Think of this as Volume 17, Number 38 of the newsletter I have written weekly since March, 1997. Enjoy.
The idea of an energy glut is so fantastic, so far outside normal business experience, as to be inconceivable, he told me. Especially given the millions now entering the global middle class in India, in Africa, and in Latin America. Of course they'll want TVs and cars and the other trappings of American life. They will compete financially to get them. And that will keep energy prices high for at least a decade.
But the U.S. is already in an energy glut. Natural gas prices here remain stubbornly below $4/mcf. The “spread” between U.S. oil prices and global prices narrowed to a few dollars recently, but has since expanded again. And E85 ethanol (which actually contains just 15% alcohol) is priced at nearly 50 cents/gallon below the price of regular gasoline.
Shale technology was pioneered by a man I once interviewed, the late George Mitchell. He explained to me, back in 1980, that conventional drilling only extracted half the oil in a field. New technology could take out half of what remained. He turned out to be right. There are enormous environmental challenges in shale drilling, and the geology of overlying rock structures has yet to be taken into account, but as a base technology it works.
And what works in North Dakota's Bakken, or Texas' Eagle Ford, can work just as well in Saudi Arabia. In theory it can even work offshore, although I think the risks are too great right now to go there. Especially since companies like Norway's Statoil are still finding big pools of oil off the coasts of Canada, and Brazil, and Angola. Especially since Iraq's oil is barely being exploited, and Russia is now using new technology to more fully exploit Siberia.
Critics note that shale drilling carries enormous risks. But here's another hard fact. It's also very expensive. Shale deposits are among the world's most expensive to exploit, exceeded in base cost only by what Canada calls its “oil sands,” which are really just bitumen that factories crush and mix with natural gas liquids before dumping on hard-pressed refineries. It's low quality, and carries a low price – margins are already razor-thin.
Afeyan and I talked mainly about a company he's backing, called Midori Renewables. Midori says it has a biocatalyst that can extract sugars from any cellulosic fiber for pennies per pound. In theory, my son the chemistry student explained, it's really pretty simple, since cellulose and sugar consist of the same chemical compounds – break the bonds of cellulose, as your own body breaks the bonds of starch, and you get sugar, our primary biological fuel.
BiofuelsDigest says “Planet Houston” won't be interested in your biofuel start-up until you can get your costs down well below $3/gallon. They want it to be as low as $2.40. But KiOR, backed by Sun co-founder Vinod Khosla, has already gotten there, and it's producing the equivalent of diesel oil from ordinary pine pellets, in Columbus, Mississippi, at about that price.
Well, you think, if a company like KiOR can make that work, others can too, so the cost of the needed biomass would have to increase. They forget that the Columbus plant is just a demonstration, that KiOR's biocatalysts – like Midori's – can work on all forms of biomass.
Another way to increase the amount of exploitable biomass is to plant something different. New types of castor beans can grow during Brazil's dry season, without fertilizer, during times when the soil is otherwise fallow, and their oil can also be used as fuel. Evogene, an Israeli company, has demonstrated just this.
What happens when you combine cheap cellulosic alcohol, cheaper sugars, and new types of oil-producing crops that don't damage the environment, with markets hungry for new energy? You get even more downward pressure on oil and gas prices.
Every recovery carries within it the seeds of its own destruction. The last recovery was driven by cheap money, meant to hide the costs of an illegitimate war, driving up asset prices and causing banks to offer “liar loans” to millions, around the world. The previous recovery, the Internet boom of the 1990s, was driven by unlimited supplies of new intelligence, which eventually bumped against demand that could not keep up with it. The recovery before that, in the 1980s, was birthed by low oil prices and policies that made money more valuable, becoming vulnerable to the higher prices of a new war and the ability of markets to destroy money on a whim.
Our present path is most like that “stagflation” decade of the 1970s, in which high oil prices caused a boom in places like Houston, where I lived then, and a long-lasting recession in places depending on trade and assets, such as Atlanta, where I live now. Thirty years ago, when I was in the market for a new house in Atlanta, the city was still recovering from the impacts of that real estate collapse, and the previous decade's white flight from the center city, so I was able to get into a lovely home, next to a train station, for under $50,000, and the neighbors thought I was being ripped-off.
But the date I'd left Houston, June 1, 1981, was also the peak of that decade's boom. Interest rates and oil prices were heading down, and the Houston economy would take a decade to recover from the blow.
In other words, energy booms carry within them the seeds of their own collapse. I knew Houston was heading for trouble in 1980, soon after talking with Mr. Mitchell, when I listened to an economist describe how he'd created economic models for that city based on rising, falling, and stable energy prices, with each one showing a recession ahead. No one listened to the warning I gave readers, any more than they listened to me 20 years later, when I warned about the coming dot-bomb.
There is currently an irrational exuberance, across the oil patch, and throughout the energy sector, based on a mistaken assumption that rising supplies will always get their price, whatever it is. This defies economic logic. At some point the fear of downward pressure becomes self-fulfilling.
Most of the oil market consists of untapped reserves, and these reserves are the basis of the industry's economics. They're assumed to be of increasing value, which is why most remain untapped. Even the fear that this may change, that reserves in the ground may be worth a little less next year than they are this year, will be enough to set off a panic.
And that is going to happen. Not this year, not next year, maybe not for another five years. Or, as Afeyan thinks, 10 years. But it will happen, and I happen to think it will be sooner rather than later, because markets are based on psychology, and as we've seen throughout my life investor psychology can turn on a dime.