Friday, March 30, 2012

Strategic Petroleum Reserve for Supply Crisis, Not High Prices

Attempting to offset rising oil prices by tapping the Strategic Petroleum Reserve would be both shortsighted and ineffectual.

The price of oil seems to be front-page news nearly every day now, and it's clearly a hot topic among American drivers filling their cars with gasoline each week.

The price of West Texas Intermediate (WTI) crude reached $100 per barrel in November and has experienced highs of at least that level for five consecutive months.

WTI is domestically produced oil and it is the benchmark for oil pricing on the Chicago Mercantile Exchange.

In January, the U.S. Department of Energy predicted that, for the first time ever, the price of crude oil would average more than $100 a barrel this year.

The elevated price of oil is raising food costs, as well as the costs of all other transported goods. Shippers, such as UPS, have raised their rates and airlines are also raising ticket prices to compensate for rising fuel costs.

The current state of affairs is spurring some people, including assorted politicians and news pundits, to call on the President to release oil from the U.S. Strategic Petroleum Reserve (SPR).

However, such a move would be unwise and ineffective.

According to the U.S. Department of Energy, with a capacity of 727 million barrels, the SPR is the largest stockpile of government-owned emergency crude oil in the world. It is stored in four locations; two in Louisiana and two in Texas.

"Established in the aftermath of the 1973-74 oil embargo, the SPR provides the President with a powerful response option should a disruption in commercial oil supplies threaten the U.S. economy," reads the DOE's Website.

The purpose of the Reserve is to to maintain a backup oil supply in case of national emergency, such as another oil embargo that could cripple the U.S. The SPR also provides a reserve for the national defense.

The President can order the release of oil from the Reserve in the event that the United States faces an economically threatening disruption in oil supplies. This has occurred just three times since the creation of the Reserve in 1975.

The first was in 1991, at the beginning of Operation Desert Storm.

The second was in September 2005, after Hurricane Katrina struck the Gulf Coast and devastated the vital oil production, distribution and refining industries in the region.

The third Presidentially-directed release came on June 23 of 2011 and was used to offset the disruption in global oil supplies caused by unrest in Libya and other countries.

Though the Reserve has a capacity of 727 million barrels, the current inventory is 696 million barrels. At the current usage level of 19 million barrels per day, the reserve would supply oil to the U.S. for just 36 days.

Apparently, those calling for the release of oil from the SPR are unaware of this fact. Attempting to offset rising prices in this way would be both shortsighted and ineffectual.

Moreover, the maximum total withdrawal capability from the Reserve is just 4.4 million barrels per day, less than a quarter of current daily usage. At that draw-down rate, it would take 160-plus days to exhaust the supply.

So even a full emergency release wouldn't offset a foreign oil embargo, the results of which would devastate the U.S. economy.

Critically, the price paid for the oil in the SPR is $20.1 billion (an average of $28.42 per barrel). If the U.S. were to run through the Reserve supply and then have to replenish it, the cost would be nearly four times the previous expense. This makes tapping the Reserve a last ditch effort.

The Strategic Reserve was designed as an insurance policy in case of significant supply disruptions; not rising prices due to rising global demand or the behavior of unscrupulous Wall St. speculators.

At this point, the U.S. is not facing a genuine oil shortage or energy emergency. Drawing down the SPR would leave the U.S. defenseless in the event that a genuine global crisis should erupt.

Friday, March 23, 2012

Federal Reserve & National Debt Have Set Stage For Soaring Inflation

In 2011, the U.S. inflation rate averaged 3.2 percent. So far in 2012, the rate is still averaging roughly 3 percent. Yet, Americans are seeing even more significant increases whenever they buy food or gasoline.

The concern among many economists and analysts is that the U.S. could be headed for a much higher inflation rate in the not too distant future.

From 1914 until 2010, the average inflation rate in United States was 3.38 percent. It's reasonable to ask, What's behind this?

Most people associate inflation with rising prices. However, rising prices are merely a symptom of inflation, not the cause.

In reality, rising prices are the result of money losing its value — its buying power. Money is driven by the same laws of supply and demand that affect almost everything else. The more rare something is, the more valuable it is. Conversely, the more readily available something is, the less valuable it is.

Money is constantly being created by the world's central banks, including the Federal Reserve Bank. When the supply of money exceeds the supply of goods and services in an economy, it devalues the currency — meaning the currency loses buying power.

The Fed is allowed to create money out of nothing. Yes, as incredible as it seems, the Federal Reserve is legally entitled to create something of value out of absolutely nothing. All of the world's central banks do this. All paper money is fiat money, meaning it is simply assigned a value by government decree. Yet, paper money has no intrinsic value. It's just paper with ink, backed by nothing of value.

However, only about three percent of the world's money is in the form of bills and coins. The other 97 percent is just numbers typed into bank databases and shown on computer screens.

Most troublingly, all money is loaned into existence. But the interest portion of all loaned money is never created; only the principle is created. So, the system is always out of balance, right from the start. The only way for the interest on debts to be paid off is by creating even more money. In essence, money is created as debt.

So, by design, our monetary system must constantly create new money, or new debt. And price inflation is the end result every time a central bank creates new money. It's the money supply that is being inflated, and all of this new money continually devalues the existing supply of money.

What is really worrisome is that the creation of money has been happening at an alarming rate.

The U.S. monetary base (the supply of money) nearly doubled between 1994 and 2006. Then it doubled twice more, increasing by an additional 221% from 2006 to 2011. That's simply staggering. In fact, it's alarming.

The result has been a devalued dollar, manifested in the form of rising prices, which is affecting all Americans. This process will continue to play out in the coming years, but the consequences are likely to become considerably worse over time. If you don't understand this, just think supply and demand.

The U.S. government has created so much debt for decades that the Federal Reserve would have to manufacture about five times more dollars than exist today merely for the Treasury to meet its obligations. The U.S. government's unfunded liabilities currently amount to $70 trillion.

Yes, you read that correctly. The U.S. government has $70 trillion in future obligations and it doesn't have the funds to pay them.

Due to its fears of deflation and persistently high unemployment, the Federal Reserve has bought trillions in mortgage-backed securities and Treasury bonds over the past couple of years, all with freshly created money. The funds from those purchases have flooded the economy with inflation-fueling liquidity, pumping up the stock market in the process.

Much of the excess liquidity has also ended up in commodities markets, which has sent crude oil and food prices into an upward trajectory.

All of that liquidity flowing through the economy has enabled the government to continue producing annual trillion dollar deficits. Whatever funding the Treasury cannot raise in the bond market, the Fed simply prints.

But the Fed isn't acting alone. The European Central Bank, the Bank of England, the Bank of Japan and the Chinese Central Bank have all been printing like mad, pumping absolutely massive amounts of liquidity into global markets.

The end result will be skyrocketing inflation.

There are limits to everything. This level of debt creation cannot go on indefinitely.

As Dr. Chris Martenson has astutely observed, beginning in January 1970, total credit market debt doubled five times by 2010. This includes all debt — financial sector debt, government debt (federal, state, local), household debt, and corporate debt.

In order for the 2010 decade to mirror, match, or in any way resemble the prior four decades, credit market debt will need to double again from $52 trillion to $104 trillion.

Does this seem reasonable or even possible to you? How can the current amount of debt ever be repaid, much less another doubling?

What is clear is that no matter how this all ends, it will not end well.

The dollar has already lost over 95 percent of its buying power since the creation of the Federal Reserve in 1913. And there is no let up in sight to all of this unrestrained money printing. Once foreign governments and sovereign wealth funds stop buying Treasuries — out of fear that the U.S. already has too much debt to ever be repaid — the only option will be for the Fed to super charge its already rampant money creation.

As it stands, the national debt already exceeds the gross domestic product. That's troubling because when public debt reaches 90 percent of the GDP, research suggests that economic growth slows by about 2%. And slow growth can pile on even more debt.

In their book, "This Time It's Different: Eight Centuries of Financial Folly," Carmen Reinhart, a University of Maryland economist, and Harvard professor Kenneth Rogoff find that a 90 percent ratio of government debt to GDP is a tipping point in economic growth. Beyond that, developed economies have growth rates two percentage points lower, on average, than economies that have not yet crossed the line.

History indicates that the U.S. will not be able to grow its way out of debt. And the long term trends for the debt and dollar are frightening.

Under the CBO’s rosiest estimates, total Federal Debt is projected to rise to at least $21.7 trillion by 2022. However, the debt could also be as high as $29.2 trillion by that time.

The end result will be an even more devalued dollar with even less buying power.

The inflation of our currency is already leading to inflated prices throughout the economy, Yet, the current inflation rate is merely a hint of the explosion that is yet to come.

The inflation rate hit a historical high of 23.70 percent in June of 1920 and got as high as 13.5 percent as recently as 1980. It shouldn't be a surprise to anyone when inflation rises to a level somewhere between those two points in the coming years.

Then we'll all sound like our grandparents, reminiscing about how cheap things used to be back in 2012.

Friday, March 16, 2012

John Maynard Keynes Was Right (and not for the reason you think)

For more than eight decades, famed economist John Maynard Keynes has been the subject of much discussion and debate.

Many observers attribute his scholarly positions on monetary policy with ending the Great Depression, while others have negatively viewed him as a champion of big government and unsustainable deficit spending. The latter has made him a scourge to conservatives ever since.

However, what is often overlooked is that Keynes advocated both tax cuts and budget surpluses. Deficits, he believed, were to be begrudgingly accepted as a necessary evil only in some circumstances.

Like all economists, Keynes theories on economics boiled down to the basic laws of supply and demand.

However, unlike others before him, Keynes believed that demand drives supply. In Keynes view, insufficient demand leads to unsold goods, which leads to layoffs. Ultimately, insufficient demand leads to a downward spiral of unemployment, poverty and even depression.

Keynes' remedy in these instances was to artificially stimulate demand by increasing government spending or cutting taxes, which ultimately encourages the public to increase its spending instead. The idea was to cause either the government or the public to increase spending to stimulate the economy.

These goals were to be achieved through fiscal policy; spending measures or tax cuts. Yes, Keynes actually advocated cutting taxes.

Keynes favored deficit spending only to combat depressions, not to fight low levels of unemployment. He also advocated creating surplus budgets to eliminate government debt in times of prosperity.

Yet, that approach has been largely ignored for decades. The overall debt has increased under every president since the 1940s, regardless of which party has controlled Congress. Even during times of extraordinary economic expansion, debt has continued to pile up.

The primary concern about large government debt is that it can fuel inflation.

Notably, Keynes believed that inflation could be cured with the help of budget surpluses and/or restrictive monetary policy. If demand (or spending) are reduced, then prices start falling.

Though Keynes argued for budget deficits to stimulate demand, he also advocated for subsequent budget surpluses to eradicate debt. That part of the equation seems to have been forgotten by many.

The public debt has increased by over $500 billion each year since fiscal year (FY) 2003, with increases of $1 trillion in each FY since 2008. The fiscal year begins on October 1 and ends on September 30 the following year.

The national debt is now in excess of $15.5 trillion and there is no end to the deficits in sight. Interest payments are consuming an ever-larger portion of the budget each year as the debt grows. And, though currently at historically low levels, interest rates are poised to increase — perhaps significantly — in coming years. That could make debt management impossible.

Budget surpluses now seem like a pipe dream. They are a distant memory from the 1990s. Keynes would surely be disappointed, if not appalled.

And though consumer demand remains constrained by a variety of factors (high unemployment, stagnant wages, the bursting of the housing bubble, etc.), with such an enormous debt the government is hamstrung to engage in further deficit spending to stimulate demand.

The nation's infrastructure is crumbling and received a cumulative grade of D from the American Society of Civil Engineers. And the nation desperately needs to invest in scientific research to remain competitive in the 21st Century.

Yet, in both instances, the government is handcuffed by its enormous debt. With trillion dollar deficits adding to the mammoth debt each year, how can anyone reasonably argue for piling on yet more debt, no matter how worthy the cause?

When Vice President Dick Cheney famously stated, "Reagan proved that deficits don't matter," he was wrong. Very wrong. They do matter. A lot.

Keynes knew this all along.

Saturday, March 10, 2012

Tar Sands Too Inefficient & Energy Intensive, Not Worth Cost

Perhaps you've heard of the Keystone XL pipeline. It's been in the news a lot lately. The pipeline was intended to carry tar sands oil across the Canadian border to the U.S.

There was a big hullabaloo in Congress over the pipeline, which was finally voted down by the Senate this week. Notably, 45 Republicans voted in favor, while the other two abstained.

The obvious question is, what is the value of tar sands?

The story currently being promoted by some suggests that Canadian tar sands (also known as oil sands) are the solution to America's energy needs and a way to relieve us of our reliance on Middle Eastern oil.

Somehow, this story ignores the fact that tar sands are still a form of imported oil, and that most of America's imported oil already comes from Canada and Mexico, not the Middle East.

But that's not the heart of the matter.

Here's the key question: What is the net energy returned after utilizing oil or natural gas to obtain more oil? In the oil business, this is referred to as Energy Return On Energy Investment (EROEI).

EROEI is defined in the following way: Energy Produced / Energy Used = EROEI

For example, if oil is selling for $100 per barrel and it costs $10 in energy to produce a barrel, the EROEI is 10. Traditional oil development is currently estimated to have an EROEI of about 15. Obviously, the higher the number (i.e., the higher the EROEI), the better.

If it requires a barrel of oil to retrieve a barrel of oil, then what's the point? Energy producers have to take into account the market price of oil or natural gas, versus how much it will cost to extract and refine them.

The light, sweet crude is the good stuff that sits at the top, where it's relatively easy to extract. The lower quality oil — like tar sands — just happens to be the most expensive oil because it is the most difficult to extract.

With tar sands, the cost to produce a unit of energy is much higher than with traditional oil. Simply put, tar sands do not come cheaply.

Just how energy-intensive are tar sands? Professor Kjell Aleklett of Uppsala University in Sweden, a recognized expert on tar sands, puts it this way: "The supply of natural gas in North America is not adequate to support a future Canadian oil sands industry with today's dependence on natural gas."

The problems begin right at the start of the operation. Tar sands are typically mined, which means a large amount of energy is required just to get the process started.

Tar sands are a mixture of roughly 90 percent sand, clay and water, plus 10 percent bitumen, a thick hydrocarbon liquid. After extracting that 10 percent of bitumen from the tar sand mixture, the bitumen can be purified and refined into synthetic crude oil.

Bitumen is one of the world's most expensive and heaviest hydrocarbons. And it is very energy intensive. In fact, bitumen production requires so much natural gas for processing and enrichment that it now accounts for one-fifth of Canada's natural gas demand.

That's the problem Professor Aleklett was referring to above.

Since bitumen is a highly viscous “heavy” oil that doesn’t flow as easily as lighter crude, it requires more processing to facilitate its flow through oil pipelines.

In fact, bitumen is so heavy and viscous that it will not flow unless it is heated or diluted with lighter hydrocarbons, such as natural gas. Typically, tar sands are produced using natural gas to heat the steam that drives the oil out of the sands. And it takes a lot of gas to do this.

Finally, bitumen has to be upgraded so that it can be refined. This can be done by adding methane or hydrogen — from even more natural gas — to the bitumen to create lighter oil.

Even if electricity is used to extract the tar sands and natural gas, this ultimately comes from a coal-fired power plant. It doesn't change the equation; you're still exchanging one form of energy for another.

Perhaps you now get a sense of just how inefficient tar sands really are. In fact, tar sands are so inefficient that just 75% of the bitumen can be recovered from sand.

At the turn of the 20th Century, it took just one barrel of oil to find and liquidate 100 barrels. That amounted to an extraordinary Energy Return on Energy Investment.

However, according to Peter Tertzakian, the chief energy economist at ARC Financial Corporation, the EROEI for tar sands amounts to 7:1 for extraction and drops to 3:1 after it has been upgraded and refined into something useful, such as gasoline.

The process of making liquid fuels from oil sands requires abundant energy from beginning to end, extraction to refining. The entire process generates two to four times the amount of greenhouse gases per barrel of final product as the production of conventional oil.

Ultimately, squeezing oil out of tar sand is an extremely wasteful process, requiring between two and four tons of tar sand and two to four barrels of water to produce a single barrel of oil. The current level of water consumption is enough to sustain a city of two million people every year, according to an analysis by Energy & Capital. And after the water has gone through the entire process, it is so toxic with contaminants that it cannot be released into the environment.

When you look at the big picture, tar sands clearly aren't the answer to our energy needs. They're not even part of the answer. They are too energy intensive, release far too much carbon into the atmosphere and are far too dirty, polluting precious water supplies.

Until some renewable, synthetic fuel is developed that can reduce our reliance on fossil fuels, conservation will be our best bet. Oil prices are in a long term upward trend, and tar sands present more problems than solutions.