Despite recent fall, oil prices will touch $100 per barrel again

light-diesel-oil-250x250Vivek Kaul

This column should complete the trilogy of columns on the price of crude oil. In yesterday’s column I had argued that it is difficult to predict which way the price of oil would go in the short-term, even though it seems that it will continue to remain low.
The more important question is which way the price of crude oil will go in the long term. While exact forecasting is risky business, the direction of the price rise can be predicted especially when structural factors are at work.
Nevertheless, before we get around to doing that, we first need to understand why is oil so important for the progress of human civilization. As Jeremy Grantham of GMO puts it in a newsletter titled
The Beginning of the End of the Fossil Fuel Revolution (From Golden Goose to Cooked Goose: “The quality of modern life owes almost everything to the existence of fossil fuels, a massive store of dense energy that for 200 years had become steadily cheaper as a fraction of income. Under that stimulus, the global economy grew ever larger.”
By fossil fuels Grantham means coal and oil. But what is it that makes oil so important? Grantham explains it through an example of one of his sons who is a forester. Grantham talks about a situation where wood is needed for heating purposes and hence, trees need to be cut. This can be done by hiring local labour who will use their axes to cut trees, and paying them a respectable minimum wage of $15 an hour. The other option is to fill a chainsaw with a gallon of gas and use that to cut trees.
As Grantham writes: “One of my sons, a forester, tells me he could cut all day, 8 to 12 hours, with a single gallon of gasoline and be at least 20 times faster than strong men with axes and saws, or a total of 160 to 240 man hours of labor. For one gallon!”
If people had to be hired to do the same job around $2,400 (160 x $15) to $3600 (240 x $15) would have to be paid. That’s the value created by one gallon(or 3.79 litres) of gasoline(or what we call petrol in India) which costs around $3 in the United States.
This “surplus value” created by gasoline and other petroleum products were a major reason which helped usher in the industrial revolution in the Western world. Before the world discovered fossil fuels it was totally dependent on wood from trees for its energy requirements.
As Grantham writes in another newsletter titled
Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever: “[Wood]…was necessary for producing the charcoal used in making steel, which in turn was critical to improving machinery – a key to progress. (It is now estimated that all of China’s wood production could not even produce 5% of its current steel output!) The wealth of Holland and Britain in particular depended on wooden sailing ships with tall, straight masts to the extent that access to suitable wood was a major item in foreign policy and foreign wars. Even more important, wood was also pretty much the sole producer of energy in Western Europe.”
Other than being used for making charcoal, wood was also used to power steam engines and for heating purposes. What this meant was that forests were rapidly cut down for wood which was required to produce energy. “Not surprisingly, a growing population and growing wealth put intolerable strains on the natural forests, which were quickly disappearing in Western Europe, especially in England, and had already been decimated in North Africa and the Near East. Wood availability was probably the most limiting factor on economic growth,” writes Grantham.
If the world had not discovered first coal and then oil, it would have run out of trees by around 1850, estimates Graham. And there would have been other impacts as well. “By 1900 wars would have been fought over forests, and the population – without oil-intensive agriculture, both for growing and transportation – would have peaked out probably well under two billion and our species would indeed have had its nose pushed up against the limits of food,” writes Grantham.
That is the importance that fossil fuels, in particular oil, have had on the human civilization over the last two hundred years. So, it is important that the world continues to have access to “cheap” oil. But will that be case?
As Niels C. Jensen writes in
The Absolute Return Letter for January 2015 titled Pie in the Sky: “The world will still run out of cheap oil (cheap as in approx. $25 per barrel of production cost, as is currently the average production cost in the Middle East) over the next decade or so. It is hard to predict exactly when, because OPEC members are not the most informative people in the world.”
This, despite the fact that over the last six to seven years the world has managed to increase the production of shale oil. In the United States oil production has gone up by 4 million barrels per day to 9 million barrels per day and almost all of it has come through shale oil production.
Even with this, the future does not look very encouraging. And there is a reason for the same. As James K. Galbraith writes in
The End of Normal: “There is no doubt that shale is having a strong effect on the American economic picture at present…But the outlook for sustained shale…production over a long time horizon remains uncertain, for a simple reason: the wells have not existed long enough for us to know with confidence how long they will last. We don’t know that they won’t; but also we don’t know that they will. Time will tell, but there is the unpleasant possibility that when it does, the shale gas miracle will end.”
Grantham goes into detail about the point that Galbraith makes. The process used to drill out shale oil is referred to as fracking. As Grantham points out: “The first two years of flow are basically all we get in fracking…Because fracking reserves basically run off in two years and can be exploited very quickly indeed by the enterprising U.S. industry, such reserves could be viewed as much closer to oil storage reserves than a good, traditional field that flows for 30 to 60 years.”
Hence, shale oil will be what Jensen calls a “relatively short-lived phenomenon”. It is not replacing cheap traditional oil which is becoming more and more difficult to find. “Last year for example, despite spending nearly $700 billion globally – up from $250 billion in 2005 – the oil industry found just 4½ months’ worth of current oil production levels, a 50-year low!,” writes Grantham.
Hence the oil industry in the “last 12 months” has replaced “only 4½ months’ worth of current production!” This, despite the boom in shale oil production.
What this clearly tells us is that the recent fall in the price of oil is at best a temporary phenomenon. Over the long term, oil prices can only go up. As Jensen puts it: “we will see the oil price at $100 again, and it won’t take many years, but it could be an extraordinarily bumpy ride.”
Meanwhile,watch this space.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 14, 2015

The ten best Nonfiction books of 2014

single-man-coverVivek Kaul

It is that time of the year when media houses go around writing about the best of the year that was. Given this, I thought it would be an appropriate time to put out a list of what I think are the best nonfiction books that I read in 2014. The list is biased to the extent of what I read, which are basically books in the area of finance and economics. Also, some of the titles were released earlier and I only happened to read them in 2014. The books are listed out in a random order. So here we go.

Saving Capitalism from the Capitalists by Raghuram Rajan and Luigi Zingales: I had read this book when it was first published in 2003. At that point of time I was basically trying to figure out what to do with my life, having finished an MBA in information systems in 2002 and at the same time having realized that the MBA degree was one big con job. In 2014, the book was published again with a new afterword. I read it again and appreciated the book much more than I had done in 2003. The book is a great read for anyone who believes in the idea of free markets. It tells you loud and clear that the incumbent capitalists are the greatest enemies of the free market. The book also helped me understand why so many big businesses in India manage to default on their bank loans without the industrialists having to face the consequences of the same.

After the Music Stopped by Alan S Blinder: This book was published in 2013, but I happened to read it only this year. The best books on historical events are written many years after the event has happened. Take the case of what I think is the best book on the Great Depression—The Great Crash 1929, written by John Kenneth Galbraith. The book was first published in the mid 1950s almost quarter of a century after the Depression started. One possible explanation for this is the fact that writing many years later, the author can leave out all the noise and concentrate on the most important issues. Over the last six years many books have been written on the financial crisis, but After the Music Stopped, in my opinion is perhaps the best book on it. It summarises the economic, the political as well as the legal angles of the financial crisis very well. If you are looking for a ready reckoner on the financial crisis, this has to be your go to book. Capital in the Twenty-First Century by Thomas Piketty: This was by far the bestselling title in economics during the course of this year, having been the number one book on Amazon.com for a while. It is very rare for an economics book running into 700 pages to be number one on Amazon. In this book the core argument offered by Piketty, who is a French economist, is that capitalism has led to greater inequality among people over the years. Piketty offers a lot of data from the developed countries to make his point. The book did not go down well with the American economists, and after it appeared many of them tried to discredit it by trying to find mistakes in the data and methodology used by Piketty. Who is right and who is wrong is too long a debate to get into here. Nevertheless, Piketty’s book remains a must read for the fantastically lucid way in which its written and the several original ideas that it offers. The Dollar Trap by Eswar S. Prasad: The United States is in a huge financial mess. Nevertheless, dollar remains the go to currency of the world at large. Whenever there is a whiff of a crisis anywhere in the world, money is pulled out and moves to the dollar. Ironically, even when the rating agency Standard and Poor’s cut the rating of the debt issued by the United States government from AAA to AA+, money moved into the US dollar. Prasad explains this “exorbitant privilege” of the dollar and the reasons behind it. While the US may not be in a great financial shape, but the world at large still has faith in the dollar. Prasad summarizes the situation well when he says: “It is possible that we are on a sandpile that is just a few grains away from collapse. The dollar trap might one day end in a dollar crash. For all its logical allure, however, this scenario is not easy to lay out in a convincing way.” The book is a great read for anyone trying to understand one of the most fundamental disconnects of the times that we live in. Flashboys by Michael Lewis: No one quite writes about finance like the way Lewis does. From his first book Liars Poker to the latest Flashboys, each one of his books on Wall Street and its ways has been a bestseller. One reason for the same is the fact that Lewis started as a Wall Street insider in the investment bank Salomon Brothers (which has since gone bust) and has managed to maintain his contacts since then. Flashboys is essentially a story of the people and systems that make up algorithmic trading that has taken Wall Street by storm. A majority of the trades on Wall Street are not driven by humans any more. They are driven by computers with a lot of processing power. And that is the fascinating story of Flashboys. If you are the kind who likes reading thrillers over weekends, this is just the right book for you.

Business Adventures by John Brooks: I first discovered Brooks in the process of writing and researching my books. Someone suggested that I should be reading Brooks’ version of the Great Depression called Once in Golconda: A True Drama of Wall Street 1920-1938. The book was a fantastic read and made me realize that Wall Street had a Michael Lewis even before the real Michael Lewis appeared on the scene. Early this year, Bill Gates wrote a blog on one of Brooks’ other books called Business Adventures. He called it the best business book that he and Warren Buffett had ever read. This blog pushed the book to the top of the Amazon charts. It was re-issued after this. The book is a collection of twelve long articles that Brooks wrote about the American businesses, government as well as Wall Street, for the New Yorker magazine. And it has tremendous lessons for almost everyone connected with business and finance.

Single Man—The Life & Times of Nitish Kumar of Bihar by Sankarshan Thakur: This book is the joker in the pack. In a list full of books on economics and finance, here is a book on politics. Having been born in erstwhile Bihar, I have always been interested in the politics of Bihar. And there is no better writer on Bihar in English than Thakur, who works as a roving editor for The Telegraph newspaper. Thakur chronicles the rather turbulent life of Nitish Kumar, starting a little before the Emergency, and goes on to chronicle the life of the Bihari politician over the next four decades. As he does that he also goes into the history of Bihar over that period. Unlike a lot of other biography writers, Thakur also goes into Kumar’s unhappy personal life. The book is an excellent model for how to write a biography of an Indian politician. What we normally get to read are either hagiographies or out and out criticism (as is the case with so many books on Narendra Modi which swing at both ends). There is rarely a biography of an Indian politician which takes the middle path. If I had to choose just one book to read this year, then Single Man would have to be it. And this would be more for Thakur’s andaz-e-bayan(the way he tells the story) than Kumar’s story per se. How Not to Be Wrong—The Hidden Maths of Everyday Life by Jordan Ellenberg: This is another joker in the pack. I absolutely love to read good books on Mathematics. Ellenberg in this book goes around explaining the practical aspects of Maths in everyday life. He explains in great detail how media often uses Maths incorrectly to draw wrong conclusions. He also tries to answer some really interesting questions: How early should you get to the airport? What’s the best way to get rich playing a lottery? And does Facebook know you are terrorist? If you are feeling a little adventurous and want to go a little out of your comfort zone, this is just the right book for you.

The End of Normal by James Galbraith: I am reading this book currently and am around half way through it. James Galbraith is the son of John Kenneth Galbraith, who I feel was one of the most lucid writers on economics that the twentieth century saw. Galbraith junior writes in the same lucid way as his father did. Since the financial crisis broke out, economists and politicians have tried to tell the world at large that “all is going to be well,” and that the financial crisis was just caused by bad policy and bad people. Galbraith challenges this world view and offers four reasons against it: the rising cost of real resources, the futility of military power, the labour saving consequences of the digital revolution and the breakdown of law and ethics in the financial sector. Long story short: The global economy will not see acche din(good days) any time soon. Hormegeddon—How Too Much Of a Good Thing Leads to Disaster by Bill Bonner: The regular readers of The Daily Reckoning would know by now that this has been one of favourite books of the year, given the number of times I have already quoted from it in my columns. I have been a big fan of Bonner’s writing since I first met him in late 2008. In this book Bonner goes about explaining how too much of a good thing in public policy, economics and businesses, leads to disaster or what he calls FUBAR (f***ed up beyond all recognition). Bonner offers many examples from history to make his point—from Napoleon’s decision to invade Russia to the outbreak of the Second World War to America’s War on Terror. He then goes on to show that these disasters cannot be prevented by well-informed people with good intentions because they are the ones who cause them in the first place. 

So that was my list of what I thought were the ten best books that I read this year. Happy reading. The India edition of The Daily Reckoning will be taking a year end break and will be back early next year on January 3. Here is wishing you a Merry Christmas and a Happy New Year. Meanwhile you can continue reading the international edition of The Daily Reckoning authored by Bill Bonner. The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 24, 2014