“The smart man learns from the mistakes of others, the average man learns from his own mistakes and the idiot doesn’t learn from either.” – Syrian Proverb
Crude oil is an amazing substance.
It is extremely energy dense, meaning that the energy that can be obtained from a barrel of crude is in excess of the energy that can be obtained from a barrel of almost anything else.
It is easily stored and does not degrade over time. You can put crude in an unpressurized tank in the back yard and come back 50 years later and it will still be there and still be ready to refine.
You can move crude around easily. You can send it through a pipeline or put it on a ship, airplane or truck.
Crude oil can be refined to suit the demands of the economy. A barrel of crude can be refined into various proportions of gasoline, kerosene, diesel, jet fuel, etc.
Oh and I almost forgot, our entire way of life is based on crude oil.
When the subject of energy comes up most people think only of cars and gasoline. Anyone who expands the discussion to home heating/cooling is typically thought of as a deep thinker.
The reality is that everything we depend on for modern life is based on oil.
Our food is grown using significant inputs of hydrocarbons for the fertilizers, pesticides and machinery. This food is transported an average of 1,500 miles before it is consumed. Large scale commercial food production and distribution would not be possible without fossil fuels. In short, the supermarket would be empty without crude.
Modern pharmaceuticals would not be possible without petroleum. Hydrocarbons are used to synthesize many of the life saving drugs we have today. This simply means that scientists find the hydrocarbon molecule chains very convenient to use as a building block in creating new compounds. Without petroleum we wouldn’t have modern pharmaceuticals.
Suburban life does not exist without abundant supplies of crude. It takes an extraordinary amount of energy to live a suburban lifestyle. Low density housing, each with its own heating and cooling systems coupled with an extreme dependence on the car create an enormous demand for energy. Without abundant supplies of crude, many of us would be living in apartment blocks.
After all this has sunk in, the natural reaction would be to ask, “So how much oil do we have left?” This topic is open to debate and there are many people who think they know and many others who claim no one knows, but one thing is for sure.
Oil production is under pressure.
We know that it’s getting harder and harder to find new oil fields and those that we do find are extraordinarily difficult to extract. Take the recent discovery of huge new oil field off the coast of Brazil. According to the New York Times, in order to extract the oil from this field:
“Engineers will have to drill up to 16,000 feet below the sea floor through salt and rocks, in water depths of up to 10,000 feet, an undertaking that is at the frontier of the industry’s technological ability, according to PFC Energy, a consultancy in Washington.
In addition, many estimate the extraction project to cost hundreds of billions of dollars and span 50 to 100 years.
Are the days of cheap abundant energy over?
Is there an alternative?
Many people has focused on the so called “Green Technologies” as an alternative to crude, but given what we have described above regarding the many advantageous properties of oil, none of the “Green” alternatives can possibly be a replacement. Nor can a combination of “Green” technologies replace crude oil.
So where are we going with this? Is this a post Halloween scare attempt?
Not at all. It’s simply another discussion on business planning. Consider the following questions:
- How viable is a 12,000 mile long supply chain with oil at $150? How about at $200?
- Is your supplier base broad or does it consist entirely of companies located in East Asia?
- Even if inventory is procured domestically, will a just in time inventory system remain viable given transportation costs and potential disruptions.
- Will this open the door to domestic manufacturing?
- If energy prices become more volatile, oscillating between $70 and $250 per barrel for example, what will that mean for pricing, procurement, cash management, etc.
Many companies have based their long range business planning on relatively cheap and stable oil supplies. This is a key assumption. If energy prices were to become more volatile with a longer term upward trend it would pose an existential threat to many business models. On the other hand, it may also create an opportunity for many business models long considered not viable.
In the past 20 to 30 years we have seen a secular trend towards deindustrialization, dependence on imports and larger homes and cars. This paradigm, of course, depends on cheap and abundant energy.
Amongst those who are not under the continual influence of psychotropic drugs (again created from hydrocarbons), the debate is no longer if this is sustainable but rather how much longer this can be sustained.
If our current economic structure cannot be sustained why aren’t we doing something about it? Isn’t this too obvious? Why wouldn’t our brilliant economists be warning us about such an epochal shift?
“Be careful, too, of the so-called science of economics. Economists have been no better in their predictions than cab drivers.”, says Black Swan author Nicolas Taleb.
The current orthodoxy amongst economists is that things are on their way back to normal. Normal being defined as the unsustainable pattern outlined above.
This reminds me distinctly of the assurances made by economists and politicians that everything would shortly go back to normal during the early years of the Great Depression.
Have a great week,
Michael Bechara, CPA
Granite Consulting Group Inc.