The only “strong reaction” in the present thread that surprised me somewhat was the back-lash by a few who seemed to take exception to your efforts to develop a strategy that could capitalize on what you believe will happen, in order to preserve your wealth, or, even (gasp) make a profit.
Maybe that reaction was because you were discussing oil-the life blood of modern society-and not some other commodity like pork-bellies (probably the government will probably price-fix or confiscate those too). Or, maybe it was just the reaction of those struggling with the anger and depression associated with the “burden” of knowing about peak oil.
At times I also have the sinking feeling that there maybe there is no escape from the loss of wealth that is highly likely to come-but I cannot fault one from using their skills the best that they can to try and mitigate it.
In any case, thanks for sharing your ideas so freely.
Off the primary topic: A couple of folks have mentioned storing gold out of the country. What is to keep the government of the country where your gold is stored from confiscating it?
Welcome Honest,
Of course nothing in theory would prevent this—laws (or their implementation) can change anywhere. However, using more than one country to store gold in would help spread the risk of total confiscation by anyone country.
Also, the IRS’s FBAR requirements (http://www.irs.gov/businesses/small/article/0,id=210249,00.html#FA3) means that the U.S. government would know the country and institution where your gold is located in. It is not out of the question that they could petition that country/institution for the gold to be “repatriated” to the USA. While this would be logistically more difficult for the US government to do, as compared to domestic confiscation, it is not out of the question.
alcohol to fuel their vehicle. Granted - we will all learn to live on less, but when anyone can make fuel - why every pay such an outrageous price - in currancy, human costs or environmental costs.
Besides, becoming sustainable is the in-evidable outcome regardless of how much oil is in the ground.
At times I also have the sinking feeling that there maybe there is no escape from the loss of wealth that is highly likely to come-but I cannot fault one from using their skills the best that they can to try and mitigate it.
Splendid essay, Erik. Well reasoned and well written, it has the ring of truth to it. Thank you!
You wrote: “Some believe the entire reason the United States has pursued war with Iraq under dubious pretenses of connections to Al Queda and non-existent WMDs is precisely because Mr. Cheney understands so well just how critical the problem of peak cheap oil will be to the U.S.”
Yes. Some years ago, during the incumbency of John Howard in Australia, coinciding with that of Bush the Younger, the-then Minister for Defence, Brendan Nelson, said in public that of course the Iraq War was all about the oil. I give his statement much credence, because Howard was an almost obsequious friend of Bush and aligned his policies closely with those of Bush.
Shortly after making this gaffe, Nelson went for a number of extended trips overseas. Comment here was that he’d been sent out of the country to make him unavailable for answering the inevitable questions in Parliament. It worked; nothing more was heard from any MP.
I suspect that Peak Cheap Oil has been on the minds of those who exercise the dominion over us for quite a long time now – they’re not stupid – and that they’ve spent much time devising policies and control mechanisms to deal with the difficult situations that will arise as the peak becomes painfully evident and obvious to all.
I’d like to point out that I was listening to the Financial Sense News Hour this weekend and Jim Puplava spoke very highly of this read and encouraged listeners to read Erik’s fine work.
Really underscores the super community CM has created!
You might want to run that $500/bbl oil price by Matt Simmons and see what he thinks. Matt already thinks that $200/bbl oil would be a bargain. For the record, world production of light, sweet crude peaked in 2005 and world production of heavy, sour crude peaked in 2008. With global oil production declining at 4% per year it won’t be long until the pain is felt by everyone who uses oil for just about anything.
One thing not mentioned in this post was the whole concept of “net energy” and the Energy Return on Energy Invested (ERoEI) for fossil fuels and so-called alternative sources of energy. In general, almost all alternative energy sources, with the possible exception of wind powered turbines, are very low net energy yielders. A fuel like corn ethnol is barely a break-even in terms of ERoEI. I would encourage you to look at the research published by Dr. Charles A.S. Hall on the mininum ERoEI needed to keep civilization running.
Without sufficient net energy you can kiss the growth economy good-bye. When push comes to shove in this country, the political class is going to use the military to seize foreign sources of oil and put our country on a permanent “war-socialism” footing. The government will assume control of all production and commodities. It will nationalize major distribution businesses, like Wal-Mart, and ration the necessities of life to all Amercians. The objective will be to provide the most comfortable life possible for the largest number of Americans as industrial civilization “unwinds” due to an irreversible decline in net energy. Other countries will likely resist and this could trigger WWW III, which could go nuclear and that could change everything.
Smart people may think they can make money profit in the early stages of the decline of industrial civilization, but they are just kidding themselves. The greatest danger lies between now and 2030 as the routines of everyday life and the operation of the economy becomes unsustainable. Things that can’t go on forever, won’t.
Two quick questions to help me understand more thoroughly…
I’m not sure what “there’s more than 100 years’ supply of crude oil left in the ground” means if we appear not to be able to meet demand by 2013.
I am under the assumption that the Fed. Resv. now buys treasury bonds that won’t sell (or perhaps, those that won’t sell at the hoped for rates), and that this is new. If this is true, what will a treasury bond market collapse look like?
Erik,
Both this and especially the follow up article on more specifics of how you are playing a likely increase in contango great stuff - both in aggregating a lot of different information into a sensible thread and in providing projections on where it should head. Question - sounds like you made out in getting a contango spread of below $3 on your trade. Now it seems it’s pushed back out to a $6-$7 range again, which to me doesn’t sound that bad given the likely slope of increase but you mentioned waiting a few months for contango to drop.
My belief is I may or may not have a few months before the Sovereign debt issues create real problems and perhaps another drop sooner rather than later. What i’m wondering is how variable is the contango over the past few months (i.e. a period where economy not cratering) and how likely to see it contract from the $6-7 zone. I’ll do some digging, but since you sat and watched it for a while wondering how likely to get a better entry point than current spread. I think a serious drop in the economy is likely in the next year, and really like your method to benefit from that drop and then the 2012-5 spike in oil as supplies tighten. Not asking for advice on what to do, but rather what kind of range does it bounce around? is it pretty consistent in the current level (after normalizing from $30…) and was a very rare time that it pulled in to around $3?
Good to see someone on this board “in the neighborhood” - i’m living over in Taiwan.
First, the comment about “100 years left in the ground” was unfortunate. I put it in for a very specific reason but it basically backfired. When you try to talk to Oil & Gas industry people about peak oil, they are usually very dismissive and point to data saying there is hundreds of years of oil “in the ground” as evidence to justify ingoring the threat of peak oil.
The central point here is that it doesn’t matter how much oil is in the ground. What matters is how much we can take out of the ground economically. The reason the numbers appear not to add up is that the declining production estimates starting in 2012 are based on analysis of how much oil can be extracted practically. There is much more oil in the ground than can be extracted, which is irrelevant except that it seems to be the nay-sayers favorite excuse for ignoring peak oil.
The reason I put that comment in the paper was to defuse the common “but there’s plenty still in the ground” objection that I know is common among the oil & gas industry people who ignore peak oil. But instead of helping to keep their attention, it seems to have upset the people who DO understand Peak Oil. Sometimes an author just can’t win!
Your question about what a treasury collapse would look like is also excellent. There are several other threads here on the site where it has been discussed at length. Please type “rethinking the short long bond trade” in the search box to find one such thread where I recently brought this question up for discussion.
Thanks for the kind words. IMHO, the key to playing the contango trade (and looking for an entry point) is to understand that the shorter-dated contracts are more volatile than the longer ones. Translation: A period where prices in general are GOING UP FAST is where the short contracts will move up faster than the long ones do, collapsing Contango. After waiting for months I realized that the Deepwater Horizon tragedy was going to create an entry opportunity for the trade. If you stop and think about it, the tragedy in the gulf should affect longer-term prices more than shorter term prices, because future bans on offshore drilling will affect the long-dated supply. But the market doesn’t seem to discount things that way.
What I do is keep a chart on my desktop that shows the Dec10, Dec12, Dec12, and Dec14 futures as separate lines on a single chart. I use line rather than bar charts to keep the display readable, and I plot the bid-offer midpoint rather than trades because the later dated contracts are so thinly traded that there sometimes are no trades. I don’t bother plotting anything later than 12/14 because there’s often no bid or offer, skewing the data. I use InteractiveBrokers, but you can also create a free account on ThinkorSwim and even with zero equity in the account you can use their futures charting tools.
That chart is my daily reference - shows me visually what the contango spreads look like. It was from looking at that chart for a month or so that I first realized the key would be the increased volatility in the short-dated contracts. I agree that the spread has widened out now to the point it’s no longer attractive to enter the trade. I already have a very nice healthy profit in my trade, and that would mean a corresponding loss to someone who enters now if the contango contracts back down to $3 - $4. I think anything below $4 spread is an attractive entry.
Another point that is in the final version of the article on my website but didn’t make it into the FinancialSense version because of a tight deadline: You really need to think about geopolitical risk in the short leg, esp. the threat of a Israeli or American strike on Iran this summer, which a lot of people think is possible if not likely. A strike on Iran could cause short-dated futures to skyrocket, pushing the market into temporary backwardation. Even though it would be a temporary condition, if the market was still elevated around the December expiry of my short leg, the loss would have to be absorbed or rolled forward (at a roll loss).
Two remedies could hedge out that risk: One is to forget the December 10 contracts and roll them forward to Mar 11 before anything goes wrong in Iran. The other is to wait for the market to drop a bit further (I think it will as everyone figures out nothing really got fixed with the EU bailout), then by protective calls on the same futures that make up the early part of the short leg. I think there’s a good chance the market will drop another $10 in the next month to six weeks, and if it does I’ll probably do exactly that to hedge out the Iran threat.
Erik,
Appreciate the chance to piggy back off your charting and tracking over the next few months. I guess i’m back to a bit of a waiting game. I bought a token one future in the out years, small enough that if oil craters i don’t have any pressure to sell no matter where it goes near term - but i had to put in at least some stake in case oil prices don’t drop from an economic decline and end up running and not looking back i’d feel like less of a rockhead by at least making something. More invested in physical and a little paper silver at this point, which has similar risk of some near term on a pullback, but I think also some very compelling upsides and protections that are making it worth the risk in my mind.
In general though, I probably have too strong a paranoia on what can go wrong so i’ll probably mainly dance around the edge on futures than ever dive in unless i have the kind of protections you’re taking on your bet here. we’ll see if the chance comes around again.
Great article, if a bit speculative in parts. But that’s the nature of bold forecasting in the realm of structural breaks.
There are other possible government responses. These include a “windfall profits” tax. This would still allow oil prices to rise while taking a progressively larger share of oil industry profits (but absolute nominal profits would still rise as oil prices rose - the windfall profits tax could simply take have the effect of taking away the leverage effect to profits).
One problem in the article is that in some parts it states that different energy sources are not fugible. Most importantly it claims transportation needs oil and cannot run on other sources, at least for several more decades. However, the article then discusses how high rise buildings and life in warm climates can’t exist (comfortably) without affordable “energy”. In this context the article lumps all energy together and implies fungibility. In fact, in the U.S. the electrical grid uses very little oil with most electricity being generated from hydro, nuclear, and coal. The first has very stable prices (it’s just the legacy capital costs and long term fixed borrowing). Uranium prices will increase, but decommissioned nuclear weapons from Russia and the U.S. will be a large, stable source for decades (*). Coal reserves in the U.S. remain high and reasonably available.
Thus, the U.S. is decently positioned with respect to electricity. The U.S. needs to invest in its grid, particularly long haul transmisssion. In doing so, it will open the door to large scale wind penetration. Thus, the shift of transportation to electrical power may be less disruptive than imagined.
Furthermore, it is widely recognized that the U.S. “wastes” huge amounts of energy. It is likely that total electricity consumption could decline by 15% or more without a meaningful impact on quality of life or productivity. With gasoline above $4/gallon we will see lots of ride sharing, use of public transit, and more utilization of smaller vehicles. This reaction can take place quickly and results in little decline in quality of life and could shave perhaps 10% of oil use quickly.
The bottom line is that there is much more flexibility in the U.S. to adapt to peak oil than is often assumed by the most involved peak oil advocates.
Peak oil is here. Prices will rise. It will cause volatility and economic problems. But adaptations may surprise the more “bearish”.
Re: “decommissioned nuclear weapons from Russia and the U.S. will be a large, stable source for decades”
Currently the U.S. gets about 10% of its total electricity from nuclear material from decommissioned nuclear warheads.
Even if the treasury market collapses the Fed does not necessarily have to ‘permanently’ create monetary base through selling the treasuries at lower prices. The Fed can hold them to maturity. Each coupon payment that the Fed receives can in fact reduce monetary base. Upon maturity the Fed receives nominal par and can choose to retire that money as well.
Oil will not just "run out" because all oil production follows a bell curve. This is true whether we're talking about an individual field, a country, or on the planet as a whole.
Oil is increasingly plentiful on the upslope of the bell curve, increasingly scarce and expensive on the down slope. The peak of the curve coincides with the point at which the endowment of fuel oil has been 50 percent depleted. Once the peak is passed, oil production begins to go down while cost begins to go up.