And so it begins. Just yesterday, we here at the TFN offices got into a late-day discussion about the fate of the nation’s natural gas markets.

With prices remaining low and entirely removed from the recent commodities bonanza, the nation’s expanding natural gas drilling industry is headed for trouble.

Today we got the news that proves our theory.

ConocoPhillips (NYSE:COP), the third largest of the nation’s Big Oil players, announced it is cutting its capital spending budget by nearly 10% and is selling some $10 billion worth of assets.

Why the drastic moves? Thanks in part to stubbornly low natural gas prices, the company needs to make the cuts to shore up a leveraged balance sheet.

If you recall, just last week the company warned Wall Street to expect reduced earnings figures thanks to a 67% reduction in natural gas prices.

There was similar news yesterday from nation’s second-largest producer, Chevron (NYSE:CVX). The California-based company quietly announced all drilling has stopped at its Piceance Basin facilities in Colorado.

I bet you can guess why they plugged the well. Yep, you betcha, low natural gas prices.

Drill, baby, drill

So if the natural gas price conundrum is having this effect on the nation’s largest companies and their multi-billion dollar cash flows, what is it doing to the tiny, marginal players?

Early last month, Trident Resources gave us a glimpse of what is likely to come. Citing liabilities of nearly a billion bucks and assets worth just $10 million, the Canadian gas driller was forced to walk into bankruptcy court and ask for protection from its creditors.

Indeed, the same companies investors were pumping their money into when gas was soaring to record highs are now failing under the weight of massive debt.

Here’s the kicker that is really going to tear the gas industry apart.

That massive debt that was picked up over the past few years doesn’t simply go away now that prices have plummeted. Drillers still have to pay their bills. That means any bit of cash flow available is direly needed.

That is how we got to where we are today, with natural gas inventories across the country at record high levels and growing by the minute.

With bills to pay, drillers simply refuse to close the valves on their producing wells. If they do, they’ll go bankrupt. But until they slow the flow, the price they get for that gas will sink lower and lower.

Eventually, prices will get so low the weak will be shaken out of the market whether they like it or not. They won’t be able to produce enough gas even to make their weekly payroll.

One of many

I could pick on dozens of small drillers that are facing gale-force headwinds, but since Rex Energy Corp. (NASDAQ:REXX) recently expanded its drilling in the Marcellus Shale formation, which is the chief cause of the current market glut, I will put their issues in the spotlight.

With $70 million in liabilities, the $330 million company is one of the better positioned drillers in its category. But much of that debt is focused on bringing the company to the Marcellus Shale region. If the move does not pay off, Rex could be forced to pay on a dud for quite some time.

Common estimates put the break-even price for Marcellus Shale drilling somewhere around $3.70 per 1,000 cubic feet of gas. Right now, drillers are able to get that price from the futures market, but the overfilled spot market is not willing to spend so much.

With nearly $1.50 difference between spot and future prices, something has got to give. With inventories about to overflow, the spot price won’t budge an inch.

The common argument throughout the market is that typical winter demand will reduce supplies and bring the markets back in equilibrium. But remember, the markets rarely go with the crowd.

The speculators have gas prices going higher over the next two months, but the facts and economic laws show prices will be going lower.

If it happens, it won’t be good for drillers. ConocoPhillips knows it. Now so do you.

Source: Natural Gas Industry Braces for Impact

According to the US Department of Energy, liquid fuel demand in the developed nations peaked in August 2005 at 41.89 million barrels per day. Since then, it has plunged by 3.6 million barrels per day to 38.27 million barrels per day. However, you may want to note that despite these tough economic conditions, consumption has been extremely resilient in the emerging world. For instance, demand in the developing countries peaked in October 2008 at 46.33 million barrels per day and it is down by only 0.36 million barrels per day! I am amazed that the worst global recession in decades has barely managed to shrink energy demand in the developing world. Whilst this is wonderful news for the energy investor, it is a terrible sign for society.

At present, our world is using up roughly 84 million barrels of liquid fuels per day and for the moment at least, there is sufficient supply to meet demand (Figure 1). However, when economic activity picks up, it won’t take much for demand to zip right past supply. Remember, it is much easier to increase usage, but it takes a long time to ramp up production. So, unless this is a permanent global recession (which I doubt), it is inevitable that the price of oil will go up significantly over the medium to long-term.

Figure 1: Supply and demand – balanced for now

Source: www.yardeni.com

On the supply side of the equation, let me be clear. If I was asked to pick the biggest threat to a sustainable economic recovery, Peak Oil would top that list. Remember, Peak Oil doesn’t mean that we are running out of oil reserves, crude will be around for decades. However, ‘Peak Oil’ does imply that we are dangerously close to peak global oil production. ‘Peak Oil’ also means that rather than experiencing a burst in oil supplies as many expect, from here onwards, we will witness sharp declines in global flow rates. In a nutshell, the era of cheap energy is over and the price of crude oil will rocket higher over the coming decade.

Now, many skeptics will argue that if Peak Oil was real, the price of oil wouldn’t have dropped to roughly US$30 per barrel in last autumn’s stunning crash. Valid point; but let us not forget that the spectacular plunge occurred at a time when global economic activity virtually came to a standstill. Let us also keep in mind that last autumn’s crash in asset prices was caused by a total freeze in credit and the associated asset liquidation. Whilst I agree that the final action in crude oil’s parabolic blow-off last July smacked of speculation, I can assure you that speculation alone couldn’t have created a multi-year boom whereby the price of crude oil went up by almost 1500%! As you can see from Figure 1 above, supply clearly fell short of demand between 2005 and 2008, and this is why we had a magnificent bull-market in crude oil.

Make no mistake, global demand for liquid fuels will rise again – and if my homework is correct, supply won’t be able to keep up. If you ignore the noise and review hard data, you will observe that the vast majority of the world’s most prolific oil provinces are now past peak production and in a state of permanent depletion. According to the BP Statistical Review of World Energy, out of the 54 oil producing nations and regions in the world, only 14 are still increasing production. Alarmingly, 30 oil producing nations and regions are definitely past their peak output and the remaining 10 appear to have modestly declining production rates. Put another way, when weighted by production, Peak Oil is already a grim reality in 61% of the oil producing world!

Still not convinced about Peak Oil? Then review Figure 2, which charts the expected combined flow rates for crude oil, lease condensates and Canadian Oil Sands. As you can see from the grey shaded area, production is about to decline by roughly 5 million barrels per day by 2012.

Figure 2: Has crude oil production peaked?

Source: The Oil Drum

Ironically, Figure 2 also plots the optimistic (almost laughable) forecast made by the International Energy Agency (IEA) in its “World Energy Outlook 2008”. Interestingly, in last year’s “World Energy Outlook”, the IEA stated that in order to fulfill its optimistic projections, the world had to install 64 million barrels per day of new supply by 2030 or the equivalent of six times the Saudi Arabian output! Furthermore, the IEA declared that the energy industry had to invest hundreds of billions of dollars every year to achieve this favorable outcome.

Now, I can understand that the IEA is a government-funded agency so it has to paint a rosy picture, but it is ominous that the energy watchdog failed to mention where this surplus oil would come from!

Well, I guess you get the idea. Global crude oil production has probably peaked, new discoveries have dried up and there is a shortage of capital for investment purposes. Apart from these factors, if you believe the energy optimists, all is well in the energy industry and the price of oil is about to drop to zero!

After years of extensive research, I have no doubt in my mind that unless global demand stays weak forever, we will see supply shortages in the not too distant future. And before that occurs, the price of crude oil will stage an explosive rally. Accordingly, I suggest that all my readers allocate a large proportion of their investment portfolio to upstream energy companies and to businesses in the energy services sector.

Finally, in the energy complex, the price of natural gas is still scraping along its recent crash low and this is a fantastic long-term investment opportunity. As we approach winter in the Northern Hemisphere and heating demand picks up, we are likely to see a big rally in the price of natural gas. So, investors may want to allocate capital to this unbelievably inexpensive commodity.

Regards,

Puru Saxena

Source: Peak Oil: Supply Data Doesn’t Lie

The trip was sponsored by the American Petroleum Institute (API), which paid for the airfare and accommodations. Managers at both Syncrude and ConocoPhillips granted me access to any parts of their operations I wanted to see (within allowances for safety). And everyone answered any and all questions I asked.

Post-trip, I have complete editorial freedom to write about what I saw and learned. And I learned a lot. So this is Part I of a two-part series. Watch for Part II.

The Past and Future of Oil and Oil Sands

The first thing that struck me about visiting the oil sands of Alberta was how much geological and social similarity there is to the oil patch of Pennsylvania.

Geologic similarity? Yes, because the reason that the hydrocarbons are so near the surface in both areas — Pennsylvania and Alberta — is that the Pleistocene glaciers scraped off much of the overlying rock. When the glaciers retreated about 10,000 years ago, they left hydrocarbon-bearing rock formations exposed near the surface, or buried not too deep. This led to oil seeps, which led to people being curious about the black, gooey stuff.

To be sure, the hydrocarbon resource is quite different between the two places. That is, in Pennsylvania, you have light, sweet crude oil that flows easily and is soft and smooth to the touch. Indeed, Pennsylvania crude feels like hand lotion. (It’s the origin of Vaseline, for example. And some people use it as the basis for a shampoo.)

While in Alberta, the “bitumen” from the oil sands is as thick as cold molasses, and very sticky. It’s got some sulfur in it as well.

On a warm day in August, oil sands have the consistency of really stiff, dry oatmeal. Bitumen is a far cry from hand lotion.

And as for social similarities? Well, the Indians of old used to skim the oil from streams near Titusville, Pa. So did people of the “First Nations” of Alberta, who used to recover the tarry bitumen from the rocks along the Athabaska River of northern Alberta. Thus both oil and oil sands have been around for a long, long time.

Early white explorers in both Pennsylvania and Alberta noted the oil seeps. They wrote in journals and logs that eventually somebody could do something with the substance.

Eventually, both Pennsylvania and Alberta had their oil booms. In fact, we’re soon coming up on the 150th anniversary of Col. Drake’s oil discovery at Titusville, Pa, on Aug. 27, 1859. Pennsylvania’s oil boom is colorful history at this point (although Marcellus Shale development will soon change that).

Whereas Alberta is still in the midst of its oil sands boom. It’s a boom that’s going to last for quite some time, I believe.

“Easy” Oil Versus Heavy Oil and Bitumen

There’s a reason Col. Drake started an oil boom in Pennsylvania more than a century before Alberta enjoyed the same thing. Col. Drake found some of that so-called “easy” oil. No, it’s not easy to find. It’s that Col. Drake’s oil flows easily from a well.

That is, for all the oil that mankind has pumped out of the ground in the past 15 decades, almost all of it has been the light, sweet stuff that flows easily. Generally, when people looked for oil they bypassed the heavy oil and bitumen. Until lately, of course.

When we think about the concept of “Peak Oil” today, we need to keep in mind what we’re talking about. The curves show oil output peaking in so many parts of the world. This phenomenon is quite real, as long as you understand that it’s the “old fashioned” kind of oil deposit that Col. Drake was drilling. The light, sweet, easy-flowing oil is getting harder and harder to find, certainly in significant quantity.

But there are a lot of other hydrocarbon molecules out there. Most of those molecules are not light, sweet crude oil. Indeed, most of the hydrocarbon molecules that the world will use in the future will be “heavy,” with lots of carbon atoms and not so many hydrogen atoms.

Here’s a graph from oil services giant Schlumberger that estimates the world’s heavy oil and bitumen resources. Canada’s 400 billion cubic meters of bitumen translates into something like 1.4 trillion barrels of oil equivalent. How much is that? Well, it’s about SEVEN times the total oil reserves of Saudi Arabia.

It just so happens that most of that Canadian bitumen is located in Alberta (with some is in Saskatchewan). And Fort McMurray, about 250 miles north of Edmonton, is the heart of the development process.

Oil Sands — Surface Mining

Large-scale oil sands development began in the 1970s. It took gigantic levels of capital investment, like tens of billions of dollars. That’s not pocket change. So a group of lease-owners got together and pooled their capital to form privately held Syncrude Canada, a joint venture. First mining started in 1978.

The way Syncrude operates, it’s not really “mining.” It’s landscape architecture. Under Alberta law, Syncrude could not turn over its first shovel of rock without a master plan for remediation and restoration at the end of the cycle. It’s quite a farsighted model for long-range resource development.

Thus for much of the 1970s, Syncrude performed baseline environmental studies and data gathering. It started digging in 1978. At first, the pit looked like a moonscape of open-pit mining. See the photo below. It looks like a mess, right? Well, there’s more to the story.

The mining process is fairly straightforward. Big shovels (really big) scoop large volumes (really large) of oil-laden sand (API number 8, the “bitumen”) into gigantic loaders (and I mean gigantic.

The loaders haul the rock to a crusher. The crushed rock goes to a washing bin, kind of like your washing machine at home except it’s the size of a high-rise office building. The Syncrude operation washes the bitumen off the sand using naphtha. Then it separates the bitumen, recovers the naphtha for reuse and takes the clean sand (and it’s clean) and replaces it in a previously mined pit.

The process uses a lot of water, but not as much as the horror stories you might hear about “draining the rivers” of northern Canada. Each barrel of water is recycled about 18 times.

The process uses a large amount of natural gas, but not as much as you may have heard (like “all the natural gas of northern Canada”). Pretty much everything about the operation is built with cogeneration in mind, so the company continuously recovers the heat at each stage. That natural gas goes a long way, from what I saw.

If it takes, say, five years to dig a pit, and then it may take five or more years to fill it back up with sand during the restoration process. Syncrude’s goal is to handle the rock as little as possible.

Eventually, Syncrude returns the land to original grade, although the company has some artistic license with the contours. It covers the land with the original topsoil, which has been in cold storage (northern Alberta… it’s cold up here for 10 months of the year). Then it replants trees, and that’s saying something, because the growing season is under two months. It takes 80 years for your basic spruce tree to reach maturity.

There’s even a new water table, despite the disturbance of the land.

Where Things Now Stand

So at this stage, after 30 years or so of mining (with about 80 years to go, at current rates of extraction), Syncrude has come to a point of delivering 350,000 barrels of synthetic crude oil per day. It takes the 8-API bitumen and upgrades it to oil that’s competitive with West Texas Light. Then it delivers it to the JV members, for whatever use the owners want to make of it.

Along the way, the Syncrude process removes the sulfur, so it’s sulfur free (refiners like that). In fact, there’s a mass of sulfur up at Syncrude that’s about the size of the step pyramid at Saqqara, Egypt. And along the way, Syncrude sells the sulfur to the chemical industry.

The former Syncrude mine that I visited is about 3.5 miles square, and formerly about 200 feet deep. Now it’s restored to grade, with trees growing and a herd of 300 wood bison grazing.

For the cynics out there, I’d say that it’s not some environmental Potemkin village, because you can’t fake a replanted forest of 25-year-old trees. You can’t fake a 300-bison herd. Not on a former mine site 3.5 miles square.

Sure, there are still issues about land disturbance, settling ponds, water usage, gas usage and myriad of other things that come up when you’re spending billions of dollars on a major mining effort. But Syncrude has built its business model around dealing with the “other” issues, and not just moving oil sands and recovering oil products. Don’t underestimate the ability of the Alberta government to regulate its energy producers. This is a long way from Appalachia.

Meanwhile, we’re talking about literally billions of barrels of bitumen (or oil equivalent) that the process makes available to the North American marketplace. And if the U.S. wants to get onto its environmental high horse about the source of the hydrocarbons from the oil sands — and tax or ban their importation — there are other buyers in the world. Like the Chinese, who have racked up many frequent flyer miles on their treks to Fort McMurray.

That’s all for now. In Part II, I’ll discuss the in situ process that I saw at the ConocoPhillips Surmont site.

Until we meet again,
Byron King

Source: Update on Canada Oil Sands, Part I

What Are These Oil Sands?

Back in Pleistocene time, the glaciers covered much of northern Alberta.  In places, there was a mile of ice.  During some of the warmer periods, there was a lot of melting.  On occasion, and in some places, there were giant, glacial-dammed lakes.

Every now and again, these glacial dams would break, sending massive volumes of water downstream, wiping away pretty much everything along the way.  Well, it turns out that in this scoured-out area that included much of the rock covering some lower Cretaceous deposits of oil.  Or rather, it was “oil” that had long ago lost the volatile components.  The stuff is properly called bitumen.

Thus we have an area in northern Alberta that’s about the size of New York State.  That area holds near 1.4 trillion barrels of bitumen resource.  To be sure, not all of it is recoverable.  In terms of recoverable “reserves,” there are only (ahem…) about 175 billion barrels, or over eight times the total of U.S. oil reserves.

Of those 175 billion barrels, about 20% are near enough to the surface to strip mine.  That’s within about 250 feet or so.  Any deeper, and the cost-benefit calculation dictates that you have to recover it via a well-and-pumping process.  Still, that makes for about 35 billion barrels of bitumen that could be extracted by mining.  (About 1.5 times total U.S. oil reserves.)  The actual, mineable area is about the size of Rhode Island.

The Heart of Oil Sands Country

All of which gets me back to why I was in Fort McMurray.  This is the heart of oil sands country.

Near 200 years ago, early explorers noticed gooey oil seeping out of the banks along the Athabaska River.  On warm days, with direct sunshine, the stuff actually flows.  Mostly, it has the consistency of peanut butter.  Unless it’s cold up here – which happens a lot – and it’s hard as a rock.

Needless to say, people talked about these “oil sands” for a lot of years.  Then in the 1960s, some people within Canadian industry and the Alberta government began to do something about it.  They decided to develop them.  It’s a long, long story.

Here’s the Short Version

The short version of the story is that large-scale oil sands development began in the 1970s.  It took gigantic levels of capital investment, like tens of billions of dollars.  That’s not pocket change.  So a group of lease-owners got together and pooled their capital to form Syncrude Canada, a joint venture.  First mining started in 1978.

Thing is, the way Syncrude operates it’s not really “mining.”  It’s landscape architecture.  Under Alberta law, Syncrude could not turn over its first shovel of rock without a master plan for remediation and restoration at the end of the cycle.

So for much of the 1970s, Syncrude performed baseline environmental studies and data-gathering.  Then they started digging in 1978.  At first, the pit looked like a moonscape of open pit mining.

The process is fairly straightforward.  Big shovels (really big) scoop large volumes (really large) of oil-laden sand (API number 8, the “bitumen”) into gigantic loaders (and I mean gigantic.)  The loaders haul the rock to a crusher.  The crushed rock goes to a washing bin, kind of like your washing machine at home except it’s the size of a high-rise office building.

The Syncrude operation washes the bitumen off the sand using naphtha.  Then they separate the bitumen, recover the naphtha for reuse, take the clean sand (and it’s clean), and replace it in a previously-mined pit.

The process uses a lot of water, but not as much as the horror-stories you might hear about “draining the rivers” of northern Canada.  Each barrel of water is recycled about 18 times.

The process uses a large amount of natural gas, but not as much as you may have heard (like, “all the natural gas of northern Canada.”)  Pretty much everything about the operation is built with co-generation in mind, so they continuously recover the heat at each stage.  That natural gas goes a long way, from what I saw.

If it takes, say, five years to dig a pit, then it may take five or more years to fill it back up with sand during the restoration process.  Syncrude’s goal is to handle the rock as little as possible.

Eventually, Syncrude returns the land to original grade, although they have some artistic license with the contours.  They cover the land with the original topsoil, that’s been in cold storage (northern Alberta… it’s cold up here for 10 months of the year).  Then they replant trees, and that’s saying something because the growing season is under two months.  It takes 80 years for your basic spruce tree to reach maturity.

There’s even a new water table, despite the disturbance of the land.

Where Things Now Stand

So at this stage, after 30 years or so of mining (with about 80 years to go, at current rates of extraction), Syncrude has come to a point of delivering 350,000 barrels of synthetic crude oil per day.  They take the 8-API bitumen and upgrade it to oil that’s competitive with West Texas Light.  Then they deliver it to the JV members, for whatever use the owners want to make of it.

Along the way, the Syncrude process removes the sulfur, so it’s sulfur-free (refiners like that).  In fact, there’s a mass of sulfur up at Syncrude that’s about the size of the Step-Pyramid at Suqqhara, Egypt.  And along the way, Syncrude sells the sulfur to the chemical industry.

I visited a former Syncrude mine, about 3.5 miles square and formerly about 200 feet deep.  Now it’s restored to grade, with trees growing and a herd of 300 wood bison grazing.  For the cynics out there, I’d say that it’s not some environmental Potemkin Village because you can’t fake a replanted forest of 25-year old trees.  You can’t fake a 300-bison herd.  Not on a former mine site 3.5 miles square.

Bottom line is that this is an immense operation.  Syncrude employs 5,000 people, plus 2,000 contractors.  Paychecks are north of $100,000 per year.  Every oil sands job supports 3 local jobs, 6 provincial and 9 others across North America (especially at Caterpillar, where they build those giant, 400-ton loaders).

In the coming weeks I’m going to delve deep into North American oil sands operations and any companies that may be set to profit. Oil sands are nothing new, but now may be the perfect time to scoop up shares of a small player or two…

Regards,
Byron W. King

Source: The Oil Sands in Alberta, Canada

Much of Brazil’s South Atlantic development will require drilling wells in waters up to two miles deep, through four-five miles of rock beneath the seabed. The prize at the end will be oil deposits with reserves estimated in the tens of billions of barrels. With access to this offshore bounty, Brazil expects to take its place among the first ranks of energy-producing nations in the world.

Brazil’s state-controlled national oil company (NOC), Petroleo Brasileiro SA (NYSE:PBR) plans to spend over $175 billion in the next five years just on offshore development. The immense investment involves buying and building dozens of new drill ships and seagoing platforms, along with many dozens more support and servicing vessels. Petrobras will lay thousands of miles of pipelines on the seafloor, connecting massive complexes of subsea equipment that will sit atop hundreds of oil wells.

To finance much of this development, Brazil has turned to China. With the active support of the Chinese government, many Chinese banks are lining up to extend loans to Brazil’s energy sector. Right now, there is an agreement for a Chinese consortium to lend Petrobras $10 billion. In exchange, Petrobras will eventually ship 200,000 barrels of oil per day to Chinese refineries. There are more such long-term finance supply deals in the works.

The Chinese government has established strategic guidelines for its national firms. That is, the Chinese government has set goals for Chinese firms to supply China’s long-term needs for energy and other natural resources. The Chinese are looking well ahead into the rest of this century, and even into the 22nd century. They want to ensure their future access to a diverse global supply chain, as well as win entrée into resource-rich regions of the world for Chinese industries and support firms.

Why are the Chinese receiving such a warm welcome in Brazil? According to Sergio Gabrielli, CEO of Petrobras, “The U.S. has a problem. There isn’t someone in the U.S. government that we can sit down with and have the kinds of discussions we’re having with the Chinese.”

In other words, there is a new geopolitics of oil at work. In the olden days, it would have been large international oil companies (IOCs) like Exxon Mobil (NYSE:XOM), Shell (NYSE:RDS.A / RDS.B) and BP walking into a room to meet with the Brazilians. The IOCs were the only game in town. They controlled the financing and the technology for large developments.

But today, the biggest deals begin with a political understanding at the top, hammered out between the highest levels of the respective governments. This top-down political deal making cuts out the IOCs, except where they have technical expertise that can be hired on a contract basis.

In essence, we are witnessing the end of the post-World War II economic construct of the world’s financial system. That construct always had a Western bias. But the 2008 crash of the Western business and financial model has changed everything. It has left a barren worldwide financial landscape for large development projects. Most traditional Western financing is simply not available for large projects. And as French author Francois Rabelais (1494-1553) once noted, “Nature abhors a vacuum.”

Thus has the Western financial crisis handed well-capitalized, government-backed Chinese banks and industrial firms an unmatched competitive advantage. With the traditional credit markets dry, Chinese banks have transformed into key lenders for the resource developments that will fuel the next generation of humanity. Indeed, for now, the Chinese are the world’s ONLY lenders for large resource development projects. See Brazil, Exhibit 1.

China’s Rare Earths Monopoly – All But Insurmountable

China’s support for Brazilian energy development is not the only angle that the Chinese government is pursuing for its future gain. China’s large reserves of foreign exchange, as well as its national strategic focus, has enabled incomparable – even insurmountable – progress for the Middle Kingdom to corner the world supply of substances called rare earths. Here’s the production chart for the past half century. Obviously, something is going on here.

Now that we’ve seen this chart, the questions arise: What are rare earths? And why are they important?

Rare earths are the 15 elements within the lanthanide series of the periodic table, plus the elements yttrium and scandium. The best known are lanthanum, cerium, neodymium, praseodymium, gadolinium, europium and samarium.

Here’s why rare earths are important. They’re used in a wide range of industrial and electronic applications. For many years, large amounts of lanthanum and cerium have been used in petroleum refining, with the result of increasing yields from each barrel of oil by about 10% while extending the life of other expensive catalysts like platinum. And rare earths find their way into myriad other applications, from aerospace super-alloys to rechargeable cell phone batteries.

More recently, large volumes of rare earths (especially neodymium) have gone into magnets. In fact, rare earths are a key component in strong, permanent magnets. It’s not those cute little refrigerator magnets; your computer contains a number of tiny magnets in its hard drive. If there are no permanent magnets, there are no computers. Or DVDs or DVRs or iPods, etc. Say farewell to your wired way of life.

And then there are the giant 1-ton magnets used in large windmill assemblies. Each windmill magnet is about the size of a car engine and uses 560 pounds of neodymium. The implication is that if the U.S. wants to erect windmills to generate electricity, the nation is making a long-term commitment to buy and use unprecedented amounts of neodymium. And there are NO substitutes. For just this one “clean energy” application, large amounts of rare earths – and the ores and mines to produce them – are essential.

There are many other clean-energy applications for rare earths as well, particularly in the now forming electric car industry. Neodymium magnets are key components in electric motors and regenerative braking systems used in hybrid vehicles. Without these magnets, no electric cars will ever roll off an assembly line, let alone whiz down an American highway.

Another significant demand for rare earths will come from large rechargeable batteries for electric cars. Nickel-metal hydride (NiMH) rechargeable batteries, for example, contain cerium and lanthanum in a form called “mischmetal.” And right now, NiMH batteries are the battery of choice for many hybrid vehicles. Overall, a typical hybrid electric vehicle can use about 50 pounds of rare earths – between the rechargeable battery pack, the permanent magnet motor and regenerative braking system. (Plus other tiny magnets for the sound system, power windows, power seats, windshield wipers, etc.)

So clearly, demand for rare earths is set to skyrocket. Just clean energy applications will drive unheralded demand for metals of which most investors – let alone consumers – have never heard.

It’s also important to keep in mind that almost none of the rare earths used in large power systems (like windmills) or electric vehicles (such as with NiMH batteries) are currently being recycled. The long lifetimes of the magnets and batteries, coupled with the lack of recycling technologies and dedicated facilities, means that any increase in supply can only come from new mining.

Another factor is that there appears to be an official Chinese policy to slow down export of rare earths. Chinese exports have decreased by 8% or so each of the past three years. Chinese suppliers have placed foreign customers on allocation, at reduced quantities from years past. The Chinese explain that they have closed mines for environmental reasons. Yet the Chinese also promise adequate supplies of rare earths if foreign users will move their industrial facilities into China.

According to Yoichi Sato, head of the Rare Earths Department of Japan’s Mitsui Industries, China is displaying its long-term strategy toward these critical elements. Mr. Sato believes that China is playing a complex game with the world’s rare earth consumers.

First, China is restricting rare earths exports, to provide its own high-tech industries with the chance to flourish and gain a competitive edge over rivals in Asia, Europe and the U.S. And second, it will force many foreign firms to move their high-tech factories and research centers to China to circumvent quotas. China, to be sure, has a small army of highly capable scientists and engineers who focus on rare earths applications – over 15,000 Ph.D.-level individuals, by one count.

Mitsui’s Mr. Sato believes that China will use its existing monopoly status in rare earths production to crush any competition that emerges. While about 42% of worldwide rare earths resources are outside China, there are NO non-Chinese sites with any significant processing or refining capacity. In the game of rare earths, China holds almost all of the cards.

Mr. Sato has stated, “Many people are looking at establishing alternative refineries and sources outside China, but the investment is not necessarily a sound one because of the threat of price revenge by China. If new projects emerge, as they have recently in Malaysia and Australia, China could just drop its prices and force rivals out of business.”

And as if on cue, in April 2009, Chinese firms used their financial muscle to buy large stakes in potential foreign rivals in Malaysia and Australia.

I hope that you now understand the importance of rare earths to the 21st-century economy of the West, particularly to the energy future of the U.S. I’m following this situation very closely. There ARE some potential investment opportunities in rare earths, but only in very small, thinly capitalized firms.

Until we meet again,
Byron King

Source: Brazil’s National Commitment to Energy – Bankrolled by China

First off, the stated objective of cutting carbon emissions by 83% by 2050 will go down in history as outrageous – akin to when Who drummer Keith Moon drove his Lincoln Continental into the pool at the Holiday Inn. I think members of Congress must be smoking the same thing Moon was.

To show you how patently ridiculous such a goal is, I turn to Questar’s CEO – a man with the unfortunate name of Keith Rattie. Questar (NYSE:STR) is an oil and gas company. Rattie is an engineer. He has been in the business since the 1970s. He walks us through the basic math in a speech he made at Utah Valley University on April 2 called “Energy Myths and Realities.” Rattie uses Utah as an example:

“Utah’s carbon footprint today is about 66 million tons per year. Our population is 2.6 million. You divide those two numbers and the average Utahan today has a carbon footprint of about 25 tons per year. An 80% reduction in Utah’s carbon footprint by 2050 implies 66 million tons today to about 13 million tons per year by 2050. If Utah’s population continues to grow at 2% per year, by 2050, there will be about 6 million people living in our state. So 13 million tons divided by 6 million people equals 2.2 tons per person per year.

“Question: When was the last time Utah’s carbon footprint was as low as 2.2 tons per person? Answer: Not since Brigham Young and the Mormon pioneers first entered the Wasatch Valley and declared, ‘This is the place.’”

You can extend this math over the whole country – a growing mass of 300 million people. To meet the Waxman-Markey bill’s goals would mean we have to go back to a carbon footprint about as big as the Pilgrims’ at Plymouth Rock circa 1620.

So I think the bill is absurd. I think it is also a great blow to what is left of American industry. But who cares what I think? As the great Jeffers wrote, “Be angry at the sun for setting/ If these things anger you.” This is the way the world works. Politicians do dumb things. We have to play the ball where it is. And that means we have to figure out who wins and who loses.

Here are some thoughts along those lines…

Agriculture. Agriculture, for whatever reasons, is exempt from the new rules. So farmers don’t have to worry about those manure pools out back or the flatulent cows emitting methane all over God’s green meadows. Those big tractors? Burn up that diesel!

Agriculture is a winner by virtue of not losing, like a hockey team that skates to a tie.

Steel. Big loser. U.S Steel, AK Steel (NYSE:AKS) and even foreign steel companies with US operations all get a big kick in the family jewels on this one. Steelmaking emits all kinds of carbon dioxide. The worst-case scenario here is that the US simply won’t be making steel at some point in the future. The plants will all go to Brazil. China is already the biggest steel producer in the world. Now we just handed the country a bunch of new business.

Avoid big steel in the US.

Utilities. Mostly losers. Under the bill, utilities will have to get 12% of their electricity from renewable sources. That means they are going to spend money buying windmills and solar panels. For some of the coal utilities, this is bad news – even though they caught a break when the government made a change to let coal have carbon permits for free to start off with. Gas utilities are better off, as they emit less carbon, but since coal gets some free carbon allowances upfront, their advantage will not be as big as I made out in my letter to you a month ago. (See, the problem with writing about potential legislation is the rules change every week.)

Still, I’d avoid coal producers or coal utilities. They wear big targets on their backs and can’t do much about it, except spend a lot of money. Bad for shareholders. There may be some very good ideas on the picks-and-shovel angle for coal, though. For example, a number of companies will sell equipment to clean up coal. And of course, the solar and wind guys are big winners.

Oil refiners. Losers. This is an industry in which it is hard to make money most of the time as it is. Now, under the new bill, refineries are really screwed. Basically, they are on the hook for about 44% of US carbon emissions. They would be among the biggest buyers of carbon emission allowances. I think with one stroke of the pen, the US government just made the US refining industry that much smaller. Lots of these older refineries will just have to close. US imports for gasoline will rise.

I think the refinery industry already sees the writing on the wall. This is one reason why Valero, the biggest US refinery, has been quick to get into the politically favored ethanol business. It’s also expanding overseas.

Avoid the refineries.

Trading desks. Winners. It figures. As if the government doesn’t help financial firms enough, it is going to hand them a nice tomato in trading carbon credits. The head of Morgan Stanley’s US emission trading desk said: “Carbon, while relatively small, is a critical piece of our commodities offering.” So some financial firms with trading desks in carbon get a nice little payday.

To sum up, this is only the beginning. At the end of the day, this obsession with carbon footprints means that Americans are going to have to pay a lot more for products that use fossil fuels. It means we are going to pay a lot more for energy. Obama and his crew can draw up whatever fantasies they want, but they can’t repeal the laws of economics, which, like forces of nature, win out every time.

Regards,

Chris Mayer

Source: Waxman-Markey Whacks Industry

Look at it this way: there likely won’t be enough demand for that many gallons by 2022 at the current 10% blend, so the only way to reach the target is by increasing the blend to 15%, perhaps 20%.

If it were only that simple.

Already, there are numerous reports of engine failure due to ethanol blends that are higher than 10 percent. Simply put, existing engines are being destroyed at a 10 percent blend. A higher blend will accelerate the process. The other big problem: auto manufacturers’ warranties cover fuel blended with up to 10 percent ethanol. Increasing the blend to 15 percent will void all factory warranties, and rightly so.

But here’s the real rub: just a little over a week ago, the Obama Administration proposed raising mile-per-gallon requirements by 2016. This would raise the required fleet average from the existing 27.5 to 35.5 mpg. Cars would see the biggest increase in fuel economy, from the current requirement of 27.5 mpg standard to 39 mpg in 2016. Light trucks would see the requirement rise from the current 24 mpg to 30 mpg.

The problem with all of this is these requirements are to be met by 2016, in the middle of the timeframe to increase the use of ethanol in a gallon of gas (remember, 36 billion gallons by 2022).

The problem is that ethanol is less efficient that gasoline!

A gallon of E85 (85 percent ethanol currently used in “flex-fuel” vehicles) has approximately 27 percent less energy than a gallon a gasoline, according to drivingethanol.org. This translates into a 10-25 percent loss in fuel economy.

So on one hand, the government is requiring that more ethanol be blended with gasoline by 2022. This will undoubtedly lead to lower fuel economy. On the other hand, the President just proposed a major increase in fuel economy be in place by 2016.

Time will tell how this plays out. But I hope that the increased fuel standards take effect and we can finally end the ethanol fraud.

Source: The Ethanol Fraud

The Shift to Heavy Oil, with an “Energy Microsoft” at the Forefront

But a significant portion of the world’s oil is much lower quality than the light, sweet stuff. Indeed, most oil that’s found in nature is a heavy, viscous hydrocarbon with the consistency of cold molasses. This heavy oil – defined as API gravity 22.3 or less – is difficult and costly to produce and refine. That’s why people have pumped and burned the light, sweet oil for the past 150 years. Throughout its history, the oil industry has usually bypassed the heavier oil fractions. Why go to the trouble and expense, right?

But now conventional oil resources are drying up. The reasons have to do with geology, politics, macroeconomics and the investment cycle. Boiled down, it’s the Peak Oil argument, which focuses on the worldwide decline in output of light, easy-to-get oil. And Peak Oil is a serious matter. As light oil gets scarce, however, a lot of new heavy oil plays are coming out of the industrial shadows.

Indeed, with the breakout of heavy oil into the marketplace, the world energy business is about to change dramatically. It’s kind of like what we saw with the computer revolution that began about 30 years ago. Big, heavy mainframes gave way to small-scale, distributed and personalized computing power. At the heart of the revolution was the operating system, much of which wound up coming from Microsoft.

Today, the energy industry is on the cusp of a revolution equally profound. And in the forefront of that change is the company that I’ll describe in this issue of Energy and Scarcity Investor. This visionary firm is sort of an “Energy Microsoft.”

How Much Heavy Oil Is Out There? A Lot!

First, let’s define a few terms and look at some numbers. According to oil service giant Schlumberger, only about 30% of the total world oil resource is the conventional, light, sweet crude (technically, API gravity 22.3 and above). Heavy oil (API 22.3 and below), by comparison, makes up about 15% of the world’s oil resource. Extra-heavy oil (API gravity less than 10) makes up 25% of the world’s oil resource. And nearly 30% of the world’s oil resource is in the form of tar sands and bitumen (with API gravities in the low single digits – it doesn’t flow at all).

Schlumberger estimates that there are between 6-9 TRILLION barrels of heavy oil in the world. Big numbers, right? Especially since the current total world demand for oil is in the range of 30 billion barrels per year. With heavy oils, we’re talking about 200-300 years’ worth of potential supply. (That’s at current rates of use. If we can get it all. Which we can’t. So it won’t happen. But it illustrates the point.)

Where is all of this heavy oil? Here are the nations with the largest estimated deposits:

This list goes on to include other nations with significant heavy oil deposits, such as Brazil, Saudi Arabia and Indonesia. Further down the list of countries holding sizeable heavy oil resources are Australia, South Africa, Nigeria, Libya, Argentina, Peru and Vietnam.

So you can see that heavy oil (and extra-heavy oil, tar sand and bitumen) is a vast and underutilized energy resource. Of course, keep in mind that nowhere near all of this resource is recoverable under even the best scenarios. But the point is that heavy oils, of all types, constitute immense energy potential – many decades worth of supply. And it’s all but certain that, as conventional oil becomes scarcer and more expensive to extract, the world’s energy industry will turn to heavy oils. It’s already happening.

Early and Current Efforts with Heavy Oil

Looking back in history, people and nations used heavy oils when necessity demanded. During World War II, Italy supplied its military (and the military of Germany) with oil products from a modest-sized heavy oil deposit in Albania. The Soviets, desperate for oil products, utilized several heavy oil deposits in south-central Russia. The Japanese exploited heavy oil deposits in Japan, Indochina and Indonesia.

Today, the energy industry has an array of projects that exploit heavy oils. Chevron, for example, lifts about 80,000 barrels per day of heavy oil from its large complex (of 8,000 wells!) at Kern River, California. Venezuela’s national oil company PDVSA produces about 400,000-500,000 barrels of heavy oil per day from projects in the Orinoco region. Offshore Brazil, Petrobras (NYSE:PZE) has a deep-water project targeted at a string of heavy oil deposits. And BP has several billion barrels of heavy oil resources located under the Arctic tundra near the conventional oil fields of Prudhoe Bay, Alaska.

When it comes to tar sands and bitumen, the massive developments in western Canada offer a $500 billion example. The Canadian tar sands projects currently yield nearly 2 million barrels of oil per day out of bitumen, strip-mined from the near-surface prairies of Alberta.

Next week, I’ll be in Denver for the American Association of Petroleum Geologists (AAPG) convention. I’ve been a member of AAPG for 30 years, and it’s been a source of great professional education and growth for me. I’ll attend the exhibits and talks and meet with several energy companies to get the latest insight into what’s going on out in the field. I’m even scheduled to be a judge on some of the programs for geothermal and heavy oil. All that, and I’m visiting with some hard rock miners while I’m in the area.

Naturally, I’ll look for great investment ideas and keep you posted.

Until we meet again,
Byron King

Source: Heavy Oil Becomes More Appealing As Light, Sweet Crude Runs Out

Saudi Arabia’s oil minister, Ali Naimi, has indicated that while demand is beginning to pick up, inventories remain dangerously high. Therefore, it would be best for the cartel to “stay its course” by continuing to adhere to previous production cuts until demand stabilizes.

After soaring above $147 a barrel last summer the price of oil tumbled more than 80% to a four-year low of $32.70 a barrel in February. To combat the sharp decline in prices, OPEC has lowered its production quotas by 4.2 million barrels per day (bpd) – about 5% of global demand – since September.

Since February, oil prices have recovered, climbing to their current level above $60 a barrel. But both Naimi and industry analysts have warned that the rally has more to do with market sentiment and the potential for a recovery than it does fundamentals.

“The price rise is a function of optimism that better things are coming in the future,” Naimi told reporters earlier this week.

The International Energy Agency (IEA) estimates global oil consumption will fall by 2.6 million bpd this year. That would be the biggest drop since 1981.

Naimi says that world crude inventories – at current levels – would be sufficient enough to meet about 62 days of global demand. OPEC members would like to see them fall to about 52 to 54 days worth of demand.

An increase in OPEC production “will not happen until we are sure that global inventories return to their normal levels,” Naimi told the Arab daily Al-Hayat.

U.S. crude oil inventories rose to the highest level in two decades earlier this month. However, Naimi did note that demand in Asia, particularly China, seems to be accelerating and crude prices could reach $75 a barrel by the end of the year.

Still, analysts are urging caution, as production quota compliance among OPEC nations is beginning to wane. Production compliance among OPEC nations reached 85% in March – an impressive level by historical standards. Members only delivered on 78% of the promised cuts in April as prices recovered.

Saudi Arabia, OPEC’s largest and most influential producer, actually pumped below its target level in April, but other members have been cheating. Iran, OPEC’s second-biggest producer, accounted for 410,000 bpd of the overproduction last month, while Angola exceeded its target by 170,000 bpd and Venezuela overproduced 130,000 bpd the IEA reported.

“Lagging quota compliance by the non-Gulf Arab states – hovering around 50% – has hamstrung any real discussion of a potential cut to accelerate the drawdown of the glut,” PFC Energy analyst David Kirsch said in a report today. “Purported requests by Angola to revise or suspend its quota, as well as moves by Venezuela to certify a higher production figure leave any proposal for further output restraint effectively stillborn.”

Source: OPEC to Maintain Production Levels at Thursday Meeting

Brazil announced over the weekend it had conducted $3.2 billion in business with China during April — a 12-fold increase in Sino-Brazilian trade from 2001. April also marks the second consecutive month that the U.S. has ranked No. 2.

What’s the trade? Iron ore. Brazilian officials say the Chinese have been buying the stuff hand over fist since the start of 2009.

As one consequence, Brazil’s stock market, the Bovespa Index, is outpacing the American equity rebound. Brazil’s version of the Dow has recouped the majority of its crisis losses. Check it out:

Brazil and China are just two areas of rich investment opportunity we’ll be focusing on with the new BRIC report we conceived with our Indian partners last week in London. Specific details on the report are forthcoming.

“The Brazilians are gearing up for the first battle of the next war,” says Byron King. “They intend to survive as a prosperous, industrialized country in the 21st century, despite intense future competition across the world for energy fuels and other natural resources.

“Down in Brazil, they’re in something like national rapture at the prospect of drilling up the deep pre-salt hydrocarbon plays in the offshore basins. The estimates are that the deep basins off Brazil hold between 20-100 billion barrels of oil. Maybe more.

“The entire nation of Brazil, apparently, revels in the prospect of investing over $120 billion in offshore development in just the next eight years. They have a plan. It’s their moonshot. The Brazilians believe that the offshore environment will bring their industries firmly into the modern era. Brazil wants to be a world power in the 21st century. And the oil? Well, of course they have plans for that oil.

“Petrobras has plans to emplace HUNDREDS of subsea systems on the deep ocean bottom to bring that oil into production. The Brazilians will lay thousands of miles of underwater pipeline, with all the associated ship support and other equipment that entails.

“The Brazilians are not living in the frozen past. They’re not hostage to paralyzing myths. The Brazilians envision a future for their nation, and they’re acting on it. They see hundreds of deep-water oil wells pulling petroleum out of the crust from many miles down and piping it ashore to their refineries and industries. Indeed, Brazil plans to win that first battle of the next war. And it’s cutting the steel with which to do it.”

Source: China Takes Another #1 Title From the U.S.