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The Business Times, Saturday 04th Oct, 2008
(An abridged version of this essay appeared in the
Business Times of 4 October 2008)
COMMODITIES
Oil be not proud
Looking beyond the current financial crisis, the future is bright and breezy
as solar and wind energy will spell the end of oil's importance.
By JOSEPH CHONG
CEO, New
Independent
In the Sunday Times of 6 July 2008 (oil was trading at about US$140 a
barrel then), I predicted that the price will fall to US$50 in ten years.
Since then we have moved half way there. The price of crude oil rose by 50%
in 7 months and fell by 35% in 6 weeks. Until today, many policy makers
insist that it is because of supply and demand and speculation played only a
minor role. Did demand rise or supply fall by 50% in 7 months? Clearly not.
Published data shows that, physical demand and supply are approximately
in balance at around 86 million barrels per day. Indeed, demand worldwide
has been decelerating since the beginning of the year. For example, US
demand has fallen by about 4% yoy in June to about 20.4 million barrels a
day. On the other hand, available spare capacity in the oil producing
nations have been thin – perhaps 1.5 million barrels per day. To aggravate
matters, demand and supply for crude oil is inelastic in the near term. Most
cars can only run on petrol and it takes 5 to 10 years to bring new field
discoveries into production. Thus, no matter what the price, consumers and
businesses have to pay up until they cannot.
Why then should prices continue to rise when crude oil demand is falling?
I believe this is because of the demand from financial investors such as
hedge and pension funds and, more mundanely, ETF holders. If spare capacity
is plentiful, the impact of financial investors would not be significant.
However, if spare capacity is small, financial demand of just the equivalent
of 1 million barrels/day could drive prices skyward. This would be
equivalent to an investment inflow of about US$50 billion per annum or about
3 months of China’s trade surplus or about 1.5% of the US$3 trillion in
Sovereign Wealth Funds i.e. US$50 billion is thus a fairly small sum. It is
even smaller if one remembers that oil futures are bought on margin.
I also suspect that both buyers
and sellers of oil have been hoarding. As a producer of crude oil, I would
delay bringing my product onto the market if prices are rising at the rate
of 10% per month if my finances are in good shape.
There was also a huge
divergence between the price of oil and the performance of oil stocks such
as BP, ExxonMobil etc., which underperformed the price of crude oil by some
55% in the first six months of 2008. Exxon Mobil, based on a present value
analysis, was being valued as if crude oil will trade at an average of
US$80/barrel over the long term. The reason for this is clear. Buy US$50
billion of the public oil companies and the needle hardly moves. Throw US$50
billion into oil futures creates a quake because it is a relatively small
market. The financial speculators know this.
Another anomaly is the huge premium over the
marginal cost of production. The most expensive marginal barrel of oil is
estimated to be around US$60 -70 a barrel. Being a commodity, that should
be the sustainable price. Indeed, coal, which is many times more plentiful
than crude oil, could apparently be converted into crude oil at around US$40
a barrel. Being replaced by another fossil fuel, however, is not the crude
oil killer. It is renewable energy.
Renewable energy sources, together with the
re-tooling of our energy supply infrastructure, will spell the end of oil’s
importance. It will come sooner than many think. A view shared by the
perpetually pessimistic “Economist “in its June 21st edition. It
is not a pipe-dream such as aiming to go the moon in 1960. Most of the
technologies are already commercially viable – it is a question of how fast
mankind can re-tool.
The most promising alternatives are wind and
(thin-film) solar energy –
our nuclear fusion reactor in the sky. The earth absorbs 400 times more
energy from the sun than all of mankind’s energy needs. Investments in
solar energy are growing at 200% per annum. Indeed thin-film solar using
nano-tailored ink as the energy absorbing medium is analogous to one of
nature’s more potent processes – photosynthesis. Yes, plants get most of
their energy needs from sunlight - not crude oil. Apparently, the leaders
in this new technology are able to generate electricity as cheaply as coal
if the cost of pollution is factored in.
Even as we get excited about
solar energy today, the developments in the laboratory are even more
exciting. Scientists have now developed material that could absorb
infra-red radiation (heat) and convert it to electricity. The potential
here is mine boggling e.g. air conditioners as we know them may be obsolete
in future.
Although renewables are
relatively small suppliers of energy currently, their rapid growth and huge
potential will erode demand for oil at the margin as their share of total
supply grows. For example the US could generate the equivalent of 6
million barrels per day of oil in its “wind belt” running north-south from
Texas to the Canadian border. If the oil market were oversupplied by 6
million barrels today, the price of crude oil would plunge fairly quickly to
US$50.
This rapid growth in
alternative energy is happening not only in the developed world. China is
now the world’s second largest wind turbine market after the US and the
central government has set clear goals for the exploitation of wind and
solar energy. Renewable energy makes even more sense for China given that
China requires about 80% more energy than the US for every GDP dollar
generated.
Unlike a coal plant that takes
5 years to build or a nuclear one which takes 10 years, and would be useless
if only half completed, a solar or wind generator takes less than a year to
build and could generate electricity even if half finished.
However, can land scarce
Singapore be energy independent? Just like our water supply, there is good
possibility that careful planning and technology will make this a
possibility to a certain extent. Every HDB block is a potential solar
generator not only for the residents but could sell surplus electricity to
the grid. Another possibility for Singapore is to float the solar
generators over our numerous reservoirs or along our sheltered coastlines.
This is what small Denmark, which gets 20% of its electricity from wind
energy, has done. It has installed some of its wind turbines offshore.
Indeed, the world’s largest wind turbine maker is a Danish company, Vestas
Wind Systems.
On a more global scale, the
commercialization of alternative renewable energy has tremendous
implications for mankind. Especially, the rural third world where the main
hurdle to development has always been affordable electricity. Cheap solar
has the potential to make irrigation, mechanization, sanitation and
communication assessable for these people. It has the potential to reverse
the trend towards urban overpopulation and squalor.
Indeed, we see this happening
to rural communities in the US. Sweetwater in Texas has seen a major
rejuvenation in jobs and population after the installation of a major wind
farm. Ironically, farmers in Texas earn more leasing their land for wind
turbine use than from farming. Texan farmers get $3000 per acre from wind
compared to $150 per acre from corn. Wind farming is the most profitable
cash crop.
In many ways, this renewable
energy revolution will dwarf the internet in its potential to improve the
lot of mankind. Looking beyond the current financial crisis, the future is
indeed bright and breezy.
The writer is CEO of financial adviser New
Independent. He welcomes feedback at : josephchong@ni.com.sg
This article is for information only.
Readers should seek independent advice before making any investment decisions
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