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Monday, March 15, 2010

$200 Oil is Coming (Part 3 of 3)

While We Waste a Perfectly Good Crisis

by James Quinn (April 08 2009)

Most people do not understand that all prices are set at the margin. There are 75 million houses in America. Only four to five million homes are sold per year. Therefore, five to six percent of the homes in the US set the price for the other seventy million homes. This same concept applies to the last barrel of oil. When worldwide demand exceeded worldwide supply in late 2007 and early 2008, those last barrels of oil set the price. This explains why those last barrels of oil set the price above $100 a barrel. It wasn't greedy speculators and evil oil companies.

It is clear that supply has stayed in the range of 86 million barrels per day while demand has dropped to the range of 84 to 85 million barrels per day. If oil demand rises by three percent, demand will outstrip supply again.

$200 Oil Will Arrive

When I was ten years old my parents told me to never touch our stainless steel sink and the electric light switch above the sink at the same time. I couldn't resist. I tried it and got knocked on my ass. I never did it again. Americans are a different lot. Last year we got knocked on our ass by $4.00 gasoline. Instead of learning, we have sauntered back to the kitchen sink and we're reaching up for the electric light switch. I wonder what is going to happen this time.

Americans are used to making tough choices. They have made choices between the Hummer H3 (thirteen miles per gallon) and the Hummer H2 (eight miles per gallon). They've made choices between a BMW 650i (sixteen miles per gallon) and a Mercedes S600 (thirdteen miles per gallon). The coming energy crisis will lead to choices between food or fuel for many people. The coming crisis is as clear as the housing bubble. Anyone with half a brain could see that home prices would need to fall thirty to fifty percent to get back to equilibrium. Therefore, no one in Congress, Wall Street, or CNBC saw it coming. Total world oil supply is in a permanent decline. Oil demand will continue to rise. Only a half wit would argue that prices will not rise dramatically in the coming years. Turn on CNBC to get the half-wit view of oil prices.

Now the bad news for Americans: We make up 4.3% of the world's population and consume 26% of the world's oil. Europe makes up 6.8% of the world's population and consumes eleven percent of the world's oil. After the oil shock of the 1970s Europe decided to dramatically increase taxes on gasoline. The high cost of gasoline forced people to buy smaller fuel efficient cars. Today in Germany, their cars average 44 miles per gallon, while in the US our cars average 22 miles per gallon. Whether Europe spent the taxes wisely is another question, but they did change behavior. No crude oil refineries have been built in the United States since 1976. During that time, hundreds of ethanol refineries have been built. It requires more energy to produce ethanol than ethanol produces. The United States has between 250 and 300 years of a coal supply. That is more than the amount of recoverable oil contained in the entire world. We will not utilize this resource because environmentalists say it is bad. Congressman Gary Miller describes the US response to the 1970s oil shock:

In 1973, America imported thirty percent of its crude oil needs. Today, that number has doubled to more than seventy percent. Gas prices are as high as they are now in part because we've had no comprehensive national energy policy for the past few decades.

The peak oil shock that is coming will affect the United States more dramatically than any other country. Are you prepared for $5.00 a gallon gasoline? We are twenty years too late to stop this from happening. The American way of kicking all tough issues down the road is about to kick us in the ass, and no one is preparing Americans for the result. Happy talk and confidence-building exercises will not solve the problem. We are not in control of our destiny. Our supply is drying up. More drilling will not work. Higher fuel efficiency standards will not work. Congressmen and television pundits will posture, expound, skewer oil executives on television, and get red in the face, but they have failed the American public again. The social upheaval that could occur from fuel shortages and outrageous prices will be ugly. Most Americans live in suburbs far from work. Our food supply requires trucks to deliver to our stores. The US military consumes 400,000 barrels of oil per day and spends $13 billion of your tax dollars per year to keep their machines functioning. War for oil becomes more likely in that environment. Is that a farfetched scenario?

The population of the world will continue to rise. The United States has no control over that fact. Developing countries will grow more prosperous. People utilize more fossil fuels as they become more prosperous. $2,500 cars are now becoming available in China and India and the rest of Asia. In a Chinese car ownership survey, 96% of respondents said they paid cash for their cars. How un-Americanlike. Imagine if GMAC could gain a foothold in China. More than 20,000 new cars per day are being sold to Chinese citizens who have never owned an automobile before. This is massive new demand being created for gasoline. China now has a middle class estimated at nearly 300 million people. 37% of people driving in China today did not know how to drive three years ago.

Oil will continue to be discovered, just not enough to keep up with demand. The pie chart below {*} paints a disturbing picture. Only thirty percent of total oil reserves are light sweet crude. The other seventy percent is difficult and costly to bring to market. Few US refineries can convert heavy crude into gasoline. Oil sands require massive amounts of water and natural gas to convert it into usable oil. The oil remaining to be discovered will be in deepwater wells. It takes at least ten years to bring a deepwater well online. We are losing the race with time.

{*} This and other charts are at

The only two people sounding the alarm have been Matt Simmons and T Boone Pickens. Mr Simmons warns that the best energy geologists and engineers are now retiring, with no one to take their place. The global oil and gas system infrastructure is rusting away and falling apart. The cost to rebuild our global energy infrastructure would be close to $100 trillion and would require ten to twenty million workers. This would not be wasted money. Mr Pickens argues that by investing $1 trillion to build wind facilities in the corridor from Texas to North Dakota we could produce twenty percent of the nation's electricity by 2020. This would free up our vast natural gas resources to be used as fuel for truck fleets and ultimately automobiles. The ideas of both men would create jobs in America and make us less dependent on Middle East oil.

None of these ideas will avert $5 gasoline in our near future. They may avert $10 gasoline and potentially a resource-instigated World War Three. The choice is ours.


James Quinn is a senior director of strategic planning for a major university. James has held financial positions with a retailer, homebuilder and university in his 22-year career. Those positions included treasurer, controller, and head of strategic planning. He is married with three boys and is writing these articles because he cares about their future. He earned a Bachelor of Science degree in accounting from Drexel University and an Master of Business Administration degree from Villanova University. He is a certified public accountant and a certified cash manager. These articles reflect the personal views of James Quinn. They do not necessarily represent the views of his employer, and are not sponsored or endorsed by his employer.

James Quinn's Blog is My goal is to provide my readers with a wide eyed view of the world. I will concentrate on social and economic issues that I feel are important to the country. My commentary will be blunt and pointed. The country needs people to see things as they are, not as they wish them to be. I'm trying to do my part in keeping our country from experiencing a Roman Empire like decline. Burning platform refers to David Walker's description of the United States government as on a "burning platform" of unsustainable policies and practices with fiscal deficits, expensive over-commitments to government provided health care, swelling Medicare costs, the enormous expense of a prospective universal health care system, immigration, and overseas military commitments threatening a crisis if action is not taken soon. Visit .

Bill Totten


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