A Look at the World That Is and What Lies Ahead

“The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.”
Sheik Almad Zaki Yamani

“Who controls the issuance of money controls the government.”
Nathan Mayer Rothchild

There is an old Chinese proverb that says, “May you live in interesting times.” That certainly describes the world we have lived through these past few years. Pandemics, wars, economic lockdowns, the return of inflation, soaring money supply, and budget deficits that are colossal in size. And that is just the beginning. There is more to come, which is the purpose of this piece, to put into perspective what I believe lies directly in front of us and how we at Financial Sense Wealth Management will likely navigate these events. For the sake of length and in light of the number of issues discussed, I will break this up into several parts with more to come in the weeks ahead. Let’s begin.

Much of what I learned about the oil markets came from a friendship I had with the late Matt Simmons. If you are not familiar with Matt Simmons, his firm, Simmons International, financed much of the innovations in the oil industry and many of our prominent oil companies. Matt was kind enough to send me all of his research studies, which ultimately led to his book, Twilight In The Desert: The Coming Saudi Oil Shock and The World Economy. Matt believed in peak oil, as do I, and thought we would be facing it soon as we entered the second half of the oil age in this century. Unfortunately, Matt passed away several years after his book was written and was not able to witness the twin, productivity-enhancing breakthroughs of fracking and horizontal drilling, which has allowed us to draw oil within tightly confined layers or regions of sedimentary rock called shale. Though this development has added years more of reserves, it is highly energy intensive. The fact that we must literally extract oil from the rocks or to drill thousands of feet below the ocean depths, tells you we are approaching an ever-steeper cost curve requiring more and more energy put in for every unit of energy we get out. All the easier-to-reach, land-based reservoirs (the “low hanging fruit” of oil reserves), which produced a steady and continual flow for decades, have already been discovered and tapped. Shale wells, on the other hand, peak within the first two years of production and decline quickly, necessitating constant drilling for new wells. Offshore drilling as well is expensive and requires billions in investment to drill and produce. As we enter peak oil—or, as some say, peak “cheap” oil—it is taking more money to find and produce oil as the EROI (Energy Returned on Investment) on oil slowly declines.

In Matt’s book, he highlighted that Saudi Arabia’s oil reserves were grossly overstated and that they would never be able to produce the level of oil they claim they can. The EIA defines spare capacity as production that can be brought online within 30 days and sustained for at least 90 days. It is now believed that their spare capacity is no more than 0.5 million barrels per day (mbpd). This was told to Biden when he was at the G-7 meeting this summer before heading to Saudi Arabia to ask them to produce more oil. As Macron of France told Biden, they don’t have much more than 150,000 barrels per day of spare capacity that they can produce, if that. Even when they have raised their total production to 10mbpd, some of that oil was either out of inventory or simply Iraqi oil that was relabeled as Saudi oil (see An Insider’s Guide to Trading the Global Oil Markets by Simon Watkins, pages 25-26). More telling is their claim of oil reserves remaining completely steady at 260 billion barrels since 1989, despite producing 3 billion barrels of oil every year since 1973. They simply announce that they magically replace whatever oil produced with oil they discover all without announcing any new field discoveries.

The Saudi IPO of Aramco raised many of the questions I am raising here. My point of raising this issue is that the world has always relied on the Saudis for decades to calm the oil markets by producing more oil when prices rise. Something they are not capable of doing as the truth of their capabilities is now being questioned. This is one reason the oil markets remain elevated is that OPEC lacks the spare capacity to deliver what the world needs, which is millions of barrels more in oil production. The safety valve the world has relied on for the last three decades is a mirage and does not exist. Another reason the oil markets remain elevated, and I believe will head higher after the mid-term elections, is the drawdown of our Strategic Petroleum Reserves (SPR). After the elections, the administration stops releasing oil from the SPR, which is dangerously low and being depleted at the fastest rate on record (see below), leaving the country vulnerable to weather shocks such as hurricanes or war, as we see now in the Ukraine.

biden spr release

If we are not at the peak, we will be there soon and should be taking steps to mitigate the decline in the global output of oil. However, given the systemic importance of fossil fuels to our modern economy, these steps should also take into account not just environmental concerns, but also the negative societal impacts when it comes to inflation, the production of electricity, food, and innumerable goods and services should we force a transition too quickly. That is not what we have done. Instead, we have liquidated our strategic oil reserves, pulled back on much-needed fossil fuel investments, and aggressively pursued renewable, but less reliable, intermittent sources of power. Look no further than the events playing out in Europe—who have made themselves completely dependent on Russia for their energy—or what we see in my own state of California where, as this is being written, we are on stage 3 alert to conserve energy, refrain from charging our electrical vehicles or operate certain appliances, as we experience rolling blackouts. Europe and California are not mere anomalies or simple victims to mere external, unpredictable accidents—they are the byproducts of many decades of political decisions to prioritize environmental concerns over societal necessities. Like much of Europe, California has attempted to dismantle our most reliable sources of 24/7 baseload energy from nuclear, natural gas, and coal power plants while ramping up on renewable energy sources. In theory, this may make sense, but it doesn’t work in the real world. The sun simply doesn’t shine 24/7, the wind doesn’t always blow, and we don’t have enough batteries (let alone enough lithium, nickel, rare earths, and copper) to aggressively scale-up from current levels.

My reason for mentioning California is that 17 states are adopting and following California’s green initiatives. What is happening here may be coming to your state as more natural gas, coal, and nuclear power plants are shut down and replaced with wind and solar. In addition to their intermittency, solar power in particular has now been shown to be far less environmentally friendly as well given that the majority of solar panels are produced at a very cheap cost in China using low-cost coal and slave labor.

As a side note, Michael Shellenberger, the noted environmentalist who also wrote the article above, points out that solar and wind need 300x more land, 300% more copper, and 700% more rare earths than fossil fuels making them prohibitively expensive to build and operate. So you don’t want to drill for oil, how many more mines are you willing to build then? Even worse, we are shifting from an energy source like oil and natural gas with an energy return on investment (EROI) of 30:1 to solar and wind which, due to their lower energy density and intermittency, factor in at 5:1 up to a high of 10:1. In other words, we are shifting from a high-density form of energy such as fossil fuels to a less efficient and unreliable source of energy. The results are exactly what you are seeing in Europe today and in my own state of California.

Economic realities are breaking out all across the globe in the face of political ideology and strategic miscalculation. In Europe, Germans scramble outside the city, chopping down forests for wood to stay warm this winter. The technocrats in Brussels are proposing wide-ranging powers to require businesses to stockpile supplies and break delivery contracts in order to shore up supply chains. They are proposing new energy taxes to redistribute subsidies to consumers to pay for the high cost of energy brought about by their lack of strategic foresight. They are now holding emergency meetings to discuss ways to cap the cost of electricity, including a plan to cut electricity use during peak demand this winter, including limiting showers to no more than five minutes. The Dutch government is encouraging people to hang their clothes to dry instead of using a dryer. In Sri Lanka, societal order imploded as a result of implementing strict ESG policies for farming, which led to a swift and dramatic increase in the cost of food. The same is happening in the Netherlands, where it is estimated that one-third of all farms will disappear as a result of not being able to use nitrogen-based fertilizers.

Not every country is going green. The Chinese and the Indians, exempt from the Paris climate accords, are taking a different, more sensible approach. According to the Helsinki-based Center for Energy Research on Energy and Clean Air (CREA), China is building 33 gigawatts of coal-based power generation. China currently has 47 operational nuclear power plants and 11 new power plants under construction. The US has 55 power plants, building only 2 while shutting down 6. The US used to be the leader in nuclear energy but now China has taken the lead with new, more efficient and smaller nuclear plants. Hard to conceive why the greens are against nuclear power since wind and solar does not work on two-thirds of the world’s land mass (see The End of the World Is Just the Beginning by Peter Zeihan, pages 262-275).

The problem we have with moving to intermittent, less energy-dense forms of power is the economic impact of these policies. Economies require energy to grow and operate. Unfortunately, all economic models are based on supply and demand curves. According to economists, as prices rise, more goods or commodities are provided by producers to meet consumer demand until the point where prices rise and choke off demand. Conversely, when prices fall, demand picks up, but producers become less willing to supply goods at lower prices until a supply-demand equilibrium is reached on price.

None of these economic models take into consideration the use of energy. Before the age of fossil fuels, economic theory was based on the premise that nature limited the flow of resources as there was an absolute scarcity of economic goods and services. After the discovery of oil, the physical limits became less important because of the concentrated power of fossil fuels. Economic theory was transformed from focusing on obtaining more from nature into an exercise to figure out who gets the goods and services and how services best enhance individual well-being. The industrial and tech revolution would not have been possible without cheap and energy-dense fossil fuels. As we enter this new century, we are at or near the global peak use of fuels, especially oil. As it becomes more expensive to find and produce (partly due to pure physical constraints but also because of political policies), society will likely undergo a large amount of turbulence as well. One reason we will be monitoring what happens to Europe this winter.

The problem of reaching peak oil is that our modern world runs on fossil fuels and will do so for decades to come. It is not just the use of oil for transportation—it is also all the products that are made from fossil fuels that I highlighted in my last newsletter. Robert Hirsh, who directed America’s nuclear program in the 1970s, discussed peak oil in a report prepared for the US Department of Energy. Hirsh believed the best way to prepare for the peak was two decades before its occurrence, next best a decade, before it arrived. The worst strategy is to do nothing. What we lack today is a coordinated global approach to the peak. Our leaders are focused on climate change, an issue that will be solved in many ways by the arrival of peak oil.

We will only know that we’ve reached the peak of oil production in hindsight. It will be noticeable as global production fails to increase and falls behind, causing oil prices to rise and remain elevated which will begin to impact economic growth. Because of what I see, oil and oil services will be in great demand and is one reason why we remain invested in the sector.

We see energy investments as a key sector weighting in our portfolios, as we expect oil prices to head higher after the shoulder months of September and October, and after the mid-term elections when the administration stops draining what is left of our energy reserves. There is nothing the industry or the government is doing now to increase supply as to where it needs to be to bring down prices or incentives to invest to replace oil lost due to depletion of existing wells. Oil companies remain circumspect on making significant investments after being demonized by the administration and the wider ESG community, so they are conserving capital, increasing dividends, and buying back stock enhancing shareholder returns.

Meanwhile, the administration continues its war on the fossil fuel industry with new taxes, regulations, and a massive reduction in Federal leases to drill for oil and gas, which are desperately needed. As shown in the table below, the number of leases is the lowest of any president since the end of World War II.

biden oil gas leases

In addition to the regulations and new taxes on energy, there is a major disincentive to invest in producing more oil and natural gas. Amin Nasser, the head of Aramco, the world’s largest oil company, said the world is facing a major oil supply crunch as most companies are afraid to invest in the sector as they face green energy pressure. He cited the fact that the world is running with less than 2% of spare capacity and that “What happened in Russia-Ukraine masked what would have happened [anyways]. We are were going through an energy crisis because of a lack of investment.” This was further complicated by the IEA report that stated that oil demand was set to fall and that no investment was needed. He stated further, “There is no good plan… When you don’t have a plan B ready, don’t demonize plan A… The pressure and the rhetoric is—don’t invest, you will have stranded assets. It makes it difficult for CEOs to make investments.

The simple fact is we have no “Plan B.” We are heading full steam ahead with green and ESG policies despite the fact we have multiple examples from Europe, England, California, the Netherlands, and Sri Lanka that they are not working. As Peter Zeihan pointed out in his new book, The End of the World Is Just the Beginning, and Dr. Charles Hall in his book, Energy and the Wealth of Nations, green does not work without nuclear. The Chinese and Indians understand this. The West does not understand this as we keep repeating the same mistakes hoping for a different outcome.

It isn’t just the use of fossil fuels to heat our homes or power our transportation, it is the myriad uses of oil in most of the products we consume in our homes from plastics, soaps, paint, drugs, computers, fertilizers to tile and roofing. Our modern world still runs and needs fossil fuels. For these reasons, we will continue to hold our energy investments and have one more energy company in our bullpen to invest in once the shoulder months and the mid-term elections are behind us.

Coming up next, Part II “The Commodity Cycle vs the Economic Cycle.”

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