More of oil at $200

AMDG

In my previous article, I wrote about how oil could bring the Philippine Stock Exchange down to its knees, and the specifics of how several companies I have invested in could be affected.

Oil is so crucial to the global economy (to our very civilization, even) because it’s used in just about everything. Switch on a light, and oil comes to play at least in the following ways: one, there’s a chance the electricity that powers the light bulb is produced by a diesel or bunker fuel generator; two, that light bulb had to be made in a factory, which consumes oil for its equipment; three, the bulb, switch and wiring had to be trucked from the factory to the retail store where you bought it, a process that consumes oil; four, you had to go out and buy the bulb, hence more oil consumed by your commute; five, the rubbery insulation around the copper wire that connects the switch to he bulb is most likely an oil byproduct, as are most plastics that make up switches, light bulb housing, etc; six, your house, in which that light is located, had to be built by people who commute and equipment that had to be mobilized and that consume oil as they operate, all of which use materials that have to be freighted as well. Care to know about the oil needed to produce a spoonful of rice that’s on your plate right now? Or the oil needed to operate your computer or your car? How about the oil needed to fly the entire family to Boracay for a weekend vacation?

Needless to say, we all consume oil. It’s a resource around which our lifestyles revolve even in ways we are not aware of. Could we live without it? Sure we can! Just at a much slower pace, though – we might have to go back to lighting candles instead of switching on light bulbs. But as it is, with lives, business, economies, demands and supplies all living in the fast lane, rising oil prices is a very nasty speed bump. Rising oil makes everything else expensive, thus dampening demand, increasing costs and depressing world economies (with the possible exception of oil superpowers such as the Middle East, Venezuela, Nigeria, Russia and, soon, Canada).

So, what now? In the far, far future, what are the chances we’ll all end up like Mel Gibson in the movie Mad Max, scrounging for gasoline from wrecks of crashed cars and fighting off hordes of scantily-dressed, paltik-wielding gothic warriors just to protect a tanker truck of gasoline? Or those (again!) scantily-clad and paltik-wielding hippies in Waterworld, riding around in an oil tanker looking for dry land?

In my opinion, very little. As I have said before, oil itself isn’t what we buy when we pay for oil; it’s energy. Of course, oil in itself does have its own uses (think petroleum jelly or engine lubrication), but by and large, energy is what we buy when we pay for oil. And as a source of energy, oil is dirty, scarce, expensive and volatile. Think about it: in terms of oil being dirty, American gas guzzling cars contribute about 20% of all of America’s greenhouse gas emissions, and airlines contribute over 15% of all global-warming carbon output worldwide; oil spill such as the Exxon-Valdez more than two decades ago still have adverse effects to the Antarctic environment even to this day; as far as scarcity is concerned, in just a little over a century since oil was discovered as a source of energy, the human race has burned through what experts estimate to be about half of all the oil in the world, and the world isn’t in much of a hurry to make more of the stuff; expensive is self-explanatory; volatility – almost all the big oil players are countries that have a high degree of instability or propensity to use oil abusively as a political power-brokering tool (think Venezuela, Nigeria or Russia – even the Middle East fits this bill in some instances). As such, given that energy is what we pay for when we buy oil, and that oil is further and further becoming a less viable source of said energy, it’s only a matter of time before the wonders of one economic and marketing concept take effect: alternatives.

Alternatives, as the name suggests, is simply other options. Butter too expensive? Use margarine. No marlin? Buy sea bass. Can’t find any disinfectant for the scrape on your knee? Chew some malunggay or boil some guava leaves. Oil’s too expensive and dirty? Well, it’s about time alternative sources rise and meet the challenge, right?

I mean, who wouldn’t want a world run by clean and affordable energy from solar, wind, geothermal or hydrogen-based power sources? With clean energy, we would no longer be at the mercies of Venezuelan dictators or Russian autocrats holding back production, or Nigerian bandits blowing up oil pipelines, or even Wall Street fund managers pouring all their extra cash into oil and driving prices higher. We would also no longer be polluting the environment, and we avert the crisis of scantily-clad, paltik-wielding Goths or hippies fighting for the last ounces of oil on the planet.

But, you say, that’s not going to happen overnight! That might not even be viable considering we use so much oil that alternatives (even dirty ones like coal) could not possibly fill the void if you take oil out of the equation.

We have two rebuttals there: time frame and viability. In terms of the latter, this I have to say: never underestimate the power of technology and conservative consumption. Take France and Germany, for example. Germany, along with much of Europe, made a lot of noise when Russia, the main source of oil and natural gas for Europe, announced increases in the prices of oil and natural gas. But the French? They complained, but certainly not as much. This was because France has probably the most well-developed nuclear energy industry in the world, one that supplies for 75% of all their energy needs (by contrast, nuclear energy in America comprises only for 20% of total electric production). This lessened their dependence on Russian oil and natural gas for energy used for heating or running their homes and businesses. How about Iceland? Has anyone ever heard the placid people of Reykjavik complain about oil at over $134 a barrel? Hardly, I assume, because most their energy needs are provided for by hydroelectric and geothermal plants. Even right now, cars that run on less or no oil at all (everything from hybrids to compressed air to hydrogen-powered vehicles) are just years away from the mainstream production pipeline. Airplanes? That will probably take a while. It’s not like you can retrofit a jumbo jet with a nuclear reactor the way the U.S. navy did with their submarines, but who knows? That said, I do believe that we could live in a civilization and economy not dependent on oil (but probably in the relatively distant future, though).

As for the time frame, that might be a bit trickier. Experts say that oil may reach as high as $200 a barrel and may never come back down from there. With that, I mostly agree. But there’s also a small part of me that says that demand and supply pressures will take its toll. For one, the price of oil now is partly artificial, i.e., brought about by excess liquidity in the financial markets looking for a safe hedge against the flailing dollar and the sagging U.S. economy. Secondly, with oil prices this high, you suddenly have projects previously considered unfeasible becoming financially viable. Take for example the smaller fields being drilled or explored, or the sudden interest in local oil stocks the likes of OV or PERC, both of which are small-time drillers/explorers. There’s also the sand pits of Canada – a proven reserve of at least 173 billion barrels that was once too considered too expensive to extract that is now receiving billions of dollars worth of investments from giants such as Shell, ConocoPhillips and Exxon (to put that in perspective, Saudi Arabia’s proven reserves, the largest in the world, is 250 billion barrels). Thirdly, with oil this expensive, you also have the inevitable dampening in demand for it (though that probably won't apply to rapidly growing economies like China or India). In line with this, SUV sales in the U.S. have fallen 50% this year alone, and GM’s Rick Wagoner recently announced his company was halting the production of big cars for good and sticking to compacts, a process that will close down four major oil-consuming plants. Business and homes have learned the value of conservation, partly because of high oil prices and partly for the sake of the environment. Bicycle sales are surging, and investments into more effective and less energy-consuming forms of mass transit are booming as well (think China’s maglev trains). Money is also fast flowing into alternative energy R&D - billions of dollars paid to make solar cells cheaper and more efficient, wind turbines quieter and less resistant, etc.

(Notice that these demand-side effects of high oil are by and large irreversible: even if oil prices fall back to earth, there’s little chance the gas-guzzling SUV will make a comeback, or newly-minted green business will turn around and start polluting again just because they could once more afford to do so. Also, solar panels, wind turbines, offshore wave turbines and others are now providing for a growing chunk of energy needs, and the chances are nil that they will be decomissioned even when oil becomes cheap again, if ever that does happen.)

The last time oil prices spiked as suddenly as this was during the Iran-Iraq war of the 1980’s. With supplies from two major oil-producing countries disrupted, oil soared and the high prices prompted a wave of investments into oil exploration and drilling ventures. After the war, a glut followed: oil from Iran and Iraq streamed again along with all the other new oil fields, and the price of oil slumped. See any similarities? Rising oil prices, investors rushing to oil and further inflating prices, new investments meant to increase oil production, easing demand (well, excluding China and India, among others), the rise of alternatives, the fact that biggest oil field found this decade was in Canada – a stable country that’s just across the border of the world’s largest consumer of oil that also happens to be its close ally. Am I hinting at a bust? No, a bust would be too strong a word considering that, (one) at the end of the day, oil will still run out in a matter of decades (according to estimates of some experts – see last months’ National Geographic) and (two), China, India and other growing economies will most likely continue to increase their oil consumption despite high prices. But, if not a bust, I do expect a strong correction in the price of oil. When and how much, I can’t say – although I do hope it will come soon and in a significant amount because my portfolio’s just about dying.

This is why I haven’t sold out of the PSE yet. Even though BSP expects double digit inflation later this year due to expensive oil, I believe it will only be a matter of time until hot money oozes out of oil to find emerging market stocks grossly undervalued. Throw in the fundie bandwagon mentality along with the correction in oil that I’m hoping for, and maybe we could see the PSEI hitting the long-elusive 4,000-point mark.

Of course, my crystal ball could be cracked too, and the PSEI descends into non-existence. I lose money and those who followed my cockamamie theories lose money too. By that time, my only hope is that readers of this blog don’t throw me to the hordes of scantily-clad, paltik-wielding hippies that would be roaming the planet to be eaten alive, or worse, to be dressed the way they are. Damn you, Mel Gibson and Kevin Costner!!!