Is Domestic Oil Drilling The Right Security Policy for the US?

This is a topic near and dear to logisticians and the overall energy strategy for the United States which then translates into what supply chains can expect for energy policy.  You cannot pick up a magazine, newspaper or watch a news show without the discussion of "energy independence" and how wonderful that will be / is for the United States.  And it is precisely that popularity which causes me to seek out other opinions.

A person once said if two people always agree with each other then probably one is not thinking.  The hoard mentality of energy independence makes me think that there must be another opinion - another way to look at things.  Well, leave it to Charlie Munger, Warren Buffett's great partner, and some may say the brains behind Warren, to give me that other way of looking at things.

In looking at this idea of energy policy he brings us to a core question:  Is it in the United States' best interest to "drain" the US now or should we in fact follow a policy of "drain the rest of the world" first and save our precious resource for the future?  A different way of looking at this problem. In order to believe that you may want to drain the rest of the world first you probably believe:

1. At some point, oil will become a scarce commodity.  This is not a popular view right now as we have moved from "peak oil" to an environment of oil abundance.  But, while we may argue about when, I think it is reasonable to believe that some day oil will be scarce.
2. You have to believe that there will not be a replacement for oil when the scarce time comes. 

If you believe those two items then the right policy is actually quite clear: drain the rest of the world first. While we can afford it and before the world catches on to us we should drain the world, even if it means drilling oil and bringing it to the US just to store then wait and see.  Here are some comments from Charlie:

"Oil is absolutely certain to become incredibly short in supply and very high priced .. The imported oil is not your enemy, it's your friend. Every barrel that you use up that comes from somebody else is a barrel of your precious oil which you're going to need to feed your people and maintain your civilization. And what responsible people do with a Confucian ethos is suffer now to benefit themselves and their families and their countrymen later. The way to do that is to go very slow in producing domestic oil and not mind at all if we pay prices that look ruinous for foreign oil. It's going to get way worse later ...

The oil in the ground that you're not producing is a national treasure ... It's not at all clear that there's any substitute [for hydrocarbons]. When the hydrocarbons are gone, I don't think the chemists are going to be able to just mix up a vat and create more hydrocarbons. It's conceivable that they could, I suppose, but it's not the way to bet. We should spend no attention to these silly economists and these silly politicians that tell us to become energy independent.

Let me pose a question for you. It's 1930. Oil in the United States is in glut. We have cartels to get the price up to $0.50 a barrel. Everywhere we drill we find more oil in our own country; everywhere we drill in Arabia we find even more. 

What would the correct policy of the United States have been in that time? Well, the correct policy would have been to issue $150 billion of very long-term bonds and cart 150 billion barrels of Middle Eastern oil into the United States and throw it into our salt caverns and leave it there untouched until the current age. 

It's easy to see that in retrospect, but who do you see who ever points this out? Zero. We have a brain-block on this issue. We should behave now to do on purpose what we did on accident then."

This is truly a fascinating position which challenges the common thought of drill in the US first.  He made me think:  Why should we drill now?  Oil in the ground is money in the bank and given that the ultimate price will be a global price to the consumer (i.e, the economy and the consumer see no benefit of local drilling) and that oil drilled in the US will be refined and then probably exported to equalize the global price, the correct policy is probably what Munger suggests - drain the rest of the world.

The only argument against this policy would be that we somehow benefit from local drilling and by the time we are drained there will be some type of substitute so it does not matter.  To this argument I reply with the knowledge of Pascal's wager.

When Pascal was asked why he believed in God he basically said it was an exercise in probability.  Basically he said he believed in God because if it turns out God does not exist than he really has lost nothing by believing in God during his life.  However, if God does exist than it certainly was good he believed and for those who did not, they are looking at an eternity of flames.

So, let's apply this to Munger's ideas.  If he is wrong, we have not lost anything (assuming we did not have to sacrafice mightly to drill the rest of the world).  If he is right, we will have ensured the security of our children for hundreds of years after the rest of the world is drained.

Makes you think.

Ht: The Motley Fool 

Watch the entire talk here:  21st Century annual Conference - ROUNDTABLE III  Charlie Munger starts making his comments on energy policy at about 36 minutes in.

Awakening the Sleeping Giant - Crude by Rail

I am short on time as I am heading to the Alternative Fuels Conference (ACT 2013).  I wanted to give the light of day to this article on the growth of Crude by Rail (which I mentioned as a trend back here).  This has huge impact on the movement of crude and will likely impact the movement of retail goods.  Think about things such as priority of movement on track, where capital spending will go and the locomotive resources.

More to follow.  Be ready.. whatever industry you are in you will be affected by this.

Crude By Rail is The New Hot Thing

Many have always said crude by rail was just a "stop gap" until new pipelines are built out to support the new finds of oil all over North America.  However, as this article in the WSJ points out (subscription required) Kinder Morgan is canceling a $2Bl pipeline project because West Coast refiners want the crude delivered by rail.  Pipelines lock contracts for a long time where rail is far more "variable".

For a while manufacturers and retailers were the beneficiaries of low utilization in rail due to the coal drop off and the switch to natural gas.  Then, an odd thing occurred which is crude by rail started and most people thought this was a stop gap to new pipelines which would eventually depress the crude by rail market.  However, this new development, and other information I have received, says that the refiners such as Valero and Tesoro value the flexibility that crude by rail brings to them very highly.  High enough that they would not meet Kinder Morgan's requests and lead the cancellation of this pipeline.

What does this mean for the average shipper?

1. Don't expect the lack of coal argument to go far in negotiations - they have found alternatives and it looks to be a very good alternative
2. Don't expect the "glut" of North American crude to depress prices very far.   One reason why the refiners like this is they can "shut off" the flow much more quickly when prices depress too far.
3. Expect a lot of capital investment to go into this segment of rail - and since there is not an infinite pot of money this will mean less investment in other areas of rail.

Oil Independence? Yes - "Cheap" Oil? - No

I have written about this before because I feel the headlines are misleading for those in energy intensive industries such as transportation.  The headlines talk about energy independence and energy dominance and the underlying assumption by most is this will translate into low cost oil.  This could not be further from the case.

We will continue to have high priced oil and the IEA in the same report where they said the US will be the dominant producer of oil also said you can expect oil priced at $125 per barrel (inflation Adjusted).  Oil is a global  commodity and therefore will settle on global prices.  The Wall Street Journal in an article entitled "Don't Expect Lower Oil Prices Even As US Output Surges" quotes the report by saying:

"But oil prices, the IEA said, will continue to rise, hitting $125 per barrel in inflation-adjusted terms — more than $215 per barrel in nominal terms — by 2035. U.S. consumers, the agency makes clear, won’t be shielded from those price increases, even if the country doesn’t import a drop of foreign oil."

The report goes on to say:

"Oil is a global commodity. What matters for prices is total supply and total demand — not where the oil is produced or consumed. That means that even if the U.S. relied only on domestically produced oil, prices would still be dictated by global market forces."

 Oil prices are based on global supply and demand and oil is very easily exported.  As soon as there is a big enough price differential where traders can make money in arbitrage they will export the oil. The graph below shows the predictions by the IEA:

So, the conclusion is clear... The US will be a large oil producer AND you will still be paying $3.00 - $4.00 in adjusted dollars per gallon.  

U.S. Overtakes Saudi Arabia in Oil Production by 2030 - IEA

This is a fascinating statement and it shows how disruptive technology (i.e, the ability to extract tight oil and shale oil / gas) will really turn the world energy markets on their head.  The International Energy Agency (IEA) has two reports out.  The first (as reported by Bloomberg) describes how the US will overtake Saudi Arabia in oil production.  Some interesting statistics:

• Last Month Saudi Arabia pumped 9.8 million barrels per day; The US 6.7 million - very close. 
• US production this year will be highest since 1991.
• 83% of the US domestic oil needs were met with domestic oil supplies in the first 6 months of 2012. 

The second report (again as reported by Bloomberg) tells us by 2030 natural gas will be the predominant source of energy in the United States as it will be plentiful and cheap.  Both of these are incredible developments given just a few years ago people were talking about "Peak Oil".

I will add a bit of commentary on sustainable practices.  I hope we as a country are wise enough to see these developments as incredible luck which gives us time to move to a more sustainable way to power our economy.  If we use this as a way to get "cheap energy": which then makes the business case for sustainable energy not economically viable then we will have squandered a huge opportunity.  

Also, as I have stated before, do not confuse "energy independence" with "cheap oil".  The oil prices will almost always be at world levels because if they are not then the energy will simply be exported rather than consumed in the US. 

The impact on transportation will be clear:

• Oil supplies abundant
• Oil prices at world levels (i.e., no "cheap oil")
• Movement to natural gas will continue. 

More on The Pickens Plan

Good interview with Boone Pickens about oil and oil independence.  I just warn all the readers that oil independence does not equate to cheap oil.  Oil and the refined products will always be priced at a world price.  If we get too cheap, it will just be exported.

I still think oil independence is something we should do.

Get Ready - CSCMP 2012 in Atlanta

Those who have been in the industry a while know the Council of Supply Chain Management Professionals (CSCMP) is the premier professional organization for our industry.  From practitioners to academics, this is the organization to belong to if you want to know what is happening in our industry, networking with top individuals / thought leaders and keep an eye on the mega-trends occurring in supply chain and logistics.

This year I have the honor to co-host Track 6 - Energy and Infrastructure at the Annual Global Conference in Atlanta from September 30 to October 3. This track will have exciting discussions concerning the overall energy marketplace right to how to specifically implement Natural Gas and alternative energy strategies.  The track objectives, as stated in the program:

"Managing a sustainable supply chain is no longer just a "cool" thing to do; it is expected by the consumer and is an extension of the brand and product being sold. This track will highlight best-in-class practices and emerging technologies to reduce your carbon footprint, enhance your corporate image, and positively impact the bottom line"

I highly encourage you to put this on your appointment calendar!

Today, I will highlight the first session we will have which is from 9:45 to 11:15 on Monday, October 1, 2012 entitled: Dispelling the Myths of Energy Independence by Walter Zimmermann, Senior Technical Analyst, United ICAP.  The description of this session is:

"US energy independence is a goal that can never be achieved due to the global nature of the economy and the ability to export energy quickly to the higher priced markets. There is a lot of talk about building a stronger economy while at the same time lowering energy prices. This speaker will explain why we can’t have both, and why the financial markets are what actually drive energy price trends. He will reveal what can be done to lower energy costs, and describe how seasonal price cycles can be employed to lock in prices near their annual lows."

This will be an exciting session as it will challenge a lot of the current thoughts which exist in our industry about how we are on the beginning of a wave of cheap energy and energy independence.  Mr. Zimmermann speaks how the laws of supply and demand are not driving fuel costs but rather the "financialization" of the energy markets are really driving the costs. This session will really challenge you to think different.

Mr. Zimmermann is an exciting and dynamic speaker which will make this session very exciting.  Bring your questions!

If you would like to see him in action, take a look at this clip from CNBC:




Here is a more recent interview: