BET ON STUFF

This article originally appeared in the July, 2009 edition of the Casey Report.

In 2008, prices of oil, natural gas, gold, silver, copper, corn, wheat, and most other commodities reached multi-year, and in some cases multi-decade, highs.They've fallen sharply since then, but commodities aren't going out of business. Another peak is coming, and it will be far higher, especially for oil.

The price run-up to 2008 came as a debt-induced economic acceleration in the developed countries sucked in imports from the emerging economies of Asia. Virtually all the world was gobbling up commodities, but supplies were still choked by the preceding decades of underinvestment in mine development, processing plants, pipelines, railroads, and other elements of the industrial infrastructure needed for producing and transporting raw materials.

The decades of low oil prices shown in the chart meant minimal exploration and little investment to develop existing fields. The price surge in 2007-2008 did give an enormous boost to drilling, but the boost was short-lived. This year's collapse in oil prices to $35 a barrel compelled oil companies to cut the number of rigs in service, consolidate operations, lay off workers, and delay or cancel projects. The atrophy in production capacity and the credit crunch's impact on exploration are setting the stage for a dramatic price rise.

That's oil, but you could say more or less the same about most commodities. For oil, however, there's more to the story. Four factors are now at work to make oil the price leader in the next commodity boom.


Factor # 1: Peak Oil

William Cummings of Exxon Mobil tells us, “All the easy oil and gas in the world has pretty much been found. Now comes the harder work in finding and producing oil from more challenging environments and work areas.” That's about as cheerfully as the harsh reality can be put. After 150 years of harvesting the Earth's “low-hanging fruit,” new supplies of oil are going to be progressively more difficult to find, and most of what is found will be expensive to exploit. That by itself means higher prices.

Mexico is a stark example of Peak Oil. Virtually all Mexican output comes from Cantarell, in the shallow waters of the Gulf of Mexico. It's the second largest oil field in the world and is run by the state-owned Pemex.

When Cantarell was discovered in 1977, it held 17 billion barrels of oil. Since then, the Mexican government has been spending the oil revenues for the benefit of the “right” people and for the all-important project of holding on to power. Pemex isn't a sideline for the Mexican economy; it provides 40% of all revenue the government collects.

The state is so dependent on oil revenue that Pemex built a nitrogen-injection project to push the oil out faster. It worked, but at a price. In 2004, production rose to 2.5 million barrels per day. But it's now declining at a rate of 15% per year, and the decline is irreversible. Mexico won't be an oil exporter for long.

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