Read it and weep. Too much evidence worldwide suggests the transition is hairy. India and Pakistan and Canada are already seeing shortages. All we need is a crisis in the middle east to make it official.
While researching his 2004 book, “The End of Oil” author Paul Roberts was allowed to see the Shayba oil field in Saudi Arabia’s “empty quarter.” Full of pride, Robert's Saudi engineer hosts boasted about the remarkable infrastructure built over the Shayba, rattling off a list of impressive production statistics. Saudi oilmen are usually very tight-lipped about their oil data, sanctimoniously guarding their data like state secrets. But this was a new post-911 world, and the Saudis found themselves in an unusual predicament: They needed to convince the US that they were a stable and dependable supplier of oil. Roberts shifted the discussion from his hosts' presentation of the Shayba field, when he asked them about the Qhawar field some three hundred miles to the northwest. Ghawar is by far the largest field ever discovered. From the time it was tapped in 1953 it has contributed roughly one barrel out of every twelve consumed on the planet. Like a proud parent sensing their guest had not fully appreciated the work they had done; a moment of careless bravado took over the Saudi oilmen. Unable to contain themselves, an engineer began to brag about the Shayba while throwing a few pot-shots at the rival operations at Ghawar, “The Shayba is self-pressurized, at Ghawar they have to inject water.” He continued, “At Ghawar the water-cut is 30 percent.” The hairs rose on the back of Roberts’s neck. If true this means that the Ghawar field is much further along the road to depletion than previously thought. Their secret was out.
Although the details are still being argued over, a consensus conclusion, reinforced by the market, is being solidly formed: If peak oil has not already arrived and passed, its arrival is in the very near future. Like the Ghawar field, all the easy oil fields have been found, and have largely begun an inexorable decline in production.
There is something else you should know, if you don’t already, about peak oil.
Once the peak arrives a plateau will ensue while countries and oil companies frantically try to keep production matching demand, effectively accelerating the depletion. The result is not a plateau followed by a gradual decline while we comfortably replace our energy infrastructure; rather it is like falling off a cliff. The decline will be sharp and severe.
In other words, get ready for extreme volatility in the price of oil. While gradually rising oil prices are typically indicative of a healthy economy, as the price continues past a certain level it begins to crush demand, reduce the profit margin of companies, and cripple consumers with higher costs.
Introducing GMO’s Jeremy Grantham.
Besides being one of the world's most respected and esteemed money managers, Grantham has an eerie talent for predicting future levels of returns from a wide dispersion of asset classes that almost borders on the supernatural. He is so good, in fact, that in a 2008 article the Economist heralded him as: “Almost Nostradamus.”
Today Jeremy Grantham is pounding the table about peak oil and resource depletion in general - across all commodities.
“The world is using up its natural resources at an alarming rate, and this has caused a permanent shift in their value." He explains in a recent report, “We all need to adjust our behavior to this new environment. It would help if we did it quickly. But Mrs. Market is helping, and right now she is sending us the Mother of all price signals. The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II.”
This graph illustrates how alarming the situation is with respect to oil.
Grantham goes on to say, “Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution.”
Grantham’s predictions carry even more weight as we today witness the price of oil, temporally held down by the 2009 financial crisis like a beach ball underwater. Now that the forces holding the ball down are abating, we are again seeing an unrestrained price rise as we again approach $100 per-barrel oil that is reflective of the monstrous demand from both the US and emerging markets on a strained supply.
How should investors get ready for peak oil?
It will serve you well to take the advice of Stephen Leeb in his remarkably prescient 2004 book “The Oil Factor, Protect Yourself-and Profit-from the Coming Energy Crisis.” In his book Leeb illustrates the power of using the price of oil as an indicator to get into or out of the stock market. Using Leeb’s oil indicator, (which is as simple as selling stocks when the year-over-year rise in oil prices is 80% or more. And buying stocks whenever the year-over-year change falls to 20% or less) “You would have avoided the 1973-74 bear market, much of the turbulence of the early 1990s, the market crash of 1987, and some of the short bear market in 1990. You also would have sidestepped much of the massive decline that occurred at the start of this decade.” Indeed, using the oil indicator from mid-1973 to mid-2003, compared with a passive buy-and-hold strategy of an S&P 500 (SPY) index fund, you would have multiplied your original investment 70 fold vs. 35 fold.
Remarkable.
(Adding more credence to Leeb’s book: Remember that the price of oil almost hit $150 a barrel right before the stock market crash of 08/09, so you would have avoided all the pain of the recent financial crisis also.)
Why employ one good strategy when you can combine two and make a great strategy?
Looking forward, from his remarkable team at GMO, Jeremy Grantham predicts high quality blue chips and large international stocks like Microsoft (MSFT), Phillip Morris (PM) International, Johnson and Johnson (JNJ), and Conoco Phillips (COP) will out-perform other equity classes, and certainly out-perform bonds. I would suggest using Leeb’s oil indicator as a signal to get into and out of equities. But instead of jumping into and out of an S&P 500 index fund, buy the companies Grantham says will have brighter futures. This way you avoid the risk high oil prices pose to stocks while maximizing the probability for profit when it is time to re-enter the market.
Superimposed on this strategy I would still keep a significant percentage of cash on the sideline until we either see the sovereign debt crises that now threatens Europe, Japan, and the US resolved, or until we see a massive move down (like in early 2009) resulting in very cheap equities. I may be wrong, but an eminent market crash seems quite telegraphed and I for one, intend to be ready this time. Never dismiss the power of cash as not only tail risk insurance, but also as dry-powder for tomorrow's opportunity set. Seth Klarman said it best, “Why should the immediate opportunity set be the only one considered, when tomorrow’s may well be considerably more fertile than today’s?”
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