you—and what happens if one gets out of balance with the other?

Now I want to qualify everything else I am about to say here by disclaiming that figures lie and liars figure; and if I have ever known a good bunch of liars they were oil men.

But here are some figures to ponder. The U.S. Department of Energy has recently reported that by the end of 2005 the total supply of oil available to the U.S. will be 700,000 barrels short of projected demand at that time. If that turns out to be true, that’s a problem.

Now, lest you haven’t been paying attention, there is another little country which has gotten pretty thirsty for oil. Have you ever heard of China? They are the folks who just came knocking at our door and offered $18.5 billion to buy Unocal. I gotta hand it to them. That’s a pretty gutsy move; and a very wise one too. The fact is that China’s three largest oil companies are aggressively buying up reserves all over the world. After all they got all that money selling things to us at WalMart and Nordstrom’s for that matter. Have you checked the label in your Tommy Bahama shirts lately?

In case you have not been paying attention, let me update you on a few facts about China. Theirs is the world’s fastest growing economy. It grows at a pace of 8 to 9 percent per year every year—for the past 20 years. That is double to triple our rate of growth—and our economy grows faster than anybody else—except China.

Some are forecasting that China’s need for oil will grow to match ours in the next 20 years. Without getting into all the gory details, all that “some” are doing to come up with that number is reflecting back on the rising rate of oil consumption in the U.S. and Europe as we industrialized in the first half of the 20th century and applying similar growth rates to the Chinese economy. The only difference is that their economy is growing much faster than the U.S. or Europe ever did back then. So much for accurate forecasting methods!

Now if you haven’t linked the two contradictory premises that you just read about, let me do it for you. Six paragraphs above this one (not counting this one) I mentioned that “if we continue to use oil at {the present} pace, by everybody’s best reckoning, we probably have a 40 year supply of oil left”. In the paragraph above this one I mention that “China’s need for oil will grow to match ours in the next 20 years.” It is at this point in the story that I feel like I am watching Sesame Street and I have just heard the question “which of these things don’t go together?”

But wait, there’s more! I forgot to tell you how different the current demand for oil is in China vs. the USA. We currently use about 21 to 22 million barrels per day. They use 5-6 million barrels per day. That is a big disparity, and the forecast is that they will grow to match our demand.

But wait, there’s still more! Do you think that demand in the USA will be static for the next 20 years? Umm, let me count some fingers here. It is estimated that our economy will grow 2 to 3 percent per annum (give or take a recession or two), and our population will grow by 100,000,000, mostly through immigration. So even by counting my fingers I can surmise that the USA could be consuming much more oil 20 years from now than we are today—actually about 38 million barrels per day at present growth rates.

But wait, if you act now—by continuing to read—we will deliver the punch line. China’s demand is not expected to grow to match our demand figures today. Their needs are expected to match ours 20 years from now, inflated by our own growth rates—because they are simply growing so much faster than we are. So it is possible that both countries will be consuming approximately 38 million barrels per day in 20 years. Where is all that oil going to come from? I don’t know about you but I am almost exhausted just thinking about it. Whoops, did I forget to mention India and Brazil?

Got a few minutes? We can forecast their growing demand too. No, just kidding. I think you get the point.

Maybe I am a little slow. After all it has only taken me 21 years to think that I have spotted a trend, but let’s make this guess together. You finish the next sentence. The price of oil is going _____ from here!

Epilogue:

Yea, yea I know we are still exploring for more oil! Anyone seen a major new discovery since 1986? (The answer is no!) That is not a trick question. Anyone seen a new refinery lately?

Yea, yea I know there are plenty of sources of alternative fuel. Seen any nuclear power plants built in the USA lately? Natural gas—well its price has only quintupled in the past 20 years. Coal—burns a little dirty don’t you think? Sure they are cleaning it up, and the price is going up, as it gets cleaner. Love to own some, it will probably be a good investment, right along with oil. Besides, I think I read somewhere that between us and the Chinese we have a 400 year supply. That is more than I am going to need.

Sure there are fuel cells; but has anybody got one that is efficient enough to replace fossil fuels right now or next year? Hydrogen? Oops, it takes fossil fuels, and lots of them, to make the Hydrogen. Imagine that. Solar power—sorry it accounts for less than 2 percent of our supply of energy. Wind, even less. Probably one to two percent of our energy supply.

The truth is folks that we have squandered years during which we could have been developing alternative energy supplies. But it has never seemed necessary because we have always allowed ourselves to believe that we’d have plenty of cheap oil. I’ve got a feeling that is really about to change. It just might be time to actually buy some wind turbines.

The good news is that we are still the country that put people on the moon in nine years from a standing start. We are still the country that struggled out of the Great Depression and won World War II, with more than a little help from our friends, in four short years.

We are still John F. Kennedy’s country and we can do the unimaginable. We can dream, plan and invent our way out of this oil dilemma, but I suspect we don’t have a moment to lose.

All the best,

Paul Krsek
For K&A Asset Management, LLC

Disclosure and Disclaimer (updated 11/28/05):

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Sincerely,

Paul Krsek
Updated: November 28, 2005

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