Financial Sense Newshour
The BIG Picture Transcription
November 25, 2006
- The Perfect Investment
- FSN Follies: Monkey Business
- Q3: follow the money
- Other Voices: Zapata George Blake
- The Energy Sector: a changing landscape
- Fishing for Juniors: where to look, how to buy
- Other Voices: David Cohen, TheOilDrum.com
- Taxes & Inflation: the scourge of the middle class
THE PERFECT INVESTMENT
JOHN: One of the themes we keep thumping here on the program tends to be that of investing for retirement. Everyone knows we need to plan for retirement. We know the governments of the West � a lot of them � will be in very hard straits in just a few years trying to keep up with all of their promises to retirees. As a matter of fact, they won’t be able to keep them, they’ll have to renege on them one way or another.
When you talk about investing you look at the stock market � there’s all of this noise and babble going on out there. The field is very complicated and complex, and it can be really daunting to someone who wants to invest. So there must be a better way and that’s what we’re going to look at right now, Jim.
JIM: What we’re talking about is the perfect investment. And quite honestly, there’s nothing out there that’s going to be the perfect investment. For example, you can invest in a Treasury bill, which has the safety and guarantee of the US government. There’s no price fluctuation in a Treasury bill, and you’re going to get a fairly decent rate of return. But the problem with that safe investment is the principal doesn’t appreciate, so it’s not keeping up with inflation, nor does the income. And if you look at the after tax rate of return on Treasuries today, they’re not even keeping up with the rate of inflation. [1:29]
JOHN: Let’s say we’re looking for the theoretical, utopian investment � the perfect investment � it obviously is going to have certain characteristics that we would be looking for.
JIM: Probably the first and foremost in people’s minds would be safety of principal. Obviously, people don’t want to lose the money that they invest, so something that would give you a reasonable degree of safety would be one criteria. Another criteria is going to have to be appreciation: both appreciation of principal � so if you invest $10,000 in a stock or some kind of investment, it’s going to be worth more 5 or 10 years down the road; and also an increasing income stream. So safety of principal, and appreciation in income, is probably going to be the closest thing you’re going to get to a perfect investment. [2:22]
JOHN: Going back to your T-bill example, we probably have safety of principal there, but we don’t have any of the appreciation characteristics.
JIM: Yes, you don’t have the appreciation characteristics and that’s one of the problems most investors are going to face in retirement because people are living longer today. It used to be 20, to 30 years ago somebody retired at age 60, they lived to age 70, and that was it. Today, people are living into their 80s, and 90s.
JOHN: Yes, my mother is 91 currently.
JIM: So given the statistics, when your mother retired she shouldn’t have lived till the age of 91, but with improvements in medical technology, better diets today, people are taking care of themselves and people are living longer � so their investments are going to have to last over a longer period of time. So one of the problems you’re going to be dealing with in trying to find a perfect investment is something that keeps pace with inflation. [3:20]
JOHN: So far, is there anything that comes close to the perfect investment? Is this a realistic, real world type of thing?
JIM: The perfect investment really doesn’t exist. I mean you’re not really going to find anything that gives you safety of principal, doesn’t fluctuate, appreciates in income and appreciates in principal. So that investment doesn’t exist. But what you can find which comes close to it, is a good dividend paying blue chip stock. A company that’s been paying dividends for 25 years is a business that is pretty sound, and has a good business model that would give you some degree of safety in the fact that you know this company has been around for a long period of time, they’ve ridden through recessions, and boom and bust markets. And so that should give you some degree of comfort that you’re going to have safety in the sense that the company is not going out of business.
Secondly, if you get a good dividend paying blue chip stock, you’ve got a couple of other characteristics. If they keep increasing the dividend � number one � you have an inflation hedge on the income side; and number two, as it increases its dividend, eventually the stock price is going to go up. That’s because, as the dividend yield keeps going up, if the stock price never went anywhere the dividend yield would get to be so high that it would just attract a whole bunch of people that would come and would try to buy that investment because of the yield. [4:48]
JOHN: Let’s take a dividend and a Treasury note and compare these two things.
JIM: Alright, let’s take a Treasury note, today you can get a 10 year Treasury note, and let’s say you invest $10,000, today the yield on a Treasury note is roughly 4.56 � let’s just round it off to 4.6%. So if you were to invest $10,000, you’re going to get $460 in income. Fast forward, 10 years from now, to the year 2015, you’re still going to be getting the same $460, because the interest on that Treasury note is fixed. And then when the Treasury note comes due, you’re going to get $10,000.
Now, let’s contrast that to a stock that is going to be paying a 3% dividend yield, but has the ability to increase that dividend 10% a year. There are a number of companies out there that you can find that not only have good dividend yields that are higher than the market, but also have a history of increasing those dividends over a period of time. So if you got a 3% dividend yield today, at a 10% growth rate, that 3% dividend would go to almost 8% 10 years from now. So on your original $10,000 investment, instead of getting $300, you’d be getting $800 in dividends 10 years from now � versus the Treasury note which would only be paying the same 4.6% (or $460).
And the chances are, if that dividend yield stays about constant � in other words, if the stock carries about 3% dividend yield � as that dividend rises, along with it is going to come appreciation in the price of the stock. And we’ve got a number of companies that have done that, and what has happened over that 10 year period as they’ve increased their dividends, the value of the stock has gone up two- and three-fold. So the chances are your $10,000 investment is going to be worth 30 or $40,000, instead of the $10,000 from the T-bill. [6:55]
JOHN: Assuming that’s the mechanism that we’re looking for, how do you find these great dividend-paying companies out there? What should I be looking for?
JIM: The chances are you’re going to have to stay with the stocks in the Value Line 1700, or the S&P 500. So you’re going to want something that is going to be blue chip oriented. And one of the things that you can get � and you can find this in any public library � is a copy of Value Line, and you’re going to get almost 20 years of dividend paying data. So you can take a look there over a 20 year period and see this is what the company paid 10 years ago � in fact, Value Line will even give you the percentage growth rate on dividends over a 5 year period, 10 year period historically; and then they’ll also tell you what their projections are going forward. So you can look at Value Line or S&P. [7:44]
JOHN: Obviously, if you find the company you’re going to have to have certain criteria to tell us what kind of quality we’ve got in this company.
JIM: I mention the word quality because what you’re looking for is a high quality company, with a high current dividend, and a high growth rate of that dividend. And one of the first criteria you’re going to look at is financial strength. You want a stock that has a very low debt ratio, because what happens is we all know the economy goes through boom and bust cycles. We go through booms, then we have recessions. And if you don’t have a lot of debt, what happens is it enables a company to weather a recession much better than a company that is highly leveraged. In fact, companies that have a low level of debt usually strengthen themselves during periods of recession because they have good cash flow, they can use that cash flow to increase their dividend, or they can buy out weaker competitors. So financial strength is one of your first criteria you’re going to be looking at. [8:47]
JOHN: This takes me back to what we said earlier, you’ve got Average Joe on the street, and you throw a financial statement at him � he may or may not know how to read them, or know what that even means. So what do we do now?
JIM: First of all, you don’t want to have a company that has a high debt ratio. And I don’t like anybody that has a debt ratio greater than 50% - in other words, debt to equity. But there are a lot of ratings agencies out there from Standard & Poor’s, to Moody’s, to even Value Line; and really what you’re looking at is a company that has a BBB+ rating from Standard & Poor’s � meaning its investment grade is BBB to AAA; or B+ minimum, if you’re looking at Value Line’s.
So if you don’t know how to read a financial statement, there are rating agencies � and if you can go to either a Value Line, or a Standard & Poor’s sheet on a company, it’ll give you its credit rating. Usually, if you see BBB+ or greater, or B+ on Value Line, that tells you that you have a company that has good financial strength. [9:51]
JOHN: Is there anything else we should be looking at as well?
JIM: You want a company that has good strong cash flow. Because remember, it’s that cash flow that is going to fund both the dividends, and also to keep the company growing and doing very well, because companies have to reinvest in new plant and equipment and expand. So what you want is a company that has good strong cash flow. And secondly, that doesn’t have a high payout ratio. Let’s say that the company makes $1 in profits. You want a company that’s maybe paying out no more than 60% of its earnings in profits. So they would pay only 60 cents, the rest is reinvested in the company to modernize plant and equipment, hire great personnel, and reinvest in the business. And also expand that business by buying weaker competitors, expanding in new lines of business � so that they continue to keep growing. Because remember, the bottom line is you have to keep increasing sales. Increasing sales generates greater profits, greater profits generate greater cash flow � and as a result of greater cash flow you’re going to get greater dividend payments. [10:58]
JOHN: You own something that has a high yield to it, but there’s always a rule of thumb: high yield, high risk. What about risks entailed with that?
JIM: You can look at some of the automobile companies whose dividends are in danger, where the yield is very high but that tells you it’s more likely to be cut. So what you want to do is look at the dividend yield compared to the industry. If the industry is paying a high dividend, for example, like a utility, then you know you would compare the industry norm first. So if the dividend yield is 3% for the industry, and you’re looking at a company paying 5% that should be a red flag telling you, “wait a minute, this company is paying a dividend yield almost 60% higher than everybody else.” That would cause you to maybe create a word of caution.
Generally, as a rule of thumb, you want to look at the industry first. Take a look at the industry by comparison, so that you know that it’s not out of line.
Secondly, you want to look at a stock or dividend yield that is usually 150% above current market yields. And right now, if we’re taking for example, the S&P 500, you’re looking at a dividend yield on the S&P that’s roughly 1 �%. So if you take 1 � times the market average for the S&P which is 1 �, you’re looking at a dividend yield of 2.6% or greater. If you’re looking at the Dow, which is really the big blue chip index, the Dow’s dividend yield is roughly about 2.16. So 1 � times that would be a dividend yield of about 3 �. So that should be your starting point.
And then, once again, comparing the dividend yield against the industry itself. So those are two criteria that you could look at in terms of your starting point. [12:47]
JOHN: So if we had to sum this thing up in a bullet form fashion, we’re going to go for investments that yield dividends � A, B, C, D?
JIM: Ok, you want to look for a company that has a long standing track record of raising dividends. That should tell you about the stability of the company and the products or services it provides.
Secondly, you want to take a look at a company that is financially strong. So you want to look at a strong Standard & Poor’s or Value Line rating of BBB+, or B+ rating by Value Line � as a minimum.
Third, you want to look at a company that has good strong cash flow; a good history of raising its dividends and earnings over a 10 year period, because in that 10 year period you’re usually going to incorporate a business cycle, so you’ll see how well they’ve done in a recession as well as how they’ve done in a recovery. And then you want to look for integrity of management.
But basically strong cash flow, financially strong, a history of raising dividends. You want to look at a high dividend yield compared to the rest of the market. And then look at a history of that company over a period of time. Some say 25 years � but certainly 10 years as a minimum. [13:56]
FSN FOLLIES: MONKEY BUSINESS
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Q3: FOLLOW THE MONEY
JOHN: Time to take a look at Q3, the third quarter. Obviously, some people were making money. Where were things happening?
JIM: What was really surprising, when you look at the number of companies reporting here in the US, is that the profit picture looked pretty good across the board. Obviously home builders in some of the other areas that are subject to a weakening economy have not done as well.
But if you start out with, for example, earnings surprises, who was doing better than what the analysts expected? And there were two sectors that really stood out in the third quarter. One of them was energy which had a 71% positive surprise � in other words, the earnings exceeded analysts expectations. And the other industry, surprisingly was utilities, who had collectively as a group 70% of the companies reported exceeded expectations. So those were two areas that were not expected to do as well that really surprised analysts in terms of the earnings that they were producing. Because remember, in the second quarter, and especially as we got into the middle months of August as the price of oil began to come down with Goldman Sachs changing its index, and then also the benign hurricane season � people were thinking with $60 oil that these companies aren’t going to be making that much money. But surprisingly, they made a lot of money. [16:43]
JOHN: Are there any other groups that stand out in your mind?
JIM: The capital goods sector was doing very well: a 54% increase in positive results exceeding expectations, and that happens to go along with a strong capital goods export sector right now, especially with a weakening dollar. Consumer staples are an obvious one that people missed; and then also technology companies exceeded expectations at a 71% rate. So there were 3 sectors that really stood out with positive earnings surprises. [17:56]
JOHN: Let’s do a comparison here. Let’s take a look at what those surprises were, and do some projection forward if we could as to what we’re expecting those to do in the future.
JIM: What’s really surprising is not only has the energy sector outperformed and provided the bulk of profits in the S&P 500, they continue to surprise analysts every single quarter � that has been the case now for almost the last 3 or 4 years. Just as analysts have underestimated the price of oil, they’ve also underestimated energy earnings. But what really stands out right now is if you take a look at the forward PE ratio � meaning what are earnings 12 months out going into next year � once again the energy sector really stands out as one of the cheapest sectors on the block. Forward PEs for the energy sector are 10 right now � when you look at the price earnings ratio on the Dow which is 21 ,and the forward PE on the S&P is almost 18 right now. So once again, energy is still incredibly cheap going forward. So they’re not only cheap on a current basis, but also if you take a look at earnings next year, on a forward basis they’re equally as cheap. [18:28]
JOHN: Well, obviously the profit to earnings ratio � the PE ratio � is one method that analysts use to determine how well a sector is doing. Any other characteristic indicators?
JIM: I don’t care if you look at across the board � price to sales ratios, PE ratios, enterprise value to EBITDA (earnings before taxes, depreciation and additional charges) where the ratio on the energy sector is 6.7 � it just really stands out how cheap these companies are in comparison to the other major sectors. If you look at price to sales ratios, there are energy companies that are selling at price-sales ratios less than one.
If you look at other metrics of value � in terms of return on capital (ROC), the energy sector has had one of the best ROC going forward, and also over the last 3 or 4 years by a wide margin. And the utilities are doing well, but the return on capital in the utility sector is not as great. Energy has a return on capital of almost 22%; if you take a look at other sectors, anything close to that would be healthcare which has an ROC of 16%; and then also the technology sector which has a ROC somewhere around the 16% level.
Using any kind of valuation metric � whether it’s price to sales, PE, dividend yield, ROC, enterprise value to EBITDA, just all the way across consistently the energy sector stands out as one of the cheapest sectors out there; and one of the best performing sectors. If you take a look at for example, sector breakdown for gross profits year over year growth in gross income: 42% for the energy sector. The only other sectors that would have to come close to that would be materials which have a year over year growth rate of 27%; 25% in the telecom area; and 31% in utilities.
And so, John, what can I say? Plain and simple � the greatest profits have been in energy; and the greatest value still today is in energy stocks. [20:47]
JOHN: And you’re listening to the Financial Sense Newshour at www.financialsense.com � online all the time.
OTHER VOICES: ZAPATA GEORGE BLAKE
JIM: There are many out there who are saying that we’re in the midst of a commodity bubble, there’s plenty of oil to go around; we don’t have to worry about peak oil till the year 2030. Not everybody buys that, and one of them is my dear friend Zapata George.
George, �don’t worry, be happy’ is what they’re telling us � oil doesn’t peak till 2030. I take it that you don’t buy that argument.
ZAPATA GEORGE: Not only do I not buy it in the long term, I don’t buy it in the short term. I saw something, just as a matter of note, the last couple of nights the price of Dubai crude � cash price � exceeds that of West Texas Intermediate. Now, that is an economic impossibility unless something funny is going on. [21:54]
JIM: They parse these inventory numbers � which I still cannot believe the financial media, whether you’re watching the cable channels, or you’re reading it in print, they take these inventory numbers like they’re gospel. Here’s the thing that they forget to tell people. Let’s just give them the benefit of the doubt that the inventory numbers are higher as they say � what is more important is that we are consuming more oil today on a daily basis than we did 5 years ago.
GEORGE: That’s correct.
JIM: So take the daily use today and divide it into those inventory numbers � and the days of supply is the lowest it’s ever been. To me that’s a more meaningful number.
GEORGE: I try to get people to think this way. I said look, do you want to talk about inventories � there’s only two places a barrel of oil can be: it can either be still in the ground; or it can be this side of the well head. Now, once it’s this side of the well head, there’s only one thing of significance that’s going to happen to it � it’s going to get burned up. Now, where it is, is of relative no importance � it only makes for headlines for CNBC and a few traders on the NYMEX to shove things around. Now, if that’s what you’re interested in, then you go play that game. But if you are truly concerned about the long range consequences and you want to make an investment in that concept, then let’s ignore all of this noise. [23:38]
JIM: The amazing thing is I was looking and parsing through 3rd quarter profits, if you want to look at where the most positive surprises were on earnings it was in the energy sector: 73% of the companies reported beat estimates with positive surprises. If you want to look at the area where the lowest forward PE ratios are: once again, it’s in energy. If you want to look at the area where enterprise value to earnings is � once again, it is in energy. And I looked across all categories � return on capital, PE ratios. And also in terms of greatest surprises, it’s once again in the energy sector. Yet today, if I look at the market as a whole, where are you going to find the lowest PE ratios, the highest return on capital, the lowest price to sales ratios? It’s in the energy sector. It’s still being underpriced because people believe there’s a glut of oil out there.
GEORGE: Well, we can only be the red-headed step-child for so long, my friend. And then we’re going to become the glorious swan. Ok. I tell you that in absolute confidence, because let’s go back to our old friend Mr. Hubbert, 50 plus years ago he said, “Gentlemen, North American crude oil production will peak in the year 1970.” It peaked in 1971. Gee whiz, he missed it by one year. He also stated that sometime around 2004 � gee, that was a couple of years ago � and 2010, world (world!) oil production would peak.
Now, there have been some other folks come out with some stuff very recently, and they want to talk about something in the future � way, way out in the future. Well, where were they in 1955? Did they call the North American peak in 1970? I don’t think so. I am the kind of fella who likes to dance with the one that brung me. Well, Mr. Hubbert is the one that brung me to the last dance, and as far as I’m concerned � even though he’s passed on � I’ll let his spirit take me to the next dance. And I’m going to dance with the one that brung me.
As far as I’m concerned when you look at giant, super giant discovery rates, they went from the 20s up to the 50s and 60s, and subsequently each decade they have declined. Each one � 60s down, 70s down, 80s down, 90s down, now down. Consumption � as you pointed out a minute ago � is continuing to rise year over year. Some place those two curves have to cross. Now, Mr. Hubbert said for all intents and purposes it’s now. I’m dancing with him. [26:64]
JIM: The other surprising thing, and one that I think will not stand up, is if you take a look at the number of cars that we’re driving here in the United States, I think it’s a couple hundred million cars. Look at the number of automobiles they’re producing in China, and the growth rate of automobiles. I do not believe as many on Wall Street would have us believe that if the US economy goes into a recession, the Chinese economy is going into a recession, and somehow the guy in China who has just bought his first car is going to leave his car in the garage and go back to riding his bicycle. That’s not the way the world works.
GEORGE: No it is not. And let me point something out to you � China expected to sell 7 million cars in the year 2010. Guess what? They’re going to sell more than 7 million cars this year. See, when you’re buying 70% of the world’s cement you’re the engine that’s driving this train. Everybody is living in the past. The United States of America is no longer the engine of world finance. Now, we are so egotistical that we don’t want to even accept any other statement. Well, this is going to be the biggest slap in the face that we’ve seen in ages and ages. The US economy will slow, the housing market has already told us that, but other economies like Germany’s, everybody is scratching their head: “why is this thing still going so good?” There’s one answer, it’s called Asia. It will be the engine that picks up the world economy train and takes it forward. The numbers tell us so. [28:44]
JIM: There was a report out recently: the exact figure is Americans have 148 million cars; the Chinese have 19 million; and the Indians have 9 million cars. Now this is coming from Goldman Sachs. By the year 2050, Goldman Sachs projects: Americans will have 233 million cars; the Chinese will 514 million cars; and the Indians will have 610 million cars. You know, something’s got to give!
GEORGE: You know what, Jim? Everyone one of those cars is going to have a gasoline tank on it. I don’t care how small a gasoline tank is, every one of them is going to have one. And all you have to do is fill every one of those gasoline tanks up and you’ve used a whole lot more than 80 million barrels of oil a day my friend. [29:38]
JIM: This is a conversation you and I have had before � but the real key is if you want to talk about increasing demand then you’ve got to talk about increasing supply; and if you’re going to talk about increasing supply you’ve got to talk about new discoveries. The fact of the matter is we’re discovering 5 billion barrels of new oil finds a year, and we’re consuming over 30. Now, something doesn’t add up there.
GEORGE: No, well that’s what I said � those curves cross. And we are at the point of them crossing. Now, I did not say that we would � quote � run out of crude oil. My point is this: the cheap crude is gone; the energy gap that is going to develop, starting right now � it’s already started � is going to be enormous. The only thing that’s going to regulate is going to be the price. That will be the distribution regulation mechanism as it always is. There will be forces put on the price that will be unbelievable. Now, I know where there are 2 trillion barrels of oil, but guess what? It’s 2 trillion barrels of $200+ crude oil; it’s not $30 or $20, it’s $200 a barrel. Well, there’s a lot: 2 trillion barrels � that’s a bunch. It’s in the United States. Whoop de do, we’re going to be the Saudi Arabia of oil production in 30 years of $200 a barrel crude oil. All I’m worried about when I’m trying to help folks invest their money is one thing: what is the price of this commodity going to be? There’s a guy on TV right now saying crude will go to $40 next year. Well, I’ve got news for him: you and me and him can make a market because if he wants to sell it short to go to 40, I’ll take the other side of that trade. [31:43]
JIM: It’s not just crude oil too, if you look at this argument that we have a commodity bubble today, there are 2 requirements for a bubble: number one, John Q. Public and Larry Lawnmower are buying into the concept � whatever it is, tech stocks or real estate; and the second one is large surplus stockpiles. And I don’t care if you’re looking at lead, copper, zinc, nickel, energy � there are no large stockpiles, number one. And number two, I would doubt very seriously if your next door neighbor is trading sugar futures or invested heavily in commodities, or is selling his silverware the way he was doing it in 79.
GEORGE: That was so much fun. I had a client when I was at EF Hutton, and he was the son of the guy who ran the copper mine around the mountain from Tucson. And they used to have a few surplus 100 oz silver bars. Well, he’d bring me one every once in a while, and I’d pay the going rate. And I saved them. Well, boom, and along comes 1979. I got them assayed, they held up. I was selling the for from 40 to 48 per oz � I had paid $1.90 for them.
Now, that was the first break out in the commodity market. Ok, we were 25 years too soon. In the history of world prices, quite frankly, 25 years is nothing. Now, to an investor, it’s his average investing life. But we are there now, this is the real commodity market. We have just seen the completion of the first leg of this commodity bull market. It was led by gold and oil. They are now completing their down moves to finish the first leg. And unlike stock markets, commodity market legs are often started before the first leg is finished. The second leg is underway � it started last Winter � remember the first time I was on your show, I mentioned corn and wheat, they are both up more than a dollar a bushel from where I mentioned them the first time I was ever on your show. They are the leaders in the second leg of this commodity bull market. Now, bull markets will either occur in threes or fives � we all know that � the first one lasted about 6 years; 3 times 6 is 18; 5 times 6 is 30 � my best guess is this commodity bull market is good for 18 to 30 years. [34:27]
JIM: George, if you were buying today, where would you be buying?
GEORGE: The two best values � and I keep saying it and they keep being the two best � are natural gas and silver. I used to say silver and natural gas, but natural gas went to 15, got kicked in the head, so I now put natural gas in first place and silver in second place. [34:49]
JIM: I couldn’t agree with you more, George. As we close, if people would like to find out more information about what it is you do, tell them how they could do so.
GEORGE: They can call me at 956.765.3595. I publish my phone number. I put my phone number on the back of the book I wrote. People said I was crazy you know, they may be right.
But remember, we gotta keep having fun.
JIM: Oh absolutely. Well, listen George, have a nice Thanksgiving and we’ll talk again in the future.
GEORGE: Yes sir. Bye now, you have a happy holiday you and John both. [35:20]
THE ENERGY SECTOR: A CHANGING LANDSCAPE
JOHN: Last week you were doing a written piece on the energy sector. And if there’s probably one sector out there where there’s a radical discrepancy between what is going on in that sector and what the public perception of it is, that is energy. So why don’t we follow that thread here for a while?
JIM: As you know, we’ve often written and had guests on this program over the last 3 or 4 years � gosh, I’ve been talking about peak oil since 2002, and wrote about oil in 2001. But in 2002, I wrote a piece called Power Shift, and I got into the peak oil debate at a time oil prices were 18 to $20. The problem that we have is the energy optimists are basically telling people: don’t worry, be happy. I don’t care if you’re looking at the IEA � which is the international energy Agency, the EIA which is the Energy Information Agency here � or for example, last week’s CERA study, or Exxon-Mobil �� they’re all saying: there’s plenty of oil and gas in there, there’s major growth in oil and gas supply, and they’re all grounded in theories that have little factual detail. Whether there’s going to be some new technology that’s going to save us, or there’s just gobs of undiscovered oil that we’re going to find, reserves will continue to appreciate � there’s just boundless unconventional oil and gas; and demand growth is faltering.
Well, as I showed last week, in my Captain’s Log, there has been no demand destruction in the United States, and demand will continue to grow in India and China. So all these myths that we keep feeding people, and especially I fault the cable channels that they don’t do any what I call real reporting in terms of showing a balance between both sides � like I would have challenged the CERA people, and said, “wait a minute, where are all the new discoveries?”
Here’s an argument. If you take a look at oil discoveries over the last 50 or 60 years, they peaked 30 years ago. In fact, between 1909 and 1972, all the giant oil fields today � Cantarell, Ghawar � were discovered between that period of time. We found about 40 of them. All of them now are mature. You’ve got to remember, a lot of these oil wells � the big giants � have been producing oil since the 1940s and the 1950s. The other thing is, in addition to being all mature, they were all lined up in a major narrow region of the world and that was in the Middle East where you find the biggest oil fields to date. And it’s no surprise that’s where the bulk of the world’s oil reserves lie.
Now you’ve got these fields not only maturing, but you’ve got high water and gas injection to keep reservoir pressure high to maintain output. And basically, the peak production or the sweet spot of the production of these fields has basically been hit. So we haven’t found a North Sea, or a North Slope � it’s been over 30 years. [38:41]
JOHN: Why do you suppose it’s so hard for cable crowd to get this right, like you say? What is wrong with putting together a comprehensive picture?
JIM: Let’s put it this way � they don’t want you to be investing in energy and commodities as people did in the 60s and 70s. They want you to buy financial paper. And the big thing that’s happened since the turn of this new century, and this new decade has been the transformation, or the change and handover from the bull market in paper, which existed between 1982 and 2000; and now the bull market in things which are tangible investments. [39:22]
JOHN: If we look at the last decade and a half, demand has gone up but at the same time, supply has gone up. And the CERA people are saying for example, that as demand continues to go up in the future, we should be able to meet that with more supply. What’s wrong with that argument?
JIM: If you take a look at the year 1990 to 2005, one of the biggest changes that came in the latter part of the 90s and this new decade, was the tremendous economic growth that we’re seeing coming from Asia � especially China and India. But if you look at the increased production gains over the last 15 years they’ve been mainly in OPEC � Kuwait increased its production; Saudi Arabia increased its production; Europe was able to increase its production.
But a lot of these increases outside of Kuwait and Saudi Arabia have been very small. Europe has bee able to increase its daily production by 1.3 million barrels; you have Brazil, an increase of 1 million barrels; Canada, the former Soviet Union and then you had China, Angola, Iran, and Mexico which have been less than 1 million barrels. Places like Nigeria, Venezuela.
However, what it doesn’t document during that period of time, you’ve seen big declines in the United States, production has fallen by 1.7 million barrels a day and Russia by almost 1 million. Indonesia has gone from an exporter of oil to an importer of oil; Egypt, Iraq, Australia � all these countries have seen peak oil and their productions have declined.
And more importantly, if you look at non-OPEC oil growth it even looks worse, because the production gains have been very, very small. If we take the last 10 years, we’ve been able to increase oil production but only by 2 or 3 million barrels outside of OPEC. For example, if you take non-OPEC oil growth from 1996 we’ve been able to increase oil production, roughly by 7.7 million barrels a day. However, during that same 10 year period, we’ve seen production declines of almost 4.3 million barrels a day. And this is the depletion side that a lot of the optimists fail to take into consideration. Yes, we’ve been able to increase oil in certain parts of the world, such as Mexico during that period of time, but we just found out that Mexico’s oil field Cantarell peaked; and Burgan � Kuwait’s major oil field � also peaked. So the big production increases from areas like Indonesia, areas like Mexico, Kuwait � they are now in decline. And so, yes, we did increase production by 7.7 million barrels a day, but the net increase was only 3.4 million barrels a day if you take all those areas of the world that have been declining in production. [42:21]
JOHN: Everyone was talking about former Vice President Al Gore’s film this year � An Unpleasant Truth � and of course, he’s talking there about global warming. But I think you’ve got a different perspective on what the real unpleasant truth is?
JIM: I think the real unpleasant truth is what we’re seeing happen with energy demand and energy supply. Number one, energy demand growth has been relentless. It continues to grow in the United States where we consume over 26% of the world’s oil; it’s been relentless in Asia � especially China and India in the developing world. As I mentioned earlier, we’ve also seen a decline in new discoveries � and remember, that’s ultimately where we’re supposed to get the increase in supply.
Growing regions of the world are now into productivity declines. The best example I can give you is Venezuela. As I talked about earlier, that spare capacity that existed at one time of 10 million barrels, we’ve basically used most of that up. That’s why, whenever we get a crisis today � like a hurricane or a terrorist attack, or a geopolitical problem � oil prices spike.
The other thing, most of our major oil wells are now maturing. And as Matt Simmons talked about in the interview is the rusting infrastructure we’re seeing in the oil industry � older rigs, older platforms. The platforms we have in the Gulf of Mexico were designed for 30 to 50 foot seas, they’re not designed for 70 foot seas as we saw with the major hurricanes in the Summer of 2005. It’s not just the aging and rusting infrastructure, it’s a lack of people; it’s a lack of rigs; it’s a lack of new projects to sustain growth. So I have never seen such a major disconnect between what we are being told publicly and what exists in actual reality. [44:12]
JOHN: This would possibly explain the question I had asked earlier, and that was, why is it people don’t see some of the things we’re talking about? In reality, when people are speaking on some of the mainline talkies, they’re really not looking at all of this stuff. In other words, it’s not in their minds that the infrastructure is going away. The infrastructure is sort of a given in their minds. Do you see what I’m talking about? And they don’t take that into account.
JIM: And it’s just because we want to believe something, and most people believe the �drive-by media’ � or so they’ve been labeled � you know, they just throw this stuff out there and they focus and concentrate on the least relevant items. These inventory reports that come out every Wednesday and Thursday, which some guy is making up with a computer model, and all of a sudden the world oil markets trade on all this information. The underlying realities � the questions that we should be asking are what about the discoveries, what about the depletion rates, what about the infrastructure, what about the demand structure? All of this supposed demand destruction is not taking place but nobody questions that. But these numbers are thrown out, and the [perception] that we have is like the CERA report, “well, there’s going to be some new technology out there that’s going to save us.” The problem is there are few breakthrough ideas on the drawing boards, and everything the service companies have got is leased out today, and there’s just been a reluctance to invest because people are afraid of these prices. That’s because the prices in the market place are throwing off signals that don’t match reality. [45:53]
JOHN: But still at the same time when we look at it daily on the talkies you hear things like, “well, what goes up, must come down. It’ll make a correction here,” etc., etc. But that doesn’t seem to be taking all of this into account.
JIM: No, I mean there’s always somebody out there who says, “Ok, remember when oil was going from 30 to 40, we were going to see demand destruction, we couldn’t live with $40 oil.” And then if it went to 50, we couldn’t live with 50. Then if it went to 60, we wouldn’t be able to live with 60. Then it was 70 and 80. At $80 oil we did not see demand destruction. At gasoline prices selling at over $3 we did not really see any demand destruction. I don’t know about you, John, but everywhere I go the freeways are crowded; even at the mobile home parks, or the trailer parks on the beach � we have a beach place and they have this park there where people can park their motor homes. I would have though when I was there during the Summer that we would have seen less traffic � not so. The park was full every single day of the week. Even now it is full. And you know how big those fuel tanks are on some of those RVs, and it’s the same way in your neck of the woods. [47:02]
JOHN: At the same time though when you talk about RVs, typically people go somewhere and plop the RV, so the cost is getting there � that’s compared to a boat for example, where if you’re going to do anything with it you have to fill it up each time.
JIM: The reality is you’ve got 45 of the 65 oil producing countries that are now in decline � their production is declining. And we also have another number of key producing areas that are facing imminent declines. We talked earlier about Mexico’s Cantarell field, and the US Gulf of Mexico deep water production is headed for decline; offshore Eastern Canada; in China, the Daqing field is in decline; conventional oil in Venezuela; non-deep water oil in Nigeria; Angola’s non-deep water oil; Ghawar in Saudi Arabia; Burgan in Kuwait. So as we look at areas that have gone into decline that tells us that we’ve got problems. Instead of focusing on what we should be doing now � building rail systems, conserving, taking all kinds of measures � we’re doing nothing. [48:16]
JOHN: And as we usually do at the end of these segments let’s sum up this whole thought into a concise little capsule.
JIM: In summing up, the perceptions in the market place that there is a glut of oil � an oversupply, don’t worry about peak for another 2 or 3 decades � these are out of whack with reality where we are seeing declines in production through depletion rates which are increasing � I don’t care if it’s the North Slopes or the North Sea, Cantarell or Burgan, or elsewhere in the world; we’re seeing fewer discoveries; production declines; and greater demand. There has been no demand destruction. The demand coming from Asia is insatiable. And forget every story you’re going to hear about such as Chinese economic growth slowing down from 11% to say 8% - it doesn’t matter, if they sell another 7 million cars that’s 7 million more people driving cars that are going to be consuming more gasoline. So plain and simple, perception and reality are out of whack. And to me, you’re just being given one more opportunity to pick up these stocks on a cheap basis. [49:30]
FISHING FOR JUNIORS: WHERE TO LOOK, HOW TO BUY
JOHN: I think I’m going to come up with a new black box here, Jim. You know when you go out on a boat, and they have these fish finders and sonar depth things, which show you where the schools of fish are, we should have something called a �juniors finder.’ So when you go fishing for juniors, bleep, here’s one.
I don’t think it’s going to work.
JIM: Yeah, depth to 200 feet, there’s a school of them.
JOHN: We’re going to talk about fishing for juniors, if your listeners haven’t gathered by this point.
JIM: One of the themes that I’ve mentioned that whether you’re looking at large oil companies, or large mining companies, what has happened in both industries are running in parallel. You saw big consolidations in the 80s and 90s, especially towards the end of the 90s in the mining industry and the oil industry. Now you have these big behemoths � whether it’s Exxon-Mobil or it’s Barrick, or Newmont � and they’re simply not replacing their reserves.
And so, the question is in this bull market, where are you going to go? And the reality is where you’re going to go is juniors because these companies aren’t finding the reserves. And you know from the time of discovery � you discover something, start poking holes, take it to feasibility, get the permits and then take it into production � that’s a 7 to 10 year process. So it’s much easier to go out and find somebody that has already done it, that has already poked the holes, come close to prefeasibility, they’re in the permitting phase, or have got their permits, have got a number of things going. It’s just much easier. So really what you’ve seen with the large oil companies and the large mining companies turn into is really they’re financial banks that are really going out and buying their production. And the best place to be is go out and buy production where it’s cheap; and where it’s cheap are juniors.
But one of the amazing things about the mining industry today is despite gold prices which are over $620 an ounce is that the premiums on mining stocks have dwindled. Where in the past you would see senior and international producers sell at 20% premiums over the last couple of years above their net asset value; today, you even have the senior producers that are only selling at 1% premium. I venture to say that until the big money comes back in to the gold market that’s going to exist, because if there’s any area that should be selling at no premium at all it’s probably your seniors because they’re not replacing their reserves � their production profile is going down.
But where it is out of line in my opinion is you’ve got junior producers today that are selling at about a 28% discount to their net asset value versus a historical range of around 20%. So the junior producers are where you’re going to want to be in this bull market. And right now, they’re being given away if you look at the price of these junior producers in comparison to the price of gold itself. And even worse is the value of juniors � or late stage junior development plays � that are selling at 40 to 50% discounts to their net asset value. I mean these things are a screaming buy. [52:48]
JOHN: We know you’ve been a big fan of juniors, Jim, but suddenly I’m noticing you have a strategy which seems to be changing. So do you want to clue us in as to what’s going on?
JIM: I think number one you’re going to start seeing in the next couple of years the price of gold go over $1000 an ounce. And once gold starts going north of $1000/oz things are going to get sort of crazy. And at that point, you’re going to want to be in companies that are producing. That’s where you’re going to see huge cash flows, huge increases in profits, huge increases in market caps. And the huge increase in market cap, profits and cash flow are going to give those companies the ability to go out and buy other resources; buy them cheaply; use their stock as currency to do that.
So you’re going to want to start making the transition now if you’re looking at juniors into late stage development plays � companies whose ounces are no longer inferred, they’re measured and indicated so they’re close to either a prefeasibility or they have one in the works. Because from prefeasibility, or feasibility to production, that’s a process or cycle that can take 18 months to 2 years so it can happen much faster. Remember, a lot of intermediate companies that are growing and also the majors, aren’t going to be able to take a new project from green field discovery to development to production. That takes 10 years. So when the price of gold really starts heating up, and the production declines of these majors continues to go down, they’re going to want late stage development plays that have 2 to 3 million ounces of reserves, or at least in the measured and indicated with the blue sky potential to almost double that; and they’re going to want them late stage because they know if they buy them they can take them into production within a two year timeframe, so that they’re adding ounces, replacing their reserves; or in the case of an intermediate company increasing their production profile.
So late stage development plays that are very close to prefeasibility, or feasibility, is where you’re going to want to be next, because the next jump in gold prices when gold crosses over $1000, when it comes you’re really going to want to be on the production side. And I see that $1000 gold price coming in the next couple of years. [55:16]
JOHN: If we look at the market I would say that there are thousands of juniors out there. But in real world terms � realistically � how many deposits are out there of any kind of worth?
JIM: That’s a surprising thing which I’ve written about in the past. You’ve heard me mention it on the program, that Ralph Bullis did a study of the major gold fields 2 or 3 years ago. He took a look at the number of deposits of 5 million or more. There are only 17 companies out there that have deposits of that size. And then, below that, you have what I call the 2 to 3 million ounce production profile. And there are really only about 30 companies out there. So if you’re looking at the universe of companies that can go out and go into production, and that have sufficient reserves to make it economically viable, you’re talking about a handful of probably less than 50 companies: 17 major companies with 5 million or more ounces; and about 30 companies that have developed at least proven deposits of 2 or 3 million. So your universe of looking for these kind of companies is rather narrow. [56:23]
JOHN: In investing there’s always the shotgun approach � you just fire off the gun and see what you happen to hit. Some of the funds go out and buy 50 or 60 of these and they hope they hit something. You try to be a little bit more precise in your aim, so to speak?
JIM: Yes, we prefer to take more of a rifle approach because as I size up the gold market as I said, there’s only about 50 prospects or less than 50 prospects that would be worth investing in. So that really narrows down the search so to speak. And within those 50, you have to look at valuation levels and try to buy those that are cheap. But I believe that is a better approach rather than trying to buy 60 to 100 juniors as some fund managers are doing and hoping that out of those 60 you’re going to find a major gold like an Aurelian out of the 60. The problem is I don’t know how as a fund manager you keep up with 60 stocks, unless you have maybe an army of analysts that can keep you informed and you assign maybe 10 or 15 companies to one analyst, and another 10 or 15 to another. But you can’t. How do you keep up with the drill results, what’s going on with management, what are their expenditures, what’s been their exploration success, what is it costing them to find each ounce? Keeping up with all those statistics � I couldn’t do it. You name me any investor that can keep up with 50 to 60 companies � it’s pretty hard to do unless you’re maybe Warren Buffet. [57:54]
JOHN: You’ve seen a number of these acquisitions over the last year, and it would seem like what you call your Pac man strategy is actually happening. So if you project this outwards, what are we looking at?
JIM: I think you’re going to see it accelerate. Just as the oil companies are waking up to the fact that it’s getting more difficult to find new prospects to drill, and new areas to go to for discovery � I think the major mining companies are still dealing with unreality yet. I heard somebody speak recently who said, “well, we’re looking for deposits of 5 million or more.” Well, good luck � there’s only 17 of them. And by the way, if you’re bidding for them, there’s 10 other companies that may be bidding as well. So the big fish or the big tuna out there are getting fewer and fewer to try to catch. And the same thing with these two and three million ounce deposits.
What I think you’re going to see eventually is the real growth is going to be in the junior producers and intermediate companies, and I see these companies as growing their production profile and also growing their ounce profile. Like I said this bull market in gold is going to be very much like the tech market where the junior producers and intermediate companies are going to be the equivalent of the Ciscos and the Intels and the Dells at the beginning of the tech market � where your senior producers are going to be more like the IBMs. And that’s where all the action is going to be � the 10 to 20 to 30 baggers are going to be in this area. But even then, the scope of what you need to look at is going to be even less and less in the years ahead � there just aren’t that many major new discoveries that are being made that are looking very promising. And as I mentioned, there’s about 30 companies out there with 2 and 3 million ounce deposit profiles. And only 17 that have 5 million or more. So it just goes to show you how narrow the scope is in terms of looking at the most promising prospects. [59:49]
JOHN: If we’re going to go out and hunt for these juniors, there are obviously � again, just as we did earlier on with investments for dividend yield � criteria we should be looking for. So what are these? And I would guess for right now, you’re probably urging a buy in this area?
JIM: Let’s put it this way, right now we’re backing up the truck, because the premiums on the senior producers is only 1%; on the junior producers they’re actually selling at 27% discounts to their net asset value. And some of these juniors � one of the companies that we like, it’s gone up but still you can buy it for $30 an ounce in the ground. Where are you going to find high quality ounces at $30 an ounce; a company that is likely to go into production in the next 2 years? And then on top of that, it has so much upside potential with major new discoveries and deposits. Those kinds of finds are very hard. And when you find them you just back up the truck. And if they knock the price down you back up the truck and you get a bigger truck, but you keep buying because a couple of years from now, when things get crazy, or the next run up, you’re not going to be able to do this.
One of the things we know in most bull cycles is what’ll happen is after a correction in gold people come back timidly into the market. So the first area that they go into are the big liquid stocks, they’ll buy the large cap stocks or they’ll buy the large intermediate producers because they’re the most liquid. So in case the market turns around and goes down again, you can get out of your position. But right now, the juniors have been lagging the performance of the major indexes, and they’re usually the last to catch up. But when they do catch up, boy, do they catch up. You can see these stocks go up 20 to 30% or 40% in a single day; and I’ve seen stocks actually with discoveries go up over 100% in a single day. That’s just the way that market is played, and right now the juniors have been the laggards with the increase in the price of gold. [1:01:53]
JOHN: Obviously, those are the criteria, but if you are going to buy into these � say the price drops � that’s not a reason to get out, that’s a reason to actually buy more. If you want to buy into these, hold � if another opportunity comes buy more.
JIM: Absolutely, because juniors aren’t as liquid as your big stocks. Sometimes they become very liquid when there’s a big run-up, the price is moving up and people charge into the stock, and then you’ve got people that are unloading it. That’s not the time that you really want to look and accumulate. You want to accumulate when they’re either lagging, they’ve been consolidating for a while, or they’ve dropped in price � because of a sell-off or whatever the news is in the market. But during that period of time you hold what you have, and when you’re given that opportunity, back up the truck, add to your positions, accumulate even more, so you’re bringing your costs down. And then that way, when the upside comes, when it turns around and the price really starts to take off that’s when you get your 5-, 10- and 20-baggers. [1:02:56]
OTHER VOICES: DAVID COHEN, TheOilDrum.com
JIM: Last week, once again, the oil markets got a bomb shell with the CERA report. As to why the peak oil theory falls down, we’ve invited the author of that program � Peter Jackson � from Cambridge to join us. So far, no response. But there was a response on a website called The Oil Drum, and a piece posted by a gentleman by the name of David Cohen.
David, welcome to the program, and before we get to that response, why don’t you tell people about The Oil Drum � your website. What is it, what is it that you guys do?
DAVID COHEN: The Oil Drum was started, actually not that long ago, in the Spring of 2005 and it was started by a couple of professors who are actually anonymous at this point because I think that they think that their weblog activity would have an impact on their careers. It was started by those two guys and we wanted to talk about peak oil and all sorts of energy policy � including alternative energy policy and so forth. We’ve had excellent growth over the last year and a half � some people think we’re the preeminent peak oil website on the internet. [1:04:26]
JIM: It’s been amazing to see all the information about peak oil and yet you will have reports like this one coming out of CERA, or you’ve had reports for example like the �creamy nougat theory’ of abiotic oil where it just replenishes itself � I’ve yet to see it occur here in the United States, but nonetheless.
Let’s talk about your response to the CERA report, because you feature a graph from the CERA report that talks about historical production and it shows conventional oil production, and then unconventional oil and these undulating plateaus. So why don’t we start with that and pick this apart?
DAVID: That’s a standard CERA graph, and what it shows is that conventional oil production � and conventional oil would be defined as crude oil, condensate and natural gas liquids � will continue to grow out to the period of about 2030 or so. And then it will be seamlessly supplemented by substitutes to conventional oil � this is called unconventional oil. And that will grow in addition, and that those two taken together will reach what CERA calls an undulating plateau in the period of 2030 to � about 2050, if I look at the graph correctly. Conventional oil production itself will peak somewhere around 2030. Our take on it in the peak oil community is that conventional oil will peak much sooner than that � most estimates by analysts are within the next decade, before 2015.
JIM: If you look at that too, there’s been a number of studies � you cite Robert Hirsch, his study was published in 2005 � that have been out there. One of the keys that strikes me about conventional oil, it would seem to me if you’re going to increase production as they’re showing in this CERA graph, then you’ve got to be making new discoveries because that’s where the new supply is.
DAVID: Yes, and there’s a considerable lag between discoveries and the time they get on stream for our use. Well, oil discoveries in general globally peaked in the 1960s; and for the last 15 years at least, oil discoveries have been declining. It’s hard to reconcile CERA’s growth in conventional oil production over time with the declining discoveries. That goes to another question which is called reserves growth. And reserve growth means that you have existing fields, that you have add-ons to those fields, or as you get to know the fields better you will find more oil in and around those fields. But nonetheless, you are absolutely right about the discoveries curve � you can’t produce what you haven’t found. And CERA conveniently ignores the declining discoveries over time. It’s a big concern. [1:07:42]
JIM: It seems like they’re ignoring two things � not only the decline in discoveries � we’re consuming about 30 to 35 billion barrels of oil a year, so just to stay even we’ve got to be finding 30 to 35 billion which we know we haven’t done in two decades; and then number two, you’ve got existing production declines. For example, the United States which used to produce 10 million barrels a day, and we’re almost about half; we’ve seen production peak in Mexico; we’ve seen production now peak in Kuwait. It seems like we have to run faster, harder, to find even more oil just to keep pace with the decline in existing production � not even talking about meeting future demand.
DAVID: I couldn’t have said it better. There is another graph in the response I issued to CERA which shows that they themselves assume a 5% decline rate in existing production. And given that kind of decline in what we already have, it is almost impossible to imagine how we’re going to replace all of that, and in addition supplement our conventional oil supply with oil that will meet their projected demand growth. For those of use who are studying the subject, we just can’t imagine how that’s going to happen, where that oil is going to come from. It just seems completely unrealistic. [1:09:17]
JIM: What you have, and you see this in the media, for example the Jack field in the Gulf of Mexico�
DAVID: Yes, I wrote about that.
JIM: When it was first announced they were talking about this being the next North Sea and the North Slope. That’s a big stretch of the truth to assume given that it may take years to come on line, and how that one field got extrapolated to contain that amount in terms of reserves.
DAVID: There are a couple of different questions in your question. One question is reserves versus production flows. In other words, when the press saw that Jack 2 discovery � and by the way, that Chevron test well was a very impressive achievement, and I don’t want to denigrate what they did � however the press account focused on a range of 3 to 15 billion barrels of oil out there in the deep water Gulf � ultra deep water actually. And they did not take into account how much oil we could extract from that over time, and as you said, in what time period. And in addition, they didn’t focus on constraints on that production: they didn’t focus on the geological difficulties; the technological difficulties � I mean in this case some of the technology has not been invented yet that would extract some of this oil. And of course, they didn’t acknowledge the enormous investments required to get that oil out of the ground. So these are the kinds of considerations that those of us studying peak oil are trying to grapple with. And so we tend to be skeptical when we hear about those kinds of reports. Given the decline rates we discussed earlier, we don’t think that you can bring enough oil out of the ground in places like the ultra deep water Gulf of Mexico to replace existing declines over time. [1:11:23]
JIM: And yet you still have these reports coming out like CERA’s, which are widely trumpeted across the media. And what we focus on, as you’ve seen, is these weekly inventory figures which are such nonsense because to me we ought to be focusing on days of supply which is at an all time low. And if you were looking at that, I think the worst thing that can happen to the oil markets right now is that they have the price of oil drop to as low as it is because that just creates greater problems down the road and keeps us from addressing the problem.
DAVID: We believe in steadily high rising prices � increasing prices. The short-termism I could say in the oil markets that just looks at current inventories is doing great damage to the investment climate which could extract more oil in the future. The cost of getting the oil out of the ground are increasing � especially given your example of Jack 2. If the prices of oil are such that it is not worth it to get that oil out of the ground because the prices are too low to make the economics good, then what you’re doing with low prices based on short term inventories is you are discouraging � not encouraging, but discouraging � future oil production. And that’s a bad thing. That’s why we want to see high prices for oil which also encourage conservation. And so if you have those two effects at once then there is a possibility as we go forward that you could mitigate what we see as future shortfalls in the conventional oil supply. [1:13:07]
JIM: I want to come back to the founding of your site which was started by two professors who are still anonymous. That really tells you something � that their careers might be jeopardized if they were writing this truth and publishing it. It’s like we live in this world of Alice in Wonderland and make believe. And so we take these stories like the CERA report, and it’s trumpeted all over the web, where the real story is what you guys are writing about. If that was told to the public I think you’d make the public understand the predicament that we’re in. It’s much easier to come up with a solution whether it’s conservation or increasing alternatives, but we’re not going to be able to get to that solution if we keep the public in an ignorant sort of mental state.
DAVID: Yes, it’s a serious problem. If I could just for a moment tell you � I had no pre-publication notice of the CERA report. And when it came out at the time I was working on another report on liquefied natural gas, and so I was busy that day and so forth, and my email box started filling up with reports about CERA and so on. And I finally got to look at it at the end of the day. And I said, “Oh my.” And we’d been inundated with requests for response: “why weren’t you guys responding?” Well, we didn’t know about it. So I took on the job of doing the response, and I spent the entire next day working on it. Now, by the time I got it done, by the time we got it published, the news cycle had ended for the report. In other words, the detailed rebuttal was there but it was nowhere to be found in the mainstream media, as we call it. It’s a problem � we don’t really know how to address that. I think that at The Oil Drum we grapple with that all the time. How do we get the message out? And there’s an additional problem, which is it’s not a sound bite argument. You have to sit down; you have to make a fairly detailed argument as to what’s going on and so far we really haven’t been able to get out into the media the way we’d like to get our message across. [1:15:28]
JIM: On the day you and I are talking, we had analysts on Bubblevision talking about $40 oil.
DAVID: Sometimes I actually think that’s possible given the trends that we’re looking at right now. And when the oil price goes down, and when CERA then, or Exxon-Mobil as they have been doing recently, when they come out with statements telling the world in sound bites that peak oil is a myth or a legend or what have you, that has definite effects on the oil price. I think it really does bring the price down, and at that point the price of the oil is divorced from the economic fundamentals of supply and demand. [1:16:10]
JIM: What you really have then is you’ve got this trading mentality that takes place, for example, prior to the month of August when we were getting close to $80 oil, and then all of a sudden a month later Goldman Sachs changed the weighting in its index, a hedge fund gets in trouble in natural gas, we had a benign hurricane season � alright, so these things didn’t happen, but did the world change in 30 days? In other words, are the Chinese selling fewer cars, driving fewer miles. We did some graphs on a piece we published last week that took a look at the amount of miles traveled and there’s been no demand destruction despite the fact that oil has gone from 20 to 60.
DAVID: Yes, there hasn’t been any demand destruction and actually OPEC didn’t fail to notice that, and that is why they are trying to set a floor for the price. And what you’re really getting at is the fact that the demand fundamentals didn’t change. Even with higher oil prices they didn’t change. And that also extends to other what are called above ground considerations, where the geopolitics didn’t change either. For instance, we still have threats to our oil supply in the Mid East and I would actually argue that they’re even more severe now than they were six months ago given the deteriorating situation in Iraq. But nonetheless, the price of oil in the market place has not reflected any of this.
Now, we got to a $78 high last Summer before the oil price plummeted, and there was a risk premium on the price given the fact that there was that Israeli-Hezbollah war, the continuing situation with Iran and so on. And it is completely mysterious, it’s really completely mysterious to me how Chinese demand � and US demand � have not really fallen off that much. The geopolitical situation hasn’t changed; the supply ceiling � or plateau, in fact, to use CERA’s terminology that we’ve been in since last year � continues so we have a supply ceiling; and yet the oil price is volatile and this time it’s down. Again, it’s hard to reconcile that with the fundamentals of the situation. [1:18:34]
JIM: Well, we all know that at times the market is out of whack in terms of public perception with the underlying fundamentals, and David, this seems like one of those times and it’s grossly so.
As we close here, why don’t you give out your web address and tell them how they can follow your articles?
DAVID: We are at www.theoildrum.com. And what we have is sort of a dual format. We have a large number of staff from various parts of the world � right now we have an Oil Drum branch in Canada and Europe and we have the main Oil Drum site which is based here in America. We try to publish an article a day on some aspect of the energy situation, and sometimes that’ll deal with peak oil but often case we deal with other situations of interest like natural gas supply into Europe from Gazprom in Russia; or North American natural gas supplies which seems to be in trouble. And we also deal with alternative energies, we have extensive posts on whether biofuels will really be helping us out in the future. We talk about the nuclear issue, various other things like that. So what we do is we publish articles, and in addition an open thread, or an open forum everyday in which intelligent people can come and give their personal observations, or direct the reader to links of useful information that they might want to see. So we’re generally an informational site and a focus site in terms of the articles we publish. [1:20:14]
JIM: Alright, Dave, I want to thank you for joining us on the program. The name of the website again is www.theoildrum.com. Dave, all the best to you and happy holiday.
DAVID: Well, I appreciate it, and I think all of us at The Oil Drum appreciate you having us on. Thanks.
JIM: You bet. [1:20:29]
TAXES & INFLATION: THE SCOURGE OF THE MIDDLE CLASS
JOHN: It’s interesting � the cost of living is going up, all the while the soothing voices are telling you: “Don’t worry, it’s a bustling economy. And if you just strip out all of these things like oil and food and medicine your costs aren’t going up at all.”
At the same time people are really struggling to make ends meet. The old nostrum used to be that the reason both parents were working, and ignoring their children, was because of the fact that they just wanted the good lifestyle and they were really selfish. But in reality, that’s what it’s taking to hold households together. So they recognize something is going on, but no one ever seems to tell them what’s going on � that’s really killing them. And there are two areas: taxes and inflation � both of these are government related phenomena. Let’s just take a look at the Social Security wage base � that’s a good jump off spot here.
JIM: Well, sure, because with Social Security reform, remember in 1984, with the Greenspan panel they doubled the Social Security tax and they began indexing the wage base every year by a special inflation rate. And that was going to make Social Security secure for the next two centuries, or something like that. We all know that all that excess money paid into Social Security was stolen by the Congress and spent � and there’s nothing but an IOU cookie jar there.
But each year, the Social Security wage base � I think it was last year 96,200, maybe it’s 96,600 this year � goes up. Now, if you think about that at 7.65% of your gross income right off the top that goes to Social Security taxes, and if you’re self-employed � as you know, John � you pay double that amount. And so, more and more of your income is going to taxes each year.
It was amazing when my youngest son got his first job out of college and he got his paycheck and he said Dad, “I can’t believe [it],” � he was thinking the dollars per hour that he was getting, he started out making $20 an hour, and he’s thinking, wow, that’s a lot of money. Then he gets his first pay check, and he couldn’t believe what taxes took out of his paycheck, between Social Security tax, Federal income tax, and State of California income tax. His first job put him in the highest tax bracket in the State of California. And here’s the thing � it’s not just that taxes keep taking more, it’s also because of inflation, you get this garbage silliness about the core rate which can you name me anybody who’s core rate of inflation applies to anything you need to live by. [1:23:40]
JOHN: There’s another form of taxation, and it’s invisible because people don’t see it directly as money coming out of their pockets, they see it in price increases everywhere � and obviously we’re talking about inflation. And what really galls you at some point or other, is when you realize the whole purpose of the core inflation rate is to deceive the public � that’s its purpose. I mean who in his right mind really believes the core rate represents anything of real world value?
JIM: Sure, because the thing that you have is rising prices, and a depreciating purchasing power of the dollar. Since the Federal Reserve was created the dollar has lost over 90% of its purchasing power, and every single year the Fed creates more money and credit in the system, which makes the dollars that you own worth even less. And so that’s why people are struggling and running harder and harder, because taxes and inflation are taking more of a person’s paycheck.
They hear things about the core rate of inflation, they hear that and they go, “Gosh, inflation isn’t that high,” and yet on a personal level they go to the grocery store, the dentist, they’re paying their children’s’ education; they’re having to fill their tanks with gas; they have to buy a new car; they’re buying clothing for their children � whatever it is they need to live on � their utility payments, their water bills � all of that is going up at high single digits a year, and yet their pay raises aren’t going up at more than 3 or 4% a year. If inflation in what I call your core living costs are going up 6 to 8%, and your pay is only going up 3 to 4%; and of that 3 to 4% increase taxes are taking a good portion of it � you know, how are you going to stay even? [1:25:32]
JOHN: There’s also the good old Jim Puplava story of the friend’s 3% pay raise, but it’s a really good example as to why everybody’s sliding backwards.
JIM: Sure, one of my best friends works for a major financial institution, and last year at the end of the year, he got a 3% pay increase. After taxes, that 3% pay increase, turned out to be about 2%. Meanwhile, his cost of living went up 6 to 8%, and he got a 2% after tax pay increase. And you think about that is just one year, but when that happens every single year, you take that over a 10 or 15 year period � remember, the inflation rate compounds, and so it takes more and more income just to make ends meet. So 30 years ago, the wife had to go to work, and now I don’t know what it’s going to be, the children are going to have to go to work to pay the bills. And that’s why you’re seeing more and more families struggle today that are going into debt, they’re taking money out of their homes.
There was a study done � I’m trying to think of the non-profit organization that did a study of credit cards � and 60% of the amounts being put on credit cards weren’t people just spending money recklessly, they were people using credit cards at the grocery store, credit cards to pay for a flat tire, to buy new tires for the car, or battery that went out, pay for doctor bills, or the part’s not covered by insurance � a lot of that credit card debt, 60% of it, was going to basic necessities rather than going out and buying luxury goods as some people would have you believe. [1:27:27]
JOHN: If you remember when Catherine Austin Fitts was here on the program a couple of years back, she said that the statistics were showing that the amount of money that the average household now was going into debt here in credit cards, was not spendthrift spending, but rather reflected the quantity they went into the hole every single year. In other words, they were doing it just to stay par.
JIM: Sure, it’s just like my friend who got the 3% raise, his wife is working 6 days a week now. And that’s what they’re doing to make ends meet. When they do their shopping, they’ll have runs, they’ll do a Walmart run, a Costco run, and they’ll buy in bulk and in quantities in order to save on living expenses, and to keep their food costs down � they’re economizing. They’re doing a lot of things. I mean they don’t go out to dinner like they did before. If they go to a movie it’s a matinee on a Saturday, instead of going out on a Friday night or a Saturday night. So they’re doing various things to economize, but at least they’re not going into debt. [1:28:90]
JOHN: But that really does put them into debt. It puts them into debt in their health, because of the amount of time they’re required to do, and also ultimate productivity. It would seem better in the long run if we just bit the bullet and stopped inflating. But once you stop inflating the game quits, prices and incomes tend to stabilize. Where it keeps going is where this little cartel of the government and the Federal Reserve in our country don’t admit there’s a problem, don’t admit that they’re causing this problem, and they just keep playing the game and everybody has to run faster and faster until it just all blows out at some point or other.
JIM: Sure, because they’re talking about raising the minimum wage so people can earn a decent living. You know they would be better off, instead of raising the minimum wage is to just stop inflating the money supply, make the dollar strong, back it by gold so it retains its value. Instead, they keep inflating, inflating, inflating. And just as I gave the example of my friend’s pay raise, the more the government inflates, the more they impoverish the people of the country. That’s because, like my friend, who got a 3% pay increase, he can’t go to his boss and say, “look, I need a 12% pay raise, so I can have an 8% after tax increase in my wages to keep up with the standard of living.” That’s not the way the real world works. And so the worse thing the government can do is the more promises they make, the more money they spend, the more pork barrel projects they spend money on � the more they have to inflate, the more they inflate the more they impoverish the country as a whole, the more they destroy the middle class, make the middle class poor, and the poor even poorer.
And one reason the rich get wealthier in periods of inflation is they have the excess money to invest and profit from inflation, where the middle class and the poor really don’t. So the worst thing the government does to its middle class and its poor is to inflate. I got into this business in 1979, and the two foremost issues which people really understood back then with the inflating money supply were taxes and inflation; which is why we got Ronald Reagan with the Reagan revolution on taxes. The only problem is Reagan turned out to be a big spender on defense. And it’s amazing how we have gone full circle. But we went through a period of disinflation. Here we are almost 25 years later, and now we’re entering the age of inflation. And understand that we’re entering into the age of inflation is the best thing you can do to secure yourself � because once you understand that, you can take steps to protect yourself rather than become a victim of it. [1:31:10]
JOHN: Well, Jim, you’re going to be at the gold show Thanksgiving weekend, that’ll be featured on the program coming up next week. And what are we anticipating at the Gold Show, and what are we looking at in December?
JIM: From the gold show, two of the main speakers � Dr. Marc Faber and Congressman Ron Paul are going to be the speakers � I’ll be interviewing both of them. I’ll probably interview a couple of independent newsletter writers, and get their feedback and input on this gold market. But most of the interviews, we’re going to do 2 hours of interviews of junior companies. Some companies we own, some companies we don’t, but the whole program is going to be designed on juniors. And juniors � all over it, from late stage to early stage, to exploration; from gold and silver, to copper, to uranium. So it’s going to be a great, great show and I’m really looking forward to that, and running into some friends there. And I can’t wait. [1:32:00]
JOHN: Happy Thanksgiving to everybody in the United States. If you’re elsewhere we hope you have a happy weekend.
JIM: Well, that just about sums up this show. It was a little bit long but we were piling up on a lot of our interviews, we had a couple that we did and we were just stacking them up. And so we wanted to get through those. And then of course, Matt Simmons was going to join us for Other Voices which are usually 10 to 15 minute interviews. And Matt’s interview, he always has a lot to say, it turned into over 30 minutes, so we put him in as the third hour.
Hope you enjoyed this week’s program, in the meantime until you and I talk again, we hope you have a pleasant holiday weekend.