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Showdown

Written by Brian Hicks
Posted March 14, 2005

Dear Wealth Daily reader:

I just returned from Wyoming after spending a Wealth Daily "brain trust" weekend with Mike Schaefer and the Phantom Trader.

We spent the last three days discussing the fate of the U.S. dollar, rising Chinese military ambitions, surging oil and gas demand, surging energy prices, and a coming commodity boom of unprecedented proportions.

To quote Mike, "Commodities are king. It will stun observers how far this rally will go."

However, if you've been reading Wealth Daily for some time, you know that we're preaching to the choir.

But, to us, it's amazing that some - if not most - market pundits believe oil will eventually go back to $20 a barrel. I read an investment report just last week that said there were "major oil discoveries last year" and that the world was "awash in oceans of oil."

Oh, really? Tell that to the Chinese, who are experiencing energy crunches and blackouts on an almost daily basis.

Ask any oilman and he'll tell you that there hasn't been a major oil discovery since the 1970s.

There's simply no more "easy" oil to be found.

Texas oilmen know it. The Chinese know it. Vladimir Putin knows it, too. And the U.S. has no other choice but to accept it now.

At the Middle East Oil and Gas Show, which opened yesterday in Bahrain, Hani Hussain, Kuwait Petroleum CEO admitted as much. He said: "Prices will never [again] go under the $40 per barrel mark."

He cited strong economic growth from China, Brazil and the United States as one reason oil will remain above $40

The International Energy Agency (IEA) expects world oil demand to grow 1.81 million barrels a day, bringing its forecast for average daily demand to 84.3 million barrels.

It has long been denied that the U.S. government bases any policy around the idea that global oil production may be in terminal decline.

But a new U.S. government-sponsored report written by Robert Hirsch does exactly that.

The report is titled Peaking of World Oil Production: Impacts, Mitigation, & Risk Management, and it's sending shockwaves through the federal government.

Why?

The report's central thesis is this: World oil peaking is going to happen. Only the timing is uncertain.

According to officials who have read it:

"This brand new senior-level report on 'peak oil' is unprecedented in U.S. government circles. It is not just the existence of the report itself that is such a landmark in the current oil debate. Its conclusions also pull no punches."

If you are so inclined, you can get a copy of the report at this site.

But here's a quick and dirty synopsis of the report:

"The development of the US economy and lifestyle has been fundamentally shaped by the availability of abundant, low-cost oil. Oil scarcity and several-fold oil price increases due to world oil production peaking could have dramatic impacts ... the economic loss to the United States could be measured on a trillion-dollar scale," the report says.

The report also dismisses the power of the markets to solve any oil peak. They call for the intervention of governments. But also they rather worryingly point to a need to exclude public debate and environmental concerns from the process. They say this is needed to speed up decision-making.

"Intervention by governments will be required, because the economic and social implications of oil peaking would otherwise be chaotic. But the process will not be easy. Expediency may require major changes to ... lengthy environmental reviews and lengthy public involvement."

Hirsch notes, despite arguments from the major oil companies and producer nations, that new finds of oil are not replacing oil consumed each year. Despite the advances in technology reserves are becoming increasingly difficult to replace.

Three scenarios

The report sees "a world moving from a long period in which reserves additions were much greater than consumption, to an era in which annual additions are falling increasingly short of annual consumption. This is but one of a number of trends that suggest the world is fast approaching the inevitable peaking of conventional world oil production".

The report then takes three possible scenarios and outcomes. Firstly that energy replacement solutions, or "mitigation" as the report states, are started 20 years before any "peak". Secondly that solutions are only enacted 10 years before any peak and, thirdly, that solutions are only put into practice as the peak becomes apparent.

In what some may see as an optimistic assessment, the authors believe 20 years is enough time to limit damage from any peak. However, they point out that "if mitigation were to be too little, too late, world supply/demand balance will be achieved through massive demand destruction".

Demand destruction is a modern way of saying catastrophic recessions and shortages. But as well as these predictions, the report lays out "signals" it believes will be apparent in the run-up to any peak. This is perhaps the most worrying aspect of the report, as it seems to describe the very events that are taking place at the moment.

Supply insecurity

"As world oil peaking is approached, excess production capacity will disappear, so that even minor supply disruptions will cause increased price volatility as traders, speculators, and other market participants react to supply/demand events," the report says.

"Simultaneously, oil storage inventories are likely to decrease, further eroding security of supply, aggravating price volatility, and further stimulating speculation. Oil could become the price setter in the broader energy market, in which case other energy prices could well become increasingly volatile and unpredictable."

The report highlights a series of ways to minimize any impacts. From increased fuel efficiency to technological help in stopping the practice of "oil-left- behind" or non-extractable oil and various forms of new liquid fuels, liquefied coal and gas-to-liquids.

But in its conclusion the report makes troubling reading, noting that "the world has never faced a problem like this. Without massive mitigation more than a decade before the fact, the problem will be pervasive and will not be temporary. Previous energy transitions were gradual and evolutionary. Oil peaking will be abrupt and revolutionary".

This report is the clearest signal yet that the U.S government is taking the subject of "peak oil" seriously.

*****

You can see why Wealth Daily believes we're in the "mother of all energy bull markets."

Until tomorrow,

Brian Hicks
Wealth Daily

P.S. In tomorrow's Wealth Daily, I'll talk about China's new law to "take back Taiwan by force" and why this means near-certain hyperbolic rallies in commodities.

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