An Easier Solution

This note was originally published at 8am on March 08, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“At the end of this decade, in the year 1980, the United States will not be dependent on any other country for the energy we need to provide our jobs, to heat our homes, and to keep our transportation moving.”

- Richard Nixon, 1973

The current obsession in the US with energy independence is not a new one.  Richard Nixon, quoted above, embarked on “Project Independence” after the 1973 OPEC embargo led to a world oil crisis; nearly every president since has set a similar goal – none have come close to reaching it.  In 1973 the US imported 34% of its consumed petroleum; today, we import 45%.

In a speech yesterday, President Obama summarized his broad energy plan, “If we are going to control our energy future, then we’ve got to have an all-of-the-above strategy.  We’ve got to develop every source of American energy -- not just oil and gas, but wind power and solar power, nuclear power, biofuels.”

That sounds like a pretty good idea, particularly as prices at the pump have ripped to an all-time high for March, $3.76 per gallon.  As a direct result, gasoline consumption has fallen to the lowest level in over a decade, and is running 6.5% below last year’s level.

While energy independence is not an original idea, is it more realistic this time around?

It’s key to understand that the US does not have an energy crisis – it has a liquids fuel shortage.  71% of the petroleum consumed in the US is by the transportation sector; only 1% is used to generate electric power.  The US is actually abundant in its two largest power-generating sources, coal and natural gas, with the 1st and 6th largest recoverable reserves in the world, respectively.

Currently, solar and wind can only be used to generate electricity, so it is difficult to see how developing these renewable sources will lower gasoline prices or make us any more energy independent.  Further, because of issues with intermittency (the sun shines during the day, the wind blows at night, and the energy cannot be stored), low electricity conversion rates, large space requirements, and higher-than-expected operating and maintenance costs, solar and wind are simply not economic.  Even with government subsidies and private investment, the EIA estimates that solar will generate less than 1% of US electricity in 2035.  Solyndra…?  First Solar…?

Nuclear power, like solar and wind, can do very little to solve our liquids fuel shortage, as 100% of nuclear energy generated in the US is for electricity.  Regardless, there has been almost no new nuclear construction in the US in the last 30 years because of rising capital costs and risks, particularly after the nuclear disasters of the 80’s.  It is puzzling why President Obama is intent on revitalizing nuclear in the US only months after Japan’s Fukushima disaster.  And nuclear power is hardly a domestic resource – the US imports more than 80% of its required uranium.

Ethanol and biodiesel supplied 0.5% of the world’s primary energy in 2010; but increasing biofuel production comes at the cost of the world’s food and water supply.  If the US were to use its entire corn harvest to produce ethanol, it would only replace 8% of the country’s annual gasoline demand.  Cellulosic ethanol (ethanol produced from agricultural waste) has less of an impact on the world’s food, water, and fertilizer sources, though is challenged by extraction and aggregation costs as well as low energy density.

This is not a smear campaign against alternative and renewable energy sources.  With investment and time, technologies that are not currently economic, viable, or scalable one day will be, lessening our need for petroleum fuels.  The US should invest more (wisely) in energy R&D, starting with natural gas vehicles and the necessary refueling infrastructure.

But energy transitions take time.  Not years – decades, perhaps even generations.  Natural gas took 60 years from the time it was first commercially extracted (1870s) before it was 5% of the world’s primary energy market.

President Obama stated earlier this week that, “Folks are getting killed right now with gas prices.”  Touting alternative energy does nothing to fix that; neither does blaming rising oil prices on tensions in Iran, growth in China, and those pesky Wall Street speculators.  The only legitimate way to lower gasoline prices in the immediate term is the one that most of our leaders never consider: raising interest rates.

Near-zero interest rates and massive liquidity injections from the developed world’s central banks have driven investors into real assets, like oil and gold, in an effort to preserve purchasing power.  Net length among non-commercial traders in NYMEX crude oil futures and options is 333,000 contracts, nearly double the July 2008 high of 170,000 contracts when oil spiked to $145 per barrel.  In 1991, there were 3.3 dollars of money supply to every 1 barrel of oil; today there are 7.1 dollars chasing that 1 barrel.  And while the price of gasoline in dollars has increased 95% since March 2009, gasoline priced in an ounce of gold is only +7% over the same period.

Many factors influence the price of oil – supply, demand, geopolitical risk – but monetary policy is really the only one within the US’s control, and that policy cannot be any more inflationary for the price of petrol.  Recognition of such would be a refreshing dose of accountability; it would also give consumers a much-needed break at the pump.

Our immediate-term support and resistance ranges for Gold, Brent Oil, WTIC Oil, Natural Gas, US Dollar Index, and the SP500 are now $1693-1725, $123.31-126.81, $106.13-109.22, $2.21-2.39, $79.36-80.21, and 1345-1363, respectively.

Kevin Kaiser

Analyst

An Easier Solution - EL chart

An Easier Solution - vp 3 8