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Mad Hedge Fund Trader

Mad Hedge Fund Trader

John Thomas, The Mad Hedge Fund Trader is one of today's most successful Hedge Fund Managers and a 40 year veteran of the financial markets.…

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The Resurrection of Peak Oil

It has been a long wait for “peak oilers,” whose passionate belief is that the world will run out of oil in coming years, sending prices through the roof.

This splinter religion came into being in 1956 when M. King Hubbert produced some simple supply/demand charts showing that US reserves of Texas tea would dry up by 1965-70, forcing a heavy reliance on imports with which we have become all too familiar. This was later expanded globally, implying that Western civilization would come to a grinding halt.

Proven Reserves

It all seemed very prescient, when in 1973 OPEC raised prices from $3/barrel to $12 in the wake of the Yom Kippur war, and the resulting boycott caused enormous lines at American gas stations. It happened again in 1979 with the fall of the Shah of Iran, taking crude from $12 to $40. Then Saudi overproduction kicked in big time, bring 20 years of falling prices, all the way down to $8. At the 1998 low, oil was selling for less than the barrel that contained it.

Then came China and the commodities boom, which suddenly sent the value of all things “hard” skyward. Virtually overnight, the Middle Kingdom became the world’s largest marginal consumer of not only oil, but all energy sources. By 2008, peak oilers had the second coming in sight, with prices soaring to $150/barrel.

Oil Consumption

Enter the Great Repression. The real damage this caused was not the temporary collapse of prices down to $28/barrel and the wiping out of many industry participants. It was the two year freeze on the financing of new exploration and development, a byproduct of the Wall Street crash. BP’s Gulf oil spill didn’t help matters either. These events have combined to create a bubble in the energy pipeline, the implications of which we may only just now be seeing.

World Population

Now the Middle East is blowing up. With populations exploding, per capita incomes plunging, and a religion that mires them in the 14th century, this sort of viral, grass roots revolution could have, and should have happened any time over the last 40 years. It took cell phones, social media, and the Internet to provide the spark. At first, the world didn’t care, as Egypt and Tunisia produce little oil, and are non-factors in the global economy.

Now it’s Libya’s turn, and it’s a different kettle of fish. Having dealt with the Libyan government myself since 1968—Muammar Khadafi overthrew the government just before I was about to cross the border —I can only say this couldn’t happen to a nicer guy. I missed the Pan Am flight he blew up over Lockerbie, Scotland by a week and lost a few friends. The sooner he is found hanging by his heels from a lamp post, the better.

The revolution there raises broader, far more concerning questions. If it can happen in Libya, why not in Saudi Arabia, where the government is still essentially tribal in nature and will not be winning any prizes for their human rights record anytime soon. Women are still not allowed to drive. Take their 12 million barrels/day off the market, even for a few days, and the geopolitical implications are large.

Obama & Saudi 

Which brings me back to peak oil. After a quiet, long term downsizing, the US now only imports 2 million barrels a day from the Middle East. Canada is now our largest foreign supplier, followed by Mexico and Venezuela. But oil is a globally traded commodity, and if you prick the supply line in one place we all have to pay. Remove Saudi Arabia from the picture, and the results could be catastrophic, for China first, but for ourselves as well.

Even without these “Armageddon” scenarios, we are still facing a huge problem. World oil production today is 82-83 million barrels/day. There is probably another 5 million barrels/day in reserve. By 2015, an additional 3 million barrels/ day in will come on stream that was financed prior to the Wall Street melt down. After that, new supplies become very problematic.

Light Crude

Even if the US can keep its own demand relatively flat through modest economic growth, conservation, new efficiencies, alternatives, and switching to natural gas, China promises to eat up all of this increase. That’s when the sushi hits the fan. I think oil could hit $300/barrel by 2020, or $225 in today’s prices. If you are wondering why I have become so cautious about investing lately, this is a major reason why.


Which leads us all to the bigger question of how do we make a buck out of all of this? Brent crude, which trades in Europe, is already at $104.40/barrel, a $12/barrel premium to our own West Texas intermediate. Prices here have stayed low because of a shortage of storage facilities. My buddies in the field also tell me there is some elaborate conspiracy to keep West Texas artificially low, because the prices for Middle Eastern imports are priced off of that highly manipulated benchmark. It is far more likely that West Texas trades up to Brent than the other way around.

I missed the window to get in last week at $85/barrel. But if you believe it’s going substantially higher, it is not too late to get involved. For a start, do not buy the oil ETF (UNG). The tracking error caused by the contango will kill you, assuring that you will take all of the risk but get few of the benefits.

Individual oil major stocks that I have been recommending, like ExxonMobil (XOM), BP (BP), and ConocoPhillips (COP) are great vehicles. A simple alternative is to pick up the double long oil majors ETF (DIG). These guys have massive  supplies in the pipeline that are about to be revalued by higher prices. So are independents like Occidental Petroleum (OXY). You can throw oil service companies into the mix as well through the ETF (OIH). Higher oil prices almost make alternative energy producers like First Solar (FSLR) much more profitable.

As (OXY) founder, Dr. Armand Hammer, told me when I was a kid, “Keep your eye on oil, because everything stems from that.” Some 40 years later, and I think the old man is still right.

By. Mad Hedge Fund Trader

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Leave a comment
  • Anonymous on February 22 2011 said:
    Political peak oil is almost as good as the real thing. Except that it isn't permanent like real peak oil would have been. More like a bubble. But one could still make money off a bubble, as long as he recognized it as such.
  • Anonymous on February 23 2011 said:
    My view is that its a combination of blowback from US foreign policy for the past 40-50 years, genuine imbalances in population growth and management in certain countries and absolute stupidity on the part of western civilisation.Firstly, a very beneficial relationship was broken with the industrial hemp plant. That was certainly a strategic masterstroke. Why is it that no-one in any government worldwide has utilised industrial hemp on a serious scale to provide extra resources and diversity for industrial societies? Its a potentially fatal mistake to put all eggs on one basket - crude oil.Why would any country wish to see itself exposed to vulnerability by being too dependent on oil. Even as an emergency measure, industrial hemp could prevent unecessary human cost in the event of oil shock.Watch Italy. ENI supported gadaffi for a significant time, and italy relies on libya (or did) for 20% of supply
  • monk on January 18 2012 said:
    Oil production has been in plateau since 2006. This was confirmed by BP and the IEA several months ago. Several banks, insurance companies, military forces, etc., argue that production may start dropping soon.
  • What on January 22 2012 said:
    Peak oil is here. The cheap oil is gone! We are not running out of oil, we are running out of cheap oil. We now know that the world can not handle a price of $ 148 because then the economy crashes.
  • MrColdWaterOfRealityMan on February 02 2012 said:
    It looks like we have 40 years of oil that's energetically and economically profitable enough to keep our economy running in some form or fashion. The issue is not oil, per se. It's oil's concentrated used in transportation and the world's dependence on "just-in-time" supply chains that is our Achilles heel. When oil becomes expensive enough and has a low enough energy return, supply chains based on the premise of cheap transportation and cheap oil can't be maintained, including the supply chains that maintain energy supplies (oil and otherwise). At that point, a cascase failure of interlocking supply chains causes an economic crash that happens suddenly, and from the point of view of anyone alive today, permanently.

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