CRUDE OIL: Prepare for hyper inflation

OILY POCKETS by Tshepo Phakathi


According to the annual list compiled by Forbes (The Global 2000, 04.08.09); of the 10 largest companies in the world by sales, 6 are in the business of oil and gas operations. With combined sales of nearly US$2 trillion, the smallest of these 6 companies generates annual sales larger than the entire South African Gross Domestic Product (GDP). That’s hardly surprising given the worlds lust for the “black gold” and its illustrious ability to create dynastic wealth, notwithstanding our precarious dependence on it as a primary energy source.

Oil has been in use since the beginning of humankind, in-fact, the word petroleum is a hybrid of the ancient Greek word Petro (meaning ROCK) and old Latin word Oleum (meaning OIL). Crude Oil occurs in underground rocks that are rich in hydrocarbons and buried deep enough for subterranean heat to cook it into usable oil. Societies throughout history have used petroleum as the primary raw material for numerous chemical products, such as, pharmaceuticals, fertilisers, plastics, pesticides and solvents. However, almost 85% of petroleum is refined into gasoline and fuel oils.

Known reserves of petroleum (crude oil) are estimated around 1 trillion barrels excluding oil sands and oil shales (uneconomical oil). Current consumption is estimated at 80 – 90 million barrels per day. At this rate all the light grades of oil, which produce the best yields of primary energy products, will be depleted by 2040, all things being equal. There’ll be another 90 years of oil (very expensive oil) once we factor in oil sands and oil shales. At an average price of US$100/bbl, the oil industry still has another US$100 trillion of possible income to earn.

So why then is there so much debate on peak oil, a looming global oil crises and supply side constraints. What if we just sped up renewable energy to force down the average price of oil and simultaneously lessen our dependence of the stuff? Well I’d like to proposition three future scenarios of oil as I see them;

Calm Waters Scenario: Assuming that claimed and recoverable proven reserves are accurately stated at 1 trillion barrels and that the increase in demand for oil remains relatively tame, coupled with weak global growth and deceleration in emerging market demand, particularly China and India, for natural resources. In terms of this scenario, oil prices will remain relatively stable over an extended period much like 1991 – 2002 where oil stabilised around US$35/bbl precipitating the global boom that followed shortly afterward. In this way any interruption in the price of oil will be mild and self-correcting as demand and supply will remain fairly constant.

Quiet Storm Scenario: Assuming that there’s accelerated recovery in the global economy, exerting supply side pressure on oil production and forcing prices higher much faster. In the near term, Chinese growth will remain buoyed by accelerated investment in infrastructure, urbanisation and recovering global demand for Chinese exports. Crude oil prices quicken to US$150/bbl causing a panic in global markets with concerns that higher crude prices could mean higher inflation forcing a W-shaped recession and pulling the world back into the hole.

The sudden upsurge in the price of crude oil causes a mild cardiac arrest on the global economy, forcing down global demand, prompting accelerated investment in renewable energy production, secondary recoveries in abandoned oils wells, renewed exploration interest and an OPEC ping-pong aimed at sanctioning production volume increases. Ironically, higher crude prices remain obstinate as the Chinese increase demand to secure supply for their growth needs and the US outbids them for continued operation of the US economy. In this scenario, crude oil prices rise sharply and quickly recede to sustainable levels of around US$110/bbl, in a 1999 – 2002 n-style, causing moderate global inflation but nothing to crash the world economy.

Downpour Scenario: Assuming that not all the known reserves are recoverable, rising marginal extraction costs get out of control, stability in oil producing countries deteriorates, emerging market urbanisation accelerates, advances in medicine and science cause a rise in global life expectancy causing runaway population growth, global warming continues to play havoc on worldwide weather making winters colder and summers hotter and ever slowing breakthroughs in scalable renewable energy production.

This is more of a perfect storm scenario not necessarily far from realism. 80% of all oil reserves are located in the Middle East, with another 7% in warzones and volatile areas such as the Niger Delta and other rebel contested African states. It is not hard to see that without success in complicated peace negotiations, democratic elections that ligitimise governments and disarmament of nuclear weapons, we could easily have tragic supply side problems, which will unavoidably push crude prices higher. Furthermore, we know that not all stated oil reserves are easily recoverable, with an increasing number of wells running deeper and sparsely located making it more expensive for oil extraction. If you add rising labour costs pushed up by inflation, dreadful working environments, deteriorating worker’s health, an ageing workforce etc, then the crude oil price outlook appears less rosy by the minute.

More oil wells will soon reach their peak in the Middle East, causing permanent reductions in produced quantities and then oil will approach and possibly breakthrough the US$200/bbl mark. For as long as the worlds depends on crude oil for its primary energy needs, the threat of peak oil, runaway demand and supply-side interruptions lingers. It is possible that within the short to medium term the forces of a global economic recovery, emerging market growth, deteriorating investment in crude oil exploration, etc, will force oil prices much higher than most people can fathom, causing perilous hyper inflationary damage.

If you are a gambling man you might want to gamble with oil and potentially oil your pockets for generations to come. When John D. Rockefeller died in 1937 his net worth was measured at 3% of the US GDP; in 2008 dollars this would mean he died more than US$400bn strong, making Bill Gates’ US$50bn look like chump change. Rockefeller is history’s best remembered oil mogul having built Standard Oil using all and any means necessary, which would have earned him the mercenary label by today’s standards. If you won’t invest in oil, then find a way to hedge against its inevitable adverse inflationary effects.