Tag Archives: oil

America’s addiction to oil

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Every time oil prices pull back, the financial press repeats the misguided mantra that crude inventories are too high. The fact is, inventories are far from excessive. Rather, they reflect the strategic importance of oil and America’s increasing dependence on foreign sources. Indeed, we believe that investors should expect crude oil inventories to continue rising along with prices. The higher inventories shield the economy from unexpected and uncontrollable disruptions in crude oil supply.

Oil inventories are strategic

As the chart below indicates, following the 1973 oil embargo, US crude oil inventories began rising steadily. Companies and the US Government correctly understood that maintaining larger inventories would help to avoid risks from further supply disruptions caused by OPEC. The increase in inventories continued for more than 16 years before stabilizing.

The attacks on September 11, 2001, triggered a similar change in perception – this time, the widespread recognition that inventories should be maintained to protect against supply disruptions resulting from terrorism or other political volatility. It is impossible to predict whether the current increasing trend of inventories will last as long or push as high as the previous one, but the increase appears ongoing.

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Crude inventories in terms of months of supply

The slow-moving trends shown above may give false confidence in US crude oil inventory management. A more important measure of inventories is how long inventories would last during a supply disruption. Inventories would provide about two months’ supply at the current pace of consumption. This two-month period is up only slightly since September 11, 2001.

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The US is increasingly dependent on foreign sources of oil

US oil production peaked in 1971. Since that time, growing demand for crude oil in the US has been satisfied by rapidly increasing imports. In 1991, imports surpassed domestic production, and since that time imports have grown to two-thirds of the total US crude oil supply.

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In today’s world, the disruption of imports is a distinct risk. In the event of a war, embargo, or terrorist act, imports could be interrupted while domestic production might continue. Current US crude oil inventories would replace about 100 days of imports. This 100-day period has essentially remained the same since September 11, 2001.

If inventories do not grow in pace with demand, the period of protection against import disruptions will decline. As inventories shrink relative to imports, the US becomes increasingly vulnerable to import disruptions that could adversely affect the labor and lifestyles of Americans. By this measure, inventories have rarely been lower.

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It is probably no coincidence that the|1973 oil embargo was triggered by OPEC when US inventories had fallen to less than three months of imports. A period of low inventories causes prices to respond dramatically to disruption. The oil crisis of 1979 resulted in long lines for scarce gasoline. Solar panels were actually installed on the roof of the White House.

In order to provide for the equivalent of six months of imports, inventories would have to rise by 79% over their current level.

Almost every aspect of modern living is tied to consumption of crude oil, directly or indirectly. The economy relies on the oil industry for gasoline, diesel, jet fuel, heating oil, natural gas, propane, asphalt, lubricants, fertilizers, antifreeze, pesticides, synthetic rubber, pharmaceuticals, and plastics. It is hard to imagine a functioning economy without these products.

Even the most optimistic experts anticipate that world crude oil production can only grow for a few more decades. After that time, production would decline as remaining sources became more difficult to recover from depleting reserves. Most prominent experts anticipate that global production will peak sooner; some even believe it peaked in 2005.

Already, energy efficiency is on the rise. We are increasingly using crude oil for applications that are best served specifically by crude oil. Other sources of energy are being exploited whenever possible and whenever the cost can be justified. The US economy has been growing faster than its rate of consumption of oil, but it is still highly dependent on crude.

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In sum, America began coping with its dangerous dependency on oil after the Arab oil embargo of 1973. But management of this dependency is ongoing. War and terrorism, increasingly scarce supplies, and changing standards in the transportation industries are likely to lead to rising energy prices as America continues to struggle with its addiction to oil.

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A Briefing on US Energy

Quotes below are from the Energy Information Administration of the US Department of Energy.

“The United States of America is the world’s largest energy producer, consumer, and net importer. It also ranks eleventh worldwide in reserves of oil, sixth in natural gas, and first in coal.”

The US is becoming increasingly dependent on imported oil compared to domestic sources. Over the last 20 years as demand has risen and US production has fallen, crude oil imports have increased to make up the difference.

“Total 2004 petroleum demand is projected to grow by 420,000 barrels per day, or 2.1%, to an average 20.4 million barrels per day.”

“The United States averaged total gross oil (crude and products) imports of an estimated 12.2 MMBD during 2003, representing around 62% of total U.S. oil demand.”

“With the rebound in world oil prices since March 1999, U.S. crude production fell slightly in 2002 and 2003, and is now at 50-year lows.”

US Strategic Petroleum Reserves (SPR) have been increasing as US production is decreasing and prices are rising.

“In mid-November 2001, President Bush directed the Department of Energy (DOE) to fill the SPR to its capacity of 700 million barrels in order to ‘maximize long-term protection against oil supply disruptions.'”

But while our oil is increasingly coming from foreign sources, oil is shrinking as a percentage of our economic picture. Demand for oil is increasing at a slower rate than US GDP. Accordingly, emissions follow this pattern.

“U.S. carbon emissions per dollar of GDP have been declining steadily since at least 1980.”

This is an important trend because the US environmental impact is a growing point of international pressure.

“The United States, with the world’s largest economy, is also the world’s largest single source of anthropogenic (human-caused) greenhouse gas emissions.”

“On March 27, 2001, the Bush administration declared that the United States had “no interest” in implementing or ratifying the Kyoto treaty limiting greenhouse gas emissions, but that it would pursue other ways of addressing the climate change issue.”

This rejection was not completely in denial of the international environmental issues, though.

“In February 2002, the Bush Administration released its proposed alternative to the Kyoto Treaty, calling for significant reductions in emissions of various pollutants (mercury, nitrogen oxide, sulfur dioxide). The program, known as the “Clear Skies Initiative,” would utilize a “cap and trade” system which would allow companies to trade emissions credits. In addition, the Bush Administration envisions reductions in U.S. “greenhouse gas intensity” — the amount of greenhouse gases emitted per dollar of GDP — by 18% over 10 years.”

This proposed alternative is likely to be achievable because the trends of GDP growth and U.S. carbon emissions growth have been in place since 1980.

For the electric power sector, coal-fired plants accounted for 53% of generation, nuclear 21%, natural gas 15%, hydroelectricity 7%, oil 3%, geothermal and “other” 1%.”

Surprisingly, electricity demand is shrinking relative to the economy as well. GDP is growing faster than electricity demand.

“Total U.S. annual electricity demand grew only slightly — about 0.8% — during 2003. For 2004, electricity demand is expected to increase about 2% from 2003 levels, driven by accelerated growth in the economy and weather-related increases in the first and the fourth quarters.”

And even though GDP per kilowatthour is growing, electricity prices have not reflected that change.

“Electricity prices in the United States fell every year between 1993 and 1999, but this trend reversed in 2000, 2001, and 2003.”