Random Thoughts

Jim Brown
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Pimco says $100 Oil is fair price, Exxon shuts down Nigerian platform, Petrobras on a winning streak, Russia drilling in Gulf of Mexico, China's Peak Coal and fuel shortage, Holiday travel to rise, used car prices hit record highs and Peak Oil is behind us.

Mihir Worah, commodity manager for PIMCO's Commodity Strategy Fund, said oil prices would be marginally higher in 2011 and $100 per barrel would be a fair price. He runs the $18 billion commodity fund for Pimco. He said slowly increasing demand and slowly decreasing production would trim supplies and begin pushing prices higher.

Exxon shut in the 45,000 barrel per day Oso oil platform in Nigeria after it was attacked on Sunday. In the attack eight members of the crew were taken hostage and are "unaccounted for." Exxon is not evacuating the platform but halting production until further notice. Several oil companies in Nigeria have been faced with multiple shutdowns over the years as violence increases. Companies are afraid an attack could come during full production and cause a massive oil spill along with cleanup expenses.

Petrobras said it found light oil in 400 meters of water at a well south of the prolific Santos Basin. The key point is this oil is post salt. That means it was found above the salt layer two kilometers under the ocean floor. All the other discoveries over the last couple years have been "pre salt" or beneath the layer of salt around three kilometers deep. Drilling through salt is a very difficult task and Petrobras is taking the pre-salt process slow to learn as they drill exploratory wells how best to complete them. A post salt well would not have any of those problems.

Petrobras owns 100% of this block but they are in the process of selling 20% interest to Australia's Karoon Petroleum. This reservoir is 15 kilometers away from the Tiro and Sidon fields and suggests a broader extent to those fields than was previously thought. It seems Petrobras can do no wrong in the exploration area. Hardly a week goes by that they don't announce a new discovery.

Russia's Gazprom is preparing to drill for oil in the Gulf of Mexico. Unfortunately it is not our gulf. Gazprom is preparing to drill on 4 blocks they have leased from Cuba with the closest locations less than 50 miles from Florida. Gazprom bought a 30% stake in those blocks. Other companies have leased 21 blocks and will be moving to setup drilling operations soon. Malaysian Of course the U.S. oil companies are forbidden from drilling for Cuba because of the 40 year old embargo of Cuba. Cuba has 38 blocks still unleased.

Analysts are concerned that companies that will be coming to drill are not as technically capable as BP or as well capitalized and a blowout off the coast of Florida could take a lot longer to cap and do much more damage to the tourist industry. The U.S. government has the clout to lean on U.S. companies in the gulf to enforce safety rules. Nobody will be leaning on those foreign companies drilling in Cuban waters so anything goes. Cuba currently produces 60,000 bpd from onshore wells. It is forced to import 115,000 bpd from Venezuela. Cuba claims it has 20 billion barrels of oil under the gulf but the USGS claims slightly under 5 billion. The USGS is rarely right on anything so their numbers don't count.

The state run media in Beijing said the government is considering capping domestic coal output in 2011-2015 because China is worried that reserves are falling so dramatically the country will run out of coal to generate electricity. China has 14% of the global coal reserves but it consumes 47% of global production. Domestic demand has been growing at the rate of 10% annually. Imposing a production cap in the country would force alternate methods of electric generation. Since China already has serious electricity shortages and rolling brownouts are common the impact of slowing coal production would be equivalent to slowing economic activity.

Over the last three year China has spent $21 billion acquiring coal reserves outside the country. Coal prices are already at six-month highs on expectations that China will import a record amount of coal in November and December. Experts are trying t predict when China is going to run out of coal. BP claims China can only produce at the current rate for 38 years before reserves are completely exhausted. Of course that assumes you could keep up the current rate as supplies dwindled and remaining reserves became progressively harder to mine. It is more of a calculation than a serious estimate. Plus different types of coal have different BTU output. Cutting those reserves by only 5% to account for the low quality heat from low quality coal means China will run out in 21 years instead of 38. Problems in China will come long before 38 years. China produces 78% of its electricity from coal. Shutdown coal imports and you would turn off the lights in China.

China is also suffering from a severe shortage of diesel. More than 2,000 service stations in southern China have closed because of a shortage of fuel. The "official" price for diesel which is controlled by China is 8,000 yuan per ton. The black market is 10,000 yuan per ton. That equates to about 8 yuan per liter. A yuan I worth about 15-cents today so $1.20 per liter. There is about four liters to a gallon making diesel about $4.80 US per gallon.

Many service stations are rationing diesel with a 100 to 400 yuan limit. Some service stations have permanent lines with waits of up to 8 hours for a fill up. Drivers pay students and vagrants to sit in their car in line while the owners go to work.

Since the price of diesel is fixed but the wholesale cost is not an average service station loses about 600 yuan per ton of diesel. This is another reason many stations have shutdown rather than sell it at a loss.

If China was a free market economy there would be no shortage of diesel. It would cost more initially but it would flow freely. Can you imagine how fast their economy would grow without daily electrical brownouts and no shortage of fuel? The productivity would soar.

In the U.S. travel over the Thanksgiving holiday is expected to rise +11% according to AAA. About 42.2 million people will travel 50 miles or more from home for the weekend. That exceeds last years 37.9 million estimate. Air passengers will rise +3.5% to 1.62 million. With the average price of gasoline between $2.85-$2.95 that auto trip will cost 10% more than in 2009. Americans will spend an average of $495 per household to travel over the weekend. The round trip will average 816 miles. Hopefully Americans will get all this travel out of their system before peak oil arrives. How many will be traveling at $7 per gallon several years from now?

Prices for used cars hit a record high in October at $18,750 according to Edmonds.com. This compares to $17,968 in October 2009. New car sales are running about two-thirds of the pre recession level but used car sales are soaring. Apparently Americans don't have the itch to drive new and shrinking paychecks and high unemployment is forcing them to buy used. The chief economist at Manheim Auto Auctions said, "It's cool to be frugal." Helping fuel these high prices is the 700,000 cars that were scrapped in the cash for clunkers program. Taking that many used cars off the road pushed prices higher on those that remain.

Another voice crying in the wilderness is ignored. The European Union's energy chief, Guenther Oettinger, said "The availability of oil worldwide has already peaked but global consumption of oil is increasing." He was presenting a plan for the EU to invest one trillion euros over the next decade to fund a common EU energy network to cut dependence on fossil fuel imports. Good luck with that Guenther!

The IEA said last week that Peak Oil began in 2006 and nobody paid any attention to them. The IEA is playing word games in an effort to desensitize the public to the term peak oil and the potential impact. The IEA has shifted to only counting conventional oil in its peak oil model. Conventional oil did peak in 2006. However, we have added oil sands production, ultradeep water production, bio fuels, ethanol and a huge amount of natural gas liquids from the gas shale production. All of these sources are defusing the impact of the peak in liquid oil but they are only temporary. As liquid oil continues to decline the rate of decline will be faster than the rate of increase in all these other sources. The end is coming but consumers and governments continue to ignore the signs.

Jim Brown

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