Financial Sense Newshour
The BIG Picture Transcription
November 12, 2005
- A Funny Thing Happened on the Way to the Capitol
- Making Conspiracies for Fun & Profit
- Investing in the Circus/Profiting from Chaos
- The Ride of the Federalies
A Funny Thing Happened on the Way to the Capitol
Senator: In the 1970s there was a movie where the lead character gets up and he says, “I'm mad as hell and I'm not going to take it anymore.” Well, I think the American people are rightfully mad as hell, and we're not going to take it anymore. we're mad as hell about rising gas prices, price gouging, and all [the] things that we've seen disgracefully over the past week. We have seen on TV many pictures of people looting stores. Well, I would say that the biggest looters have been the big oil companies. They are looting the American public. There is no way that increased gas prices at the pump could have been reflected in two days after the hurricane, with spikes of 30 to 50 cents per gallon. It is absolutely shameful and unconscionable that big oil companies are making profits off people’s misery with this hurricane. There is no other way to say it, because when the cost of oil drops “a gallon drops” it takes several weeks for it to be reflected at the pumps. So how could this be reflected in a matter of two days? These increases in gasoline prices are unconscionable, and should not stand. The oil companies own the means and costs of production, they have long term contracts on the oil fields, they own their drilling equipment, they own their tankers. These haven’t changed, their costs haven’t changed. That's why their profits are soaring to record levels. Why make profits off people’s misery and cause the entire American public to suffer gasoline over $3 a gallon? Unconscionable!”
JOHN: Well, Jim, that was the circus that ran on Capitol Hill this week, as we sat and watched hours and hours of testimony. What radically became clear is that a large number of our Congress people do not understand the economics of how things work.
Senator: “I hope no member has the audacity to suggest that weakening environmental standards, or drilling in the Arctic wilderness, or any other transparent, political fix will alleviate this energy crisis. The only way to mitigate this impending catastrophe is for Congress, with this great Committee taking the lead, to be bold enough to enact laws that will hold down costs, prevent profiteering off the backs of the American people, and protect those who are hit hardest by increases in energy costs.”
There's that age old call for price controls. It was to a large degree a blame game. and everything was focused on why the prices are high, but very few of the Senators that were there, or others, recognize the fact that this has been a long time in coming. This was not just immediate. You and I were talking about this on the program, along time ago before Katrina ever came roaring through.
JIM: We began writing a series of articles right around the year 2000. Between 2000 and 2002, I wrote Hubbert’s Peak, and what I was looking at is the amount of foreign imports into this country: whether it was oil, or gasoline. It got to the point where we were no longer self sufficient in our refinery capacity and so we now import a [large proportion] of our gasoline from Venezuela, for example. Gasoline demand is up 45% in this country in the last 2 decades. There are a lot more people in the United States today than there was in 1980 in the last energy crisis. There are a lot more cars on the road today than there was in 1980. The cars on the road today are bigger, they have bigger engines, they consume more gasoline, like the SUVs. Therefore we're consuming more gasoline. So, what we have is demand has been going up by decade, and supply has been going down by decade. By supply, I mean domestic production, which has fallen every single decade, going back to 1970, which was the last year the United States was energy independent. So, we don't determine the price of oil anymore. The price of oil is determined in the world markets, and what we have done is cut off supply in the United States. [4:33]
JOHN: How have we done that? We need to lay that out, first of all, as to what we have done to kill the supply.
JIM: First of all is the amount of regulations that have gone into play. We had 325 refineries in 1980, [but] you couldn't make any money in refinery capacity [which] is the reason we only have 149 today. The returns on capital were so poor, that like in any business, unless you're an integrated oil company, if you're losing money in a division, and you continue to lose money you get rid of that business. It's common sense. Why keep something that isn’t making money? And so what we did is we sold off our refineries. A lot of independents closed down, and these were smaller refineries that basically made gasoline, not the large complexes that make all the 30-40 different products. And while we were doing that, we kept adding one regulation after another, one permit after another to the permitting process. So, today There's over 800 different permits to build a refinery.
Senator Sununu: “For our part state and federal regulators have passed a lot of Byzantine regulations that result in about 100 different formulations of gasoline and other fuels to be sold, and we all know no one wants a refinery built in their backyard. And those I think are some of the access issues and some of the regulatory issues that we absolutely need to deal with.”
That was Senator Sununu of Hawaii. The other thing that happened, as we were passing more regulations requiring more permits, we were also allowing State and city governments to say, “you know what, in our neck of the woods we want certain kinds of gasoline blend.” California has its own special blend I call it a filet where you can't burn California gasoline in Arizona, or [have it] go to Texas or go to other States. And John, as many varieties of gasoline as we have right now, we're going to have more varieties next year. [6:53]
JOHN: The difficulties with these varieties is not just that you have to produce them, which is a logistical issue in and of itself, but even in shipping them there, as far as the pipelines or other related issues. They have to clean the lines, in other words, they can't just say, “OK, we're done with that blend, feed the next batch down.” It's a different batch because the amount in the lines contaminates the new batch, with whatever the ratios are of the different ingredients.
JIM: And not only that we have these different ingredients, we've got 50% of our refinery capacity located along the Gulf coast in the path of hurricanes. let's say that you have 7 or 8 refineries [shutdown] I forget how many were shutdown as a result of Katrina and Rita if there was a shortage how do we make up for that shortage? let's say the EPA came in and said, you know what, “we're going to have a new law, and we're going to have one environmental blend of gasoline, and we're going to have one environmental blend of diesel.” If we only had one blend of gasoline, who cares what it is, but think how more efficient a refinery could be if it could run one blend, instead of doing 10 or 15 different blends, depending on the markets that it serves.
Also think if you have a bottleneck, as a result of a storm, in the Gulf of Mexico, you might have refineries in Missouri or refineries elsewhere that could pick up the slack and get the extra fuel to the areas that have been shutdown. But we can't do that today. [8:35]
JOHN: One of the prime examples of this has been what has been going on in Arizona. They have been trying to build a refinery there for over a decade, and this is what they have been up against during all of this time:
“We need only to look as far as Arizona to see the obstacles that the government has placed in front of those trying to build new refineries. The Maricopa Refining Co. received a permit to build a 50,000 bpd refinery on January 16 1992. MRC operating under the name of Arizona Clean Fuels continued to develop its refinery project through the 90s. Because of delays presented by the government it lost a significant investor. In 1999 the project scope was changed and ACF applied for a new permit, and that permit however was lost in red tape as the EPA and other agencies squabbled about whether a refinery could be built on the originally proposed site. The permit application is still under review as the ACF attempts to hit the moving target presented by bureaucrats at the EPA, and Federal regulations. This story is not unusual. It's not an anomaly. It's common. And It's one reason we're facing these shortages. No one is suggesting that we sacrifice environmental stewardship to power SUVs. However, we must face the reality that our economy, whether we have SUVs or not, needs oil to run. And while there might come a day, and I hope this day comes, when we find a suitable alternative to oil and gas, we're still far away from discovering a source of energy that is as potent and reliable as oil. So we must find an environmentally responsible way to increase our refining capacity. We simply cannot go any longer without expanding our capacity to refine oil.”
Remember, Jim, we've been talking for quite some time about a collision between peak oil, and environmentalism, and/or global warming. And then an attempt at a marriage. And here you're seeing the first part of the collision coming in here.
JIM: Another thing that is happening too, as he was addressing, is this is a refinery that They’ve been trying for 13 years to get permits to build. Last week the Senate turned down a measure or bill that would have been brought to the floor that would have got rid of all the regulation and red tape so that we could speed it through. In fact, in the questioning that came out this week of the oil executives, one Senator asked I think it was to Lee Raymond, maybe it was the Chairman of Chevron “how long does it take you to build a refinery?” It takes us 4 years to build a refinery overseas, and about 8-12 years here in the United States. So, if you're going to build a refinery where are you going to build it. Are you going to build it here, like the attempts in Arizona? we're going on almost 14 years now of trying to get permits to build a small gasoline diesel refinery so we can get the fuel, because 65% of oil consumption in the United States goes to transportation. They can't get the permits, and next year we're adding more varieties of fuels to the mix That's going to drive up the price even more. [11:45]
JOHN: wasn’t that the issue, [even] if one of the oil providers Saudi Arabia, or whoever it might be were able to get oil to us, we can't process it, and it'll be just sitting there?
JIM: Yeah, people think we get these ships that come in from overseas, they drop the oil off and take it directly to a gas station. That's not the way it works. you've got to take the oil and get it to a refinery, depending on who’s going to need it, and remember we've got 50 different varieties of fuel. we've got to say, “OK, maybe we've got heavy demand in a refinery in the Midwest, so we've got to put it on a railroad car, and get it over there, or maybe we're going to have to get it up to Northern California where There's a refinery.” Once the oil gets here off a ship, then It's got to be shipped to a refinery, but until that refinery takes the raw oil and goes through the different processes to turn it into a finished product, that oil doesn't do us any good. You can't put unrefined oil in your car, or in a jet airplane, and that is the problem: we do not have any refineries here. And we're doing everything we can while browbeating these energy companies for higher prices to make it virtually impossible for them to build the refineries so we can get more supply. Everybody is talking about increased demand, and we're doing everything we can to shut off supply. [13:20]
JOHN: Jim, let's face it, to a large degree the shut-off here has been due to government regulation. That's one of the key factors in there. So, effectively we have shut off supply. That alone would begin to drive prices up. Second of all, we're now importing, as a result of that shut-off, 60% of what we use, and as a result we are now participating in the world market. The world market sets the price of oil, and also the futures market. As you remember, a lot of what came out of the hearings this week was over the issue of: “Jeepers, I live in Oklahoma, we weren’t affected by the hurricane and blah, blah, blah, but our prices went up as well, That's price gouging.” And they don't understand It's a world market now.
JIM: It's not only a world market [but] the price of oil is set in London, Tokyo, and in New York. And remember, the minute something happens like a hurricane, or a geopolitical event, what do you think these futures traders are saying: “holy cow! we've just wiped out nearly one third of our oil production in the Gulf of Mexico.” What do you think They're going to do to the price of oil in the futures market? They're going to start bidding up the price, because they know that supply has been cut off. So, it is a worldwide market and you don't have special prices for a small town in Ohio. If There's a gas station in Toledo, They're going to have to buy their gas from an oil company that is going to have to go on the world market. If Saudi Arabia says We'll sell you oil but the price of that oil is $61 a barrel, or $70 a barrel the price on, say, September 1st, That's the price you're going to pay if you're a refinery. And you can't go to Saudi Arabia and say, “you know what, since you're only producing oil at a $1.50 a barrel, I only want to pay you $20.” [15:21]
JOHN: It's interesting as you say that, one of the things that really struck me is a clip that we pulled off the O’Reilly factor the other day. He doesn't seem to understand this either.
O'REILLY: But I don't know what the market is or the commodity or the mercantile. These aren't human beings.
JOHN BIRGER, SENIOR WRITER, FORTUNE MAGAZINE: I can tell you, there are no big, long, shiny tables where a cabal of oil moguls are out there setting prices. These prices are set on open markets by traders and investors all around the globe, who are simultaneously bidding or selling and buying oil. And the price…
O’REILLY: Are you telling me the five big oil companies don't buy oil? Of course they do.
BIRGER: Of course they do, yes. But they don't...
O’REILLY: They negotiate the...
BIRGER: But the chairman of Chevron doesn't wake up one morning and say the price of gasoline is going to be $3 a gallon.
O’REILLY: Well, doesn't the chairman of Chevron, David O'Reilly, say to OPEC, "I'll pay you this amount for the oil. This is what I'll pay you"
O’REILLY: He doesn't say that?
O'REILLY: He doesn't control his product?
BIRGER: No, he doesn't.
O'REILLY: All right. That's interesting.
It's just absolutely amazing. You know what it is, John? The United States was once the largest producer of oil. We were exporting oil because we produced so much of it, and we were energy independent. What has not dawned on the average American, or the average Congressman, is that since 1970 the United States has produced less oil and less energy every single year, every single decade, and as a result of that we are importing over 60% of our energy needs. We no longer have the oil clout that we did 30 to 40 years ago when at whatever the United States wanted to set the price, that was it. That condition no longer exists. And we've been talking about the refinery capacity as being one issue.
The other issue is we have basically shut off exploration for oil and natural gas. 85% of the outer Continental Shelf, outside the United States, from the Oregon/Washington coast, all the way down to California, has been shut off to exploration. A large section around Alaska has been shut off. A large section around the Gulf of Mexico, and Florida, has been shut off for exploration. A large section along the Atlantic Seaboard has been shut off. And what is amazing is that the United States right now has about 18 billion barrels of oil reserves in Alaska, and about another 7 billion barrels of oil reserves in the lower 48 States. So the United States roughly has about 25 billion barrels of oil, which is a lot when you take a look at other countries. But here's the significant fact, and what the oil companies have been saying for a long time: we have an additional 11 billion barrels of oil reserves off the Pacific coast; 21 trillion feet of natural gas. Off Alaska we have 25 billion barrels of oil; 122 trillion cubic feet of natural gas. In the Gulf of Mexico we have an additional 37 billion barrels of oil; 244 trillion cubic feet of natural gas; and off the Atlantic coast there are 4 billion barrels of oil, and 33 trillion cubic feet. If you take 85% of [the areas] where the oil is and you make them off limits, and say you can't go there and get the stuff, we [are neglecting] an additional 74 to 80 billion barrels of oil sitting off our sea coast, and in the Gulf of Mexico, that if we would open it up to drilling we would increase our reserves over 100 billion barrels. We could go a long way to mitigating this supply crisis that the world is facing. [19:22]
JOHN: But there doesn't to be the willpower to do that right now.
JIM: The reason is we've had an easy policy in the United States: shut off all access to energy; don't build any energy infrastructure. I call this the Banana-Nimby syndrome. It's basically We'll just import it, either from Venezuela, or the Saudis, or Iran, or Iraq or some other place on the globe, but we won't do it here. And as a result of that, we are no longer energy independent as we used to be, and we are subject to the whims of OPEC.
There was a piece that was released this week by the International Energy Agency (IEA) and it was probably one of its grimmest forecasts. It's called the World Energy Outlook 2005: the Middle East, North Africa and Insights. I just got my copy delivered this Friday, It's about 650 pages, but I downloaded an extract. Basically, the IEA has issued probably its grimmest oil forecast that I've ever seen come out of this agency. It says we better start doing something on oil investment energy investment otherwise we're in trouble, not only here in the United States but elsewhere, especially in the Middle East, where the bulk of the supply is expected to come from.
In this new World Energy Outlook, they raise their long term forecast for oil prices by almost one third, and they painted a pessimistic picture of the future economy if the global use of oil and natural gas isn’t reduced. And the one problem that we have right now that we haven’t had, say 10-15 years ago, is we didn’t have a China and India and when we get into this third segment called How to Profit from Chaos, we're going to talk about the disinformation That's being fed to investors to mislead them. Remember all the stuff you've been hearing in the news about demand destruction [such as] the $3 gasoline, or China’s not consuming as much. In the IEA’s report issued on Friday, entitled Demand Destruction is Overstated, Chinese demand leaps, the IEA said, “Chinese oil demand in September surged almost 9%, led by a huge increase in gasoline consumption of more than 14%.” And they go on, to quote: “it is important to emphasize the widely reported drop-off in demand in the weeks following the hurricanes is overstated. Oil demand growth is rising.” So There's never been any demand destruction. What has happened is There's been supply destruction. And with all the areas where the oil is located and been taken off limits, and then the fact that They're browbeating these companies for not doing anything about it, just goes to show you how little our Congressmen understand. It reminds me of O’Reilly: “you don't tell me the oil companies go to Saudi Arabia and say, ‘you know what, we only want to pay you 40 bucks this week, take it or leave it.’”
That's not the way the markets work. [22:53]
JOHN: Yeah, but we may get to that, only we may have to do it with military force if this scenario plays out long enough. you're going to see some real fights over where things are going as people get desperate.
JIM: The Chinese realize it, and That's why They're going into Venezuela, and elsewhere in Latin America, trying to secure oil contracts. They're trying to secure oil contracts in Africa, and Canada in the Canadian oil sands. They're not stupid, they know what is happening to their economy, and how critical it is. And It's amazing [but] Europe is taking steps to expand wind power in the Netherlands, Germany is using solar, France nuclear energy, China, Japan, and India going to nuclear energy, while we're trying to get laws to shut down our nuclear plants rather than build new ones. I have never ever seen a society that is so self-destructive. That's why Matt Simmons is on the circuit right now talking about how you better look forward to $100 or $200 oil by the end of this decade. Dr. Michael Economides is predicting by next Summer we're going to be looking at $100 oil prices. And forget about all this nonsense about demand destruction: there isn’t any demand destruction. Oil is inelastic. If you have to put it in your car to get to work, you're going to pay whatever price you have to pay at the pump. If you're an airline, and you want to fly across country, or anywhere, you're going to pay whatever jet fuel is. If you're a trucker and you need to put diesel in your truck to get merchandise across the country you're going to pay whatever the price is. Remember, we've got new regulations that are going to drive the price of diesel up to $5 a gallon. And it won't be because of the oil companies, and it won't be because of a lack of supply, it'll strictly be because of more red tape as we add another 5 or more blends of gasoline. By the time this is done, We'll have 57 different varieties of gasoline in this country. I have never seen anything so insane in all my life.
“There is something else. As an industry, when asked earlier, when we started the hearing today, what could be done, we have so many different fuel requirements and specifications from one season to the next across the United States, that one of the things that we feel quite strongly that we need to do, and certainly, I think, that you working here in Congress and all in the Senate, could help us is to a more standardized fuels and get away from the <inaudible> fuels.” [25:33]
JOHN: Obviously, That's one direction It's going to have to go. Of all the drubbing I heard the oil companies take this week, [the one thing] I hear echoed over and over every time I flip on the radio, is It's record profits. And there are record profits, but they are not out of line with what a company makes, around 9%, or something like that. Other companies make much higher profits. But no one ever points out that the biggest profiteer from oil is government itself, right? In the form of taxes.
JIM: here's the amazing thing, and I'm surprised the media didn’t pick up on this. And nobody has picked up on this as far as I know. Immediately following Katrina, when we lost all those platforms the government immediately opened up the strategic petroleum reserve. But they were building the strategic petroleum reserve when Bush started to do this immediately on becoming President of the United States in his first term. He was buying oil for the strategic petroleum reserve in the $20, $30, low $40 price. And when they released that oil they sold it to the oil companies at world prices. In other words, if the spot price was $60, $65, or $70, that was the price that the government was selling oil out of the strategic petroleum reserve. I didn’t hear anybody ask the Congressman, “well, if you're worried about us gouging, why did you guys sell your strategic petroleum reserves into the market place at world market prices, instead of the $20 and $30 a barrel you bought this stuff for?”
JOHN: That would be an oops! A politically incorrect oops.
But you know, Jim, if we look at the total income, say, what the oil companies are making off this versus what government is making off this, What's the ratio, and What's the percentage difference?
JIM: The government makes more than twice as much in energy taxes as the energy industry makes on exploring, finding, and producing energy itself. Think of how the government released tens of millions of barrels from the strategic petroleum reserve, barrels that they paid $20 to $30 which they sold at market prices. They didn’t sell it at what they paid for it, and if we take 1974 to 2004, the oil industry collectively made $640 billion in profits from finding and producing energy. The government, and this is State and Federal, collected $1.34 trillion in energy taxes. We have graphs and charts which show governments’ take on energy versus the oil industry’s. Not once in these hearing did I hear anybody say: “you know what, we're making a lot of money in energy taxes right now, tell you what, we're going to reduce that tax.” And nobody said: “since we're releasing oil from the strategic petroleum reserve, and since we've bought a lot of this stuff at $20 and $30 a barrel, we're going to sell this to the oil companies to refine, under the condition they reduce the price of gasoline, because instead of buying oil in the market at $60 a barrel, we're going to sell it to them at the cost that we paid to put it into the strategic petroleum reserve.” You don't hear that. You want to talk about windfall profits, think of somebody that bought oil at $20 a barrel and They're selling it at $65 or $70, as the government was doing in September. [29:24]
JOHN: What's interesting is all this week we've been hearing the concept of raising gasoline taxes being talked about everywhere, especially as the economy tightens up. Nowhere is there the discussion of lowering gasoline tax, which would obviously lower the price at the pump.
JIM: Yes, It's absolutely amazing because for every dollar of profit the industry makes, the government makes $2.30. So the government makes twice the amount of profit, and yet They're talking about even adding more taxes and regulations to the price of energy, and yet They're beating up on the companies that actually produce it. It's hypocrisy, John. They're beating up on these companies. It's like we're almost in denial here in this country [about] the fact we are no longer energy self-sufficient. We are basically dependent as the IEA report talked about this week their concerns as I wrote here, we are ending up with 95% of our economic well-being on the decisions made by 5 or 6 countries in the Middle East. And yet you would think with this crisis clearly upon us, especially as we head into the Winter months, and with the crisis that we have had in the last 3 months, that they would be stepping up to ramrod this legislation, and meeting with industry officials and saying, “alright, we're going to repeal all the red tape guys, start spending the money, start spending the profits, start building refineries, start building power plants, and let's get this country energy efficient again.” Instead, every single proposal that goes through Congress is thrown out by the nimby and banana crowd as they come in and put pressure on Congressmen. So, no, we're going to do nothing to make it easier to build a new refinery. we're still going to make 85% of the [areas] where the oil is off limits, and so you can't get to it. The only energy policy we have right now is to look and beg for oil from 4 or 5 countries in the Middle East or Hugo Chavez. That's it. That's our energy policy. [31:44]
Making Conspiracies for Fun & Profit
JOHN: Well, with a hi-ho, a deep breath and a sip of water we're off to Segment 2. You actually brought us right to the doorstep of Segment 2 here of the Big Picture today, Jim. That is the issue of national security because as desperately as things are going, the concept of not having control over our oil and energy, which runs our armed forces and our economy, and parts of the power grid etc., means we are putting ourselves in dire straits. There is a bigger danger, a bigger green dragon over the hill. Now, if we were to make a conspiracy for fun and profit, say we got tired of played whist one night, and you and I conspired to undermine a country and we're not saying there is a conspiracy by the way what we would we do to cripple the United States, Jim? I'm going to let you put your fiendish brain to this one.
JIM: let's take a look at what runs an industrial society: It's energy. you've got to have energy if you want to produce food, the fertilizers are made from natural gas; the tractors and combines that enable farmers to farm large tracts of land run on diesel fuel. Once you collect the harvest, you have to transport it so you've got to once again put it on a truck and get it to a storage facility. So from producing food to producing goods everything we do in our society takes energy. So, if you want to cripple a country take away its energy independence, or make it totally dependent on somebody else. You lose your economic destiny to some extent. Last September was the highest trade deficit on record, John. Our trade deficit was $66 billion. So, even though the cost of energy went down as we have to import more gasoline in this country, more oil, more natural gas, and the price goes up, it costs us more and we no longer control our economic destiny.
let's suppose we are the greedy oil companies and 1980 the price of a barrel of oil was $40. Over the next couple of years as Reagan got rid of all the regulations, got rid of a lot of the windfall profits tax, and got rid of all the things that were hampering domestic production, the price of energy came down from almost $40/barrel to almost $10/barrel. In fact we had a crisis in Texas in the mid-80s because oil prices plummeted. Now, this is what always gets me and somebody get this to Bill O’Reilly because he needs to get educated here if the oil companies were this big greedy cabal that controlled the world oil price I mean O’Reilly is thinking back to the turn of the century when John D. Rockefeller and Standard Oil controlled the oil of the world. That's no longer the case.
Another point I'd like to make is if the oil companies really did control things then why did we have an almost 22 year bear market in energy. let's suppose now, going back to the early 80s, the price of oil has dropped from $40 down to $10, and you and I, John, both run major oil companies, and we get together along with all the other major oil companies in a smoke-filled room, we're smoking our cigars
JOHN: some place like Jekyll Island?
JIM: Yeah, Jekyll Island. OK, and we're at JP Morgan’s hunting lodge and we’re saying, “OK, how can we drive up the price.” Well, one of the ways to drive up the price is to enact a bunch of legislation and take supply off the market. So, if we can restrict supply, then There's not much of it and that would mean the price would go up. [35:54]
JOHN: But you can't do that directly, right? You can't say you're going to cut off supply because there would be this revolt, so to speak.
JIM: Yeah, and you couldn't say, “OK, we've got a whole bunch of stuff in inventory, and we're just going to withhold it from the market.” You couldn't do that. We would have to do something more subtle. So, let's take not only supply off the market, but let's say where ever the oil is, we pass legislation and take it off limits, so you can no longer explore for oil in this country; you can no longer explore for natural gas in this country. Then what We'll do is We'll pass 800 different permits and regulations so you can't build a refinery. it'll be so costly that nobody would want to build one, because We'll just have red tape after red tape, and then allow all these frivolous lawsuits, so that it will make it virtually impossible to build a new refinery.
Now, let's say we've got two different varieties of gasoline, and we allow everyone to come up with their own gasoline mix. Then We'll also make it virtually impossible to build a power plant. You won't be able to build nuclear power plants, We'll just scare [everyone] and say if you build one of these you'll all be glowing in the dark or something. Then We'll make it impossible to build a pipeline, or if we do then it will be so costly with the permits and time delays, it may take you a decade to build one. So what We'll do is restrict access to exploration for oil; We'll restrict access to exploration for natural gas, We'll take 85% of where it is off-limits; then We'll make it virtually impossible for you to build a new plant or new refinery, such as we did in Arizona which tried to start one in 1992, and It's 2005 and they still haven’t got past the permit phase. Then what We'll do is pass all these environmental regulations, and We'll make it impossible to build even a natural gas terminal. Now, if I was in the oil industry and we were doing that, I couldn't ask for a better group of friends than I have in Congress because think of what They’ve done. They’ve taken supply off-line. They’ve made it impossible to build a refinery, That's why most existing refinery expansion that we've gotten in the last 7 or 8 years is basically expanding existing facilities. [38:46]
JOHN: The States have to take some responsibility for that too, depending on the local rules and regulations.
JIM: Yes, but we just allow it. And here's a good example, we just passed an energy bill that allows the government to override States when it comes to energy security. So, for example, They're trying to build a natural gas LNG terminal in Long Beach, and the minute that we pass this law California immediately files a lawsuit against the Federal government. So It's now in a courtroom which if it gets thrown out of this court the government plans to take it to an even higher court. But basically the Federal government has got to override the State, and say, “look, we can't have this nonsense where every State gets its own blend of gasoline, and every State makes it impossible to drill or explore for energy, and for that matter put in an LNG terminal, or build a power plant.” It's like that one cut where [the Senator] said: “nobody wants a refinery in their back yard.” So what the President is proposing is OK, we don't want them next to large Metropolitan areas, let's take abandoned military bases, places out in the desert, places away from major cities and let's build a refinery. But They're stopping that too. But if you and I were sitting there back in 1984, when the price of oil is around $10 to $20 a barrel, and we were trying to drive the price up, John, I couldn't think of a better conspiracy. [40:17]
JOHN: I would have thought you would’ve cackled more as you did this, you know, nyaaahahaha, here's what we're going to do. Or at least you could have passed out the cigars.
JIM: Yeah, passed out the cigars, and if you think about it That's exactly what has happened. And very rarely is the fact mentioned there was a debate on O’Reilly, and one of the guys was trying to point out to O’Reilly that we haven’t built a refinery, [O’Reilly ]“I've heard those arguments, I don't want to hear that, I don't want to hear that.” Well, guess what folks...[40:45]
JOHN: Sorry to confuse you with the facts.
JIM: Confuse you with the facts, but if you have what is it? 50 or 60 million more people in the country than we did say 3 decades ago, if demand for gasoline has gone up 45% because we've got over 200 million cars in this country compared to 3 decades ago, when I think we had 100 million or whatever that figure was and yet you don't build a refinery, and you're not allowing the drilling of oil, then the net result of that is production has declined, as you can tell by taking a look at the increased imports into this country. If you were to ask for a conspiracy of how to drive [up] prices, look no further than to Washington, DC. Between Washington, DC and then allowing basically environmental laws and groups to run wild all over the country, this is the mess that we're in.
It's amazing that we've got the IEA out of Paris this week, and I'd recommend anybody who wants to get a hold of it to go online and Google for the World Energy Outlook 2005. It is simply sobering as you look at this, and it lines up with a lot of things the experts we've had on this show, from Matt Simmons to Michael Economides to James Kunstler, all of these [showing how] we're dealing with denial. The only thing we can do is pander to the crowd and come up with the simplistic solution that the reason oil prices are up at $3/gallon is because of these greedy oil companies. let's just forget the fact that we made a fortune selling oil out of the strategic petroleum reserve, or that out of every dollar you pay for energy the largest profiteer is government not the energy industry itself. You couldn't build a better scenario. [42:46]
JOHN: And remember by the way, under questioning this week in Congress, Exxon for example gets the bulk of its sales overseas, and not in the US, and That's another factor people aren't thinking about.
JIM: Yeah, just slap a windfall profits tax and We'll have a repeat of what we saw in the 70s and 80s. What will happen is Exxon, and the other oil companies will stop exploring, and drilling here in the United States, and what They'll do is just import because the imports that come from Saudi Arabia or Venezuela or Nigeria or Iran, or Iraq will not be subject to a windfall profits tax.
Investing in the Circus/Profiting from Chaos
JOHN: Jim, I have a question. What were you doing in there anyway?
JIM: Doing in where?
JOHN: Well, you guys were in your little war room this week, and I didn’t have time to place the bug that I usually put in there so I could hear what you guys were saying. we're in the next segment here, called investing in the circus, so obviously this has something to do with it. What you guys were talking about in there?
JIM: Well, there were a bunch of us. Our entire investment staff and some outside consultants got together for a whole day session on Thursday to map out our investment strategy in terms of what we see unfolding over the next 6 to 9 months. I sort of gave a heads-up on last week’s program.
One of the segments that we spent some time on was energy. There has been a lot of disinformation that has come out on the energy markets ever since Katrina. I think it was done deliberately to drive the price of energy down, because you heard a lot of this in terms of demand destruction. That is, the higher prices were driving demand down, people weren’t driving as much, there was less demand for energy. Then we saw stories come out that China wasn't consuming as much energy. Then you saw reports that the weather was going to be warmer this Winter. You know the first two weeks of November are Winter; I hate to tell people but the storms and the snow really come around Thanksgiving and go all the way into January and February.
So, there was a lot of disinformation out there, and we became highly [suspicious], and in fact were on record in the energy segment of this show back in September there was a lot of hot money that ran into the market. I became suspicious of that, but then we saw this big fall out in energy prices in October. A lot of that was the hot money moving out, a lot of it was the fall out from Refco, but a lot of it too was disinformation that was being fed through the media to the public which was saying that demand was going down, supply was going up and we had warm Winter weather. Well, we were gathering information we're basically a fundamentals shop where we look at fundamentals, and then we buy based on technicals we take a look at the figures you heard, that demand was down year over year, [but] we found as we did some research that it was based on refinery output. In other words, when you compared what the refinery outputs were from September of this year to the year before, you've got to [take into account] that 15-20% of our refinery capacity was taken offline in September. So, they were measuring demand based on refinery output. Well, that was a totally bogus number because you had a lot of your refinery [capacity] taken offline. And then also, we heard and you hear this often “well, demand is slowing globally” which was not be consistent with the reports that were saying that the economies in Europe and Asia were looking stronger. It's amazing that on Friday the IEA, out of Paris, issued a report that said demand destruction is overstated, and that Chinese demand is leaping. [46:56]
JOHN: As I'm understanding this, you and your think tank began investigating a lot of the same materials ahead of time, and your conclusions were different than say a lot of what we heard coming down the mainline pipes this week.
JIM: Yes, prior to this meeting everybody was to come up with material. I had a bunch of information I was looking into. I ordered the World Outlook from the IEA, and got that downloaded, all 650 pages, and obviously I didn’t get through the whole thing, but I cruised through it. Frank Barbera was also there and he had information.
And so we got together and the first thing that we saw, and I checked with NOAA, I checked with AccuWeather, and of course I get the Browning newsletter, and everything I was getting from the weather professionals was saying, “no, this Winter is going to be cooler than normal.” In fact, I quoted Evelyn Garris who basically said throughout this Winter, cold fronts are going to collide with abnormally warm, wet ocean air, and the East Coast will be buried in snow. Additionally, the wind chill factor of these storms are going to lower the temperature and raise heating bills. AccuWeather said the same thing. NOAA said the same thing. So, the only thing that happened was that there was a weather report that said November 11th to the 17th we'll get a warming trend that will last briefly. The markets and CNBC seize on this, and they go, “warmer than normal Winter,” and the traders seize on this, and they start bidding down the price of oil. And guess what? the latest forecast is cold weather returns next week. So, everything that we were investigating on the weather front told us we are going to have a colder than normal Winter.
The second thing we looked into was the demand destruction. They were measuring it based on refinery output, and so we came to the conclusion that if your refineries are offline, obviously you're going to have less output in September and October of this year, than you did the year before, because when your refineries weren’t offline your production wasn't offline. So, we were looking at the demand destruction, and then getting confirmation from what we were seeing from the economic numbers from overseas. The economy was stronger in Japan, and Asia, so that if their economic growth rates are going to be higher why would their energy consumption go down? That wasn't adding up, and so when we got the IEA agency report on Friday, it just confirmed for us that, no, there hasn’t been any demand destruction. In fact, demand for energy is actually accelerating. [49:40]
JOHN: Are there any other tip-offs or clues that you noticed?
JIM: The other thing that we saw is in the last couple of months and in fact when I interviewed Larry Williams, he made a comment during that interview too is what you've had in the last month is speculators in the futures market have gone short energy, [with] one of the largest short positions by short term speculators. At the same time, the Commercials, who are the users, and producers of energy, have gone especially long. So, the smart money is long natural gas, the smart money is long heating oil, and regular oil, and the dumb money is short.
Another thing that we began to see, not only were the Commercials going heavily long the energy markets, but there was something else that Frank Barbera brought up, and something I've seen.
A lot of times I will go in the Options Market and buy options on a stock because I can leverage my position if I think there is going to be a strong movement. let's say there is an oil stock right now, We'll call it ABC Oil, and They're selling at $80 a share. If I want to buy $100 shares of ABC oil, it will cost me $8000 (100x$80), but let's suppose I want to leverage my position, in other words I want a big bang. I think ABC Oil is going from $85 to $95 a share. That's a nice profit in a short period of time, so if I have bought a stock for $80 and sold if for $95, That's almost a 19% profit. But let's suppose that I want to leverage my position and make even more money. Well, I could go into the options market. I could buy options at $85, or options at $90, so that would cost me less money, and I could control more stock. But what we started to see was normally if a stock is selling at $80, usually most of the option activity of your average small term trader is two strike prices away from $80 your first strike price might be $85, your second might be $90 and so you would go into the options market and buy let's say an $85 call, or a $90 call. Now, another way to play this market however is to go into deep money calls, and go into a $40 or $50 call which would be $30 in the money. What I could do by doing that is buy twice the amount of stock or control twice the amount of stock. So for $8000 I would control 100 shares of stock if I wanted to buy an $80 stock, and pay cash for it. If I bought a $50 call however, what I could do is with the same $8000, I could control 200 shares of stock for the same money. So, instead of my profit being 19%, by leveraging, my profit would be 38%.
Now, let's suppose I want to leverage it even further, while I'm buying the $50 calls, I may be turning around and selling $50 puts, and what I can do by selling a put is get money, because I'm guaranteeing the price if the price of the stock drops. Then what I do is I sell my puts. I take this money and I put it on buying the calls, so instead of controlling let's say maybe 200 shares of ABC Oil I now control 300 shares. So if ABC Oil goes up 19% on that same $8000 investment plus the money I get from writing puts, which is free money to me, then what happens is I can almost triple that rate of return. This is how you can use derivatives to increase your position.
The point I'm making here is that what we began to see is that most of the trading activity was occurring in the deep money calls on certain select oil stocks, and you don't see this very often that is the smart money saying, “you know what, we think this oil sell off is overdone, so what we're going to do is we're going to speculate on this, but we're going to want to leverage our returns because we want a big bang for our buck, because we think as we head into the Winter months the evidence that we've looked at tells us the weather is going to be colder than normal. That means natural gas prices are going to go up, natural gas will lead oil and We'll take positions.” So, certainly, for natural gas companies the deep money calls were huge contracts where you might see maybe 1000 contracts in open interest on say an $85 strike, or a $90 strike, when you look at the $50 deep money, you're seeing 10,000 and 20,000 contracts. So, what this was confirming to us is that the smart money crowd the Commercials were not only going heavy the energy market, but also the smart money was also doing deep money calls on stock, and leveraging their positions. So this confirms for us the misinformation about energy: none of the fundamentals made sense.
I had a laundry list of ten things that we were looking at fundamentally. Every one of those ten things was in perfect alignment, for a strong move in energy. And so what we did is we took a look at a confirmation of not only the Commercials moving heavily long energy, but also what was occurring on the equities’ side, going into deep money calls put activity on put options which were far from the current price of the stock. There was heavy activity there. So that matched up, especially when you talk about hedge positions that a fund would take if you were going in and leveraging yourself. You might want to hedge on this. So it could be either the funds hedging themselves by buying puts, but it didn’t make sense because they would have the put buying at prices at one or two strike prices away from the current price of the stock. But this confirms once again the direction that we have a strong move in our prediction of energy in the next 2 to 3 months. [56:43]
The Ride of the Federalies
[sound of helicopters]
JOHN: And to the rescue of this situation up in the air It's a bird, It's a plane, no It's the Federalies. How is the Fed going to respond in the few months to come, especially as helicopter Commander Bernanke assumes control of the fleet?
JIM: Well, there was a Federal Reserve press release on Friday. Beginning on March 23rd 2006, the Board of Governors of the Federal Reserve system will cease publication of the M3 monetary aggregates. [57:22]
JIM: They're not going to report it anymore. You know, they don't want to show the trail of helicopter money. It's amazing because if we take a look at a graph of M3, [it shows] since August, that M3 has grown by almost $300 billion. It's growing at an annualized rate of over 12%. And one of the things That's happened while the Fed has been raising interest rates, They’ve been injecting money into the financial system to make sure It's kept liquid, and one of the ways to alert the market that we're creating a lot of money is the M3 aggregates. The definition of M3 is basically M1, M2 and consisting of institutional money funds and certain managed liabilities of depositories, namely large time deposits and repurchase agreements. When the Fed really wants to tinker with the money supply it'll go into these repurchase agreements in euro dollars. And voila, they're no longer going to publish it. So, we're no longer going to have a monetary trail of what the Fed is doing as it inflates. What we're doing is we're looking into measures in which we can track it all, and I'm sure I'm going to talk to John Williams, and we can do it either here, or internally, but we will be tracking the money supply. But the Federal Reserve is no longer going to report it, as helicopter Commander becomes Chairman of the Fed.
We know we have doctored CPI numbers, doctored unemployment numbers, doctored productivity and GDP numbers, but [at least] you could follow the money supply. For example, when everybody was talking about deflation after 2001 with the recession, with the stock market’s bear market from basically 2000-2002 when the NASDAQ lost 75% of its value. Everybody was talking about deflation in 2003, when in fact the drop in the consumer price index was done statistically. Instead of new car prices it was used car prices. While everybody was buying new cars the price of used cars was plentiful [and so] their price went down. Instead of measuring the cost of housing which was going up at double digits a year, they were talking about measuring owner’s equivalent rent, and rents were going down while housing prices were going up. So the drop in the CPI in 2003 was basically a result of changing what it was that we measured. Because if we go back to January 2001, from January 2001 [and look at the] money supply, we were literally printing almost a trillion dollars a year. We were flooding the markets with money. As a result, interest rates came down, money became plentiful so if you wanted to borrow money for a loan equity loan, furniture loan, car loan it didn’t matter what you wanted to do, the money supply kept growing. And they were really pumping out the money and credit as the US began to borrow I think on average $7 trillion a year. So, beginning next March 23rd They're no longer going to publish the monetary aggregates, so you can't keep track of it. That tells me they are planning a massive reinflation. As we come off the housing bubble, We'll be turning over. The stock market will be turning over, the economy will start turning over and we're going to begin the next reflation.
Of course, the other thing we laid out in this game plan and war scenario over the next 6-9 months we basically laid out our game plan for the next 12 months which We'll sort of be feeding periodically through the Big Picture and It's just amazing we got two confirming pieces of evidence on Friday that confirmed our war theories, in terms of where the market and economy are going: one is the IEA releasing on Friday that demand destruction is overstated basically they said It's a crock that somebody is feeding the market; the other is the Federal Reserve announcing they are no longer going to be measuring M3. [1:01:50]
JOHN: And That's so no one can follow what They're doing. It's very much like in the field of education they have renormed the SAT scores every so many years, so you can't tell how badly education has been failing the American public. It's the same game.
How hard is that [M3] going to be to regenerate. What will we call it the P3 index, the Puplava 3 now?
JIM: No, we're going to continue to measure the M3, because we're going to keep track of it. you're just going to have to put it together as a puzzle. What I suspect they're going to do is come up with some new measure that will sidetrack people like, for example, the inflation numbers are rising. It's obvious to everybody we've got inflation. But every time we have a jump in inflation whether It's September, October in the CPI numbers, or the PPI numbers, or the import prices it doesn't matter, whatever it is you're looking at if you take a look at the last 3 months, annualized, we are growing at double digit rates in price increases at the wholesale level, at the retail level, consumer level, and at the import level. But every time we come out with these whopping, big increases in the inflation rate, we always go back to this statistical nonsense number called the core rate. What I suspect They're going to do is come out with a new monetary measure that They'll keep the markets focused on to distract them, like the core rate. They're going to come out with something knew and say, “well, you can't look at M3 anymore, It's no longer relevant, we no longer follow that, since we're inflating the heck out of it, but what we want you to focus on is our new, improved monetary measure that says There's no inflation.” [1:03:26]
JOHN: Ignore that man behind the curtain. That's exactly what it sounds like from the Wizard of Oz.
JIM: Yeah, ignore What's going on. I am just absolutely amazed at this. So, once again let's just [regard this as] another confirming piece of information that They're getting ready, and preparing for, the next major reflation. We expect that will start taking place by the time we get to the Summer of 2006. [1:03:56]
JOHN: What's that going to do to the housing bubble That's already underway?
JIM: I think eventually They're going to reinflate the housing bubble. you'll see it come down, but They'll inflate it. They'll talk about low inflation [though].
After our meeting yesterday, I took Frank Barbera and myself to visit Big Sky Ranch because I'm working on the final installment, Part IV, of The Day After Tomorrow, which I hope to release by Thanksgiving. And Frank was always curious and he said, “I've got to see this Big Sky Ranch you keep writing about.” I took him through this area we call Big Sky Ranch in my Day After Tomorrow and I just showed him the stuff that was going [up there], they have 1500 condominium units that are being built all at once. I mean it is just nuts. And I think what is going to happen is over the next couple of years, you may see the average price of a home, like in California, the median price will be a million dollars. It won't mean anything. Frank was telling me in his neck of the woods, There's a home that was built 40 years ago, so obviously it has plumbing and electrical problems. It's about 2200 sq.ft. but it is going for $1.5 million. So, as crazy as some of the things I was showing Frank at Big Sky Ranch, he was saying this looks moderate compared to where he lives up in Los Angeles.
And so, what I suspect is going to happen is the next reflation and it'll be coordinated globally, because Europe is going to need to reflate, They're doing it now, Asia is reflating the money supply in China is growing at about 18% a year and so they are going to continue to do this. And it'll be a coordinated effort. In the meantime, what We'll do is remove some of the ways that we measure it by no longer reporting it. [1:05:37]
Unfortunately, John, what we're saying is just confirming what we hatched out in our war room on Thursday, and with these two pieces of information getting rid of reporting on M3, the IEA talking about there is no demand destruction, in fact oil consumption is accelerating. Why don't we just end it [by saying] energy is going to be a great bet over the next 2-3 months, and We'll be having further guests on the program that will be confirming it. This isn’t the last time We'll touch upon this topic.
In the meantime, on behalf of John Loeffler, and myself, We'd like to thank you for joining here on the Financial Sense Newshour, coming up next week my guest will be Ike Iossif whose guest will be Joe Myers. [1:06:26]