Obviously, the biggest news on the energy front last week was the momentary dip in crude oil prices to just below $50 per barrel. Many if not most oil analysts were predicting that oil would hold steady at $60 per barrel throughout this year, but they were confounded by market events. Now some commentators, including famed economist Arthur Laffer, are predicting a return to the low prices of the eighties and nineties and price stability thereafter on into the indefinite future. Indeed, one Terence Corcoran, writing for the Financial Post, avers that, “the scale of the decline pretty much puts peak oil theorists out of commission.”
The Los Angeles Times went further in the January 17 Business Section where a market report predicted that investors would desert energy en masse as it would no longer be highly profitable in the future, given the prospect of permanently depressed oil prices. Apparently, many are willing to take what could still be construed as a market fluctuation as evidence of a sea change.
Certainly the decline has sent a shudder through the alternative fuels community—both the biofuels contingent and the unconventional fossil fuel folks. Many ethanol stocks have been hammered, and there’s a big scare up in Canada where there’s $100 billion in capital investment toward augmenting oil sand production. Still, no announcements have been issued to the effect that any major stakeholders are prepared to desert alternative fuels just yet, though there could be if Laffer’s prediction of $35 per barrel oil comes to pass.
We are not an investment journal in the usual sense, and we do not issue buy or sell recommendations with respect to individual stocks or even whole industry segments though we comment freely on the health or ill health of both. Still, we definitely have a dog in this fight, and in fact it’s the family pet. If the energy bears are correct, then the alternative fuels business is facing a debacle and with it us.
Given the grave import of the oil price decline for the industry, it behooves to dig deeper, and attempt to determine both what is behind it and what it portends.
The pricing of oil, and, to a lesser extent, natural gas, in international markets differs somewhat from that of other commodities in that a disproportionate share of production occurs over an extremely limited geographical area, and because much of that same area is under the jurisdiction of regimes that are unstable, and, in some cases, willing to use oil as an economic weapon to achieve political or ideological objectives. In other words, prices are not entirely the result of pure market forces.
Few doubt that the ongoing turbulence in the Middle East was a factor in the price spike of 2006, though assigning a precise weight to it is difficult. With three hot wars raging in the Middle East last year, the integrity of region’s oil supplies was unquestionably on the minds of oil traders. But now with the very real prospect of war between the U.S. and Iran and of further unraveling in Iraq the future should appear equally if not more foreboding, and yet this terror tariff, as some have called the increment in pricing due to political uncertainty, does not appear much in evidence at present.
We are on firmer ground when we look at simple demand for oil, which has been declining overall globally for over two years running and was generally flat in the opening years of the decade. More recently, due to exceptionally warm weather in Europe, the demand for residual heating oil declined 27% worldwide, and that alone could be the most significant factor in the recent market plunge.
The decline in prices has most assuredly not been due to major increases in production such as occurred in the wake of the oil crises of the nineteen seventies. Oil production is more than 70% greater today than during the last oil shock of 1979, but this entire decade has seen it grow only a few million barrels per day out of total of 84 million barrels.
Most of the growth in oil demand in the last two decades has occurred in the developing world where it has tripled. In the same time frame demand has grown in the industrialized world only about 30%, and, as we have seen, demand has almost leveled off in the most prosperous nations during the course of this decade. What this means, of course, is that demand in China, India, and the developing nations of Southeast Asia will be the driver in the years to come, and we see little likelihood of that demand abating.
I might mention here that I derive most of my income by compiling statistical surveys on industrial growth for market research and technology assessment firms, and I have had recent occasion to perform projections for the global auto industry which happens to account for almost half of all petroleum consumed. I see the already very large Chinese market increasing by as much as 20% per annum over the remainder of this decade, and I see possible double digit annual increases in India as well. Quite possibly, global production of automobiles in 2010 might be some 30% higher than it was in 2006.
The question naturally arises as to why, with all of the economic growth in East Asia during the course of this decade, the demand for oil should be so slack. The answer is simply that the combined economies of China and India are still dwarfed by those of the U.S., Japan, and the industrialized nations of Europe. Surging demand for liquid transportation fuels still lies in the future, though not, I think, in the too distant future.
As for supply, I think Mr. Corcoran is wrong in supposing that the admittedly significant drop in crude pricing from last summer is evidence that imminent peaking of production is a myth. Cambridge Energy Associates and Exxon-Mobil have issued some well publicized refutations of the peak oil warnings coming from other quarters, but Exxon-Mobil’s figures on proven reserves are so out of whack with anyone’s else’s as to be highly suspect, while CEA’s predictions of greatly increased oil production are based upon speedy exploitation of unconventional resources, which I deem unlikely. Still, there is no knowing as to whether a peak in oil production is several years away or very near, and that uncertainty begets a further uncertainty in regard to pricing.
I believe that long term growth in demand in developing nations and the continued decline in conventional oil discoveries along with the slow progress in the exploitation of unconventional oil resources virtually ensures that oil will remain costly in historical terms for at least the remainder of the decade. And I would add that there are commodities analysts who utterly discount current price dips and predict $100 per barrel oil in the near term—among them, Jim Rogers, chairman of Beeland Interests, Inc. and the originator of a number of commodity indices in wide use today.
It is difficult for me to see any combination of political events, technological developments, investment patterns, or social changes within the next decade that would allow for a decline of oil prices to nineteen nineties levels. I’m not saying that crude oil prices might not decline further temporarily, but I’m betting against sustained low prices over the long term.
Does that make for a bullish outlook for alternative fuel investors? Not necessarily. As in any industry rife with startups and new technologies, a flood of business failures is almost a given even under best of circumstances. And given the impatience of most venture capitalists and what might be argued is a dangerous over-involvement of venture capital in new energy technologies, the next year and the year after could prove difficult.
The problem with alternative fuels facilities is that they demand heavy up front investment in capital projects as well as patient investors willing to wait for plants to come on line and achieve profitability—a process which normally takes a years. Fuel production is a species of heavy industry eliciting clear expectations on the part of both the public and investors. A plant makes a specific product which sells in specific markets at specific prices. It’s all cut and dried. It’s not like YouTube and MySpace and selling sizzle in the investment space and maybe someone will figure out how to monetize it some year. Unfortunately, venture finance firms come from the world of YouTube and the equally frenetic sphere of biotech where a miracle drug can lead to truly giddy stock run ups in the space of days. Possibly some of the firms touting new, ultra-high output batteries can play in these highly speculative markets simply because they serve similarly agitated segments of telecommunications and consumer electronics industries, but alternative fuels, regardless of their promise, seem unlikely to inflate investment bubbles.
Other than discussion of oil prices, which appeared to overwhelm other news pertaining to alternative fuels, I happened upon one other announcement of considerable interest, a press release from Dynamotive of Vancouver, BC, stating that the company had succeeded in producing a higher energy product from its patented fast pyrolysis process.
Pyrolysis oil of the sort produced by earlier iterations of the Dynamotive pyrolysis reactor, as well as from that of its chief competitor, Fortum, is a relatively low energy brew roughly equivalent to residual petroleum oil, the heaviest liquid distillate. Pyrolysis oil, also known as bio-crude, is used for similar purposes, firing boilers and operating other types of heating apparatus. Because bio-crude is corrosive and unstable it is not normally used as a motor fuel.
Dynamotive claims that its new BioOil can be used in turbines and can also serve as a convenient feedstock for synfuels. If these claims are true, this is a definite breakthrough.
No word in the press release on how the new fuel is produced or what are the economics of production. We shall attempt to follow up on this story shortly.