If foreign governments continue to nationalise major development projects, it will be bad for public company earnings, but probably bullish for oil. The heightened politicization of oil has made it harder for companies to decide which projects to invest in. The net effect may be to reduce the number of projects which put real shareholder capital at risk. If earnings decline, valuations may follow.

Another risk is a new pricing scheme for oil. OPEC grouses about the value of the dollar, and periodically, stories surface about pricing oil in euros, or trading it on an Iranian oil bourse. But another possibility to consider is that the oil market moves to a less regular, negotiated, or auction pricing scheme, not unlike the current regime that exists for iron ore and coal between Australian producers and Asian customers.

Oil was “commodified” in 1983 when the NYMEX futures contract began trading. The futures markets provided the world’s growing number of buyers and sellers a little more price certainty and a little less volatility than in the spot markets.

Liquid futures markets see pricing power shift between the buyer and the seller based on changes in the market, including changes to both supply and demand. What we may see with oil in the next few years is shift in pricing power that distinctly and permanently favours the sellers. We may, in fact, witness the “decommodification” of oil as it becomes a crucial strategic asset.

Right now, the sellers currently benefit from market pricing because volatility has led to higher prices. But those prices are denominated in a declining currency, the U.S. dollar. Is it inconceivable that some OPEC sellers or even non-OPEC sellers might agree to sell annual production at a fixed rate to a buyer who pays in something other than U.S. dollars? A buyer who pays in yen, euros, or yuan?

Debtor and Inflater Beware

It’s certainly conceivable. We just conceived it. But it would be a much different world than the one we live in now. What kind of world would it be?

It would be a world where oil is sold for geopolitical reasons and used as an economic weapon. It would be a world where there’s no longer a free market for oil.

Declining production and growing demand puts oil producers in the position of deciding what they want to charge, and who they want to sell to. It would be a world with a bouncer at the front door of the producer’s club and a big velvet cord in front. No debtor nations with dodgy currencies allowed inside.

The last and least desirable possibility is the collapse of our wonderfully complex, energy –intensive society. Globalisation has created a system of interconnected systems; energy, logistics, transportation, food, finance, travel, and entertainment. Up until recently, the system has provided a historical amount of surplus food, leisure, and comfortable sweat pants.

But like any system, it requires energy. Epic amounts of energy. When you start reducing the energy available to the system, it ceases to function in the same way. In some cases, it may cease to function altogether.

That the modern industrial world will cease to function because of structurally higher energy prices is a thought we all should consider and plan for. There is nothing any of us can do to prevent it if the world’s conventional energy resources are already being depleted faster than they can be replaced.

It’s clearly the worst case scenario. It would not be the first time an advanced civilization went from decadence to poverty in one generation. But as it is the first time it has happened to this particular civilisation—the one you and I were born into—we don’t relish the prospect and are cheering for and investing in credible alternatives to the world’s petroleum resources.

Dan Denning
The Daily Reckoning Australia

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Source: Where Will Future Oil Production Come From and How Can Investors Profit Today, Part 2

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Pages: 1 2 3