This diary is intended as a primer for those who may usually ignore economic discussions. I'd like to give an easy to follow description of the trouble the US is in, and why you need to protect yourself. I will try to keep it simple because this is very important to you!
The next time you go to fill up your car at the gas station consider the following scenario:
The gas station only has enough gas for 10 more cars, yet there are 25 cars waiting. The station owner decides that unlike the first come, first served system used in the past, he will now auction to the highest 10 bidders (all the nearby stations are sold out). How much will you bid to fill up your car? Would you pay $5/gallon? $10? $20?
In a very real way this is what is going on in the oil market today. In the past, there was always enough supply so producers had to sell at the going rate (just as gas station owners could not auction gas when there was more than enough to go around). But now it is different and here is why and how it affects YOU!
This is part 5, with other parts to follow in future diaries (hopefully). If you missed the first few installments click on the links below to read them.
Part 1.
The Bushies have dug a big, big hole.
Part 2.
Consumers are up to their eyeballs
Part 3.
How low interest rates have destroyed America
Part 4.
Our foreign friends (?)
Why now?
It took the planet several hundred million years to "make" the oil that we use today. In our infinite greed, we have managed to use up a good portion of that in a paltry 100 years or so. Today we are approaching or have reached what is called "Peak Oil".
It is important to realize that "Peak Oil" does not mean that we are running out of oil. It just means that from now on we will NEVER have more to use each day than we do now. Think about that. From now on and forever (until there is an alternative) you must use no more oil than you use now. Oh and as population goes up, you will actually get a little less each day!
And, also at some point in the near future, world production will start to go down, so we will each have even less to use each day. Doesn't sound too great does it? Well actually it gets worse. You see some of your neighbours who up until now have actually used very little oil (think China, India, etc) can now afford to buy more. In fact, they are willing to pay more than you are paying to get it. So....do you match their offer, or do you make do with less? If you decide to do with less, how much less and how do you adjust?
America's position (and yours too):
While you may not think that you use unreasonable amounts of oil, consider the following. Americans with 5% of the world's population use 25% of the world's oil. To put it another way, on average, every 100 Americans use 7 barrels of oil every day. In the rest of the world, all together, every 100 people use 1 barrel of oil every day. So on average, each other non-American on the planet uses only 1/7 of what you do!
Now let's look at what happens if one group wants to use more oil than it is using now. If Americans want to use more they need to get some from the 1 barrel per 100 folks oil. If the Rest of the World (ROTW) wants to use more they need to get some of the American's 7 barrels per 100 oil. It should at least be obvious that it will be more difficult for Americans to increase consumption that for the ROTW to do so.
America used to be self sufficient in oil. It produced all that it used. But the funny thing about oil is that there is only so much in the ground. Once its gone, it is gone. Way back in 1972 America produced the most oil it had ever produced. Since then production has steadily dropped (that was America's Peak Oil year) and dropped. Of course that would have been fine if what we used had also decreased - but it hasn't. It has kept going up. So...America has been importing more and more oil to make up the difference. And so each year the amount imported had to go up. This year the US will import fully 60% of the oil it uses! So if we go back to example above, of the 7 barrels each 100 Americans use every day, more than 4 of those barrels are bought on international markets from our foreign friends and imported (and we send the money to them).
Who else wants the oil and why?:
An easy question to answer. Just about everyone wants more oil. I have spent a lot of time traveling in developing countries and I can tell you every one would like more, if they could afford it. Once people get a bit of money one of the first things they buy is a small motorcycle. If they get a bit more a couple of families may share a car (you would not believe how many people you can get into a sub-compact if pressed, and the alternative is walking.) Then with more money, air conditioning would be real nice, especially when temperatures hit 110 degrees in the shade.
Remember the vast majority of folks on this planet do not have these "basics". Now in order for them to get them, they need to use some of the oil Americans are using (remember there are no more supply increases). The only question is how much can they pay vs. how much can Americans pay? Remember also they may only want an extra gallon or two so it won't cost each of them that much, but there are a lot of them (20 of them for each one of you!).
Interestingly the Chinese are being the most "strategic" about getting access to oil. While the US spends a fortune on fighting oil wars, the Chinese simply go in and buy up the oil, in advance. The Chinese have lately made long term oil supply deals with the Iranians, bought sizeable assets in Russia, been talking to Canadians about the oil sands, tried to buy a US major oil company, and completed a number of other smaller, less visible deals.
It is as if in our opening example, 4 of the 25 drivers had a side deal with the gas station owner in advance. As a result, there is now only enough oil for 6 more cars for the remaining 21 people! The competition just got more intense. The price probably also just went up even higher.
(As an aside there is a wonderful quote from Sun Tzu's Art of War - "the height of skill is to win without fighting" - man could we learn a few lessons by reading that book)
Impact on America
I don't think it is possible to underestimate the impact of this on America. Unlike any other nation on earth, America has literally been built on the assumption of cheap energy. That is why many (but by no means, not all) Americans can drive gas guzzlers, commute 100 miles to work, live in monster homes, transport goods primarily by truck and run air conditioning while the rest of the world looks on with a mix of envy and horror.
If America was still producing all its energy, it might have been able to maintain its lifestyle. If America had managed to find alternative cheap energy sources, it might have been able to maintain its lifestyle. If America was the only country on the planet it probably could have maintained its lifestyle a lot longer.
So far the US still has a relatively valuable currency, but as we have seen in previous diaries, this is likely to change and when it does and the US dollar drops, America will find it even harder to afford the cost of imported energy. The less valuable US dollar will have to compete with the more valuable Yen or Yuan or Euro, making it harder for Americans to match the prices the others are willing to pay.
It is hard to imagine how there will not have to be changes as America either starts to use much less oil and or has to pay much more for it. Think how your life will change, how it will change for the company that you work for, for your neighbors. Now the changes don't have to be major at first, and they may not be. A little recession will drop demand temporarily, also dropping prices, temporarily. But in the future, we will use less energy, and we will pay more for it. It will never go back to how it was. (unless we find an alternative cheap energy source that is) You might want to start thinking now about how in the future you will live using 10% less energy, 20% less, or even 30% less.
Addendum:
The other Energy Crisis - Natural Gas.
We have talked here about oil, but natural gas is probably the energy source that will get the most press over the next few months (over 50% of Americans heat their homes with NG). As a first point it is important to realize the difference between oil and natural gas. Oil is a commodity that is shipped around the world. Anyone can bid for it, all you need to do is pay the highest price. Natural gas though is a local North American market (at least until NA gets more into liquefied natural gas). Almost all the gas that the US uses is homegrown or imported from Canada.
Why is this important? Well...Rita and Katrina did a very nice number on Natural Gas production in the Gulf of Mexico, which just happens to be where 25% of the US's gas production comes from. Now most of the media focused on flooding and refineries etc. and almost totally ignored natural gas (due to pure ignorance I believe). In fact, Rita and Katrina acted like bowling balls knocking out rigs and platforms throughout the Gulf and along the coast. Not only was there extensive damage to existing production, the hurricanes also destroyed drilling rigs, and have made it much more unattractive for oil companies to drill further in the Gulf (higher costs, shortage of drilling equipment and increased insurance rates).
Yesterday Natural Gas prices hit an all time record. A few years ago you could get gas for about $2-3 per 1000 cubic ft, last year it was around $6. Yesterday it was $15! Unless you are lucky enough to have signed up for a long term gas contract you are looking at a huge increase in what you will have to pay to heat your house,. Not only that, but many utilities also use natural gas to generate electricity, so you can expect your electric rates to increase too.
Can it get worse? It all depends on how much people cut back on how much they use. There is no doubt that there will be less gas to use this winter than there was last year. So again the question is who gets the limited supply. Do we ration it (not a good idea) or do we let prices climb until enough people don't want it that there is enough to go around?
Clearly it would make immense sense to start a crash conservation program NOW with a target of dropping demand by 10% NOW! (But since when is common sense involved in anything anymore). This program would do three things.
a) It would signal the market that something was being done on the demand side.
b) Less demand and the signal to the market would mean lower prices
c) Lower prices would ensure that more people could get the gas they will need this winter.
Conclusion:
There is a slowly developing mega crisis in natural gas. Make sure you are prepared. Start putting away some cash for those winter heating bills because they could well be be much higher than you expect.