The Energy Crisis of 2007

There were still people out in the streets drinking as we made our way to the Old Hat Factory this morning. We even heard music thumping from one of the clubs we pass on St. Kilda Road. The new year is here. What will it bring?

Black lung, probably, if you live in the Chinese city of Datong. Datong, abeout 260km west of Beijing, is the coal capital of China. And coal is most definitely king in the Middle Kingdom. “The Chinese plan to build no fewer than 500 new coal-fired power stations, adding to some 2,000, most of them unmodernised, that spew smoke, carbon dioxide, and sulphur dioxide into the atmosphere,” writes Michael Sheridan in today’s Australian.

And you thought Melbourne was smoky.

China estimates that pollution from coal-fired power plants results in 400,000 premature deaths…each year. Yet there are 21,000 coal mines in the country and coal output has doubled in the last five years. China’s Shanxi province produces more coal than Britain, Russia, and Germany combined.

Coal production is so high because coal is not oil. We know, it sounds simple. But the simplest explanation is often the best. Oil is expensive. It is cheaper for China to power its economic wunder-economy with coal it can dig from it’s own dirt, rather than oil it must import from the sands of Arabia.

Cheaper maybe, but certainly not cleaner, healthier, nor if Al Gore is right, better for the future of the planet. Yesterday we squirmed in a wiry, narrow seat at the Astor Theatre (our favourite local cinema) to watch Gore’s documentary “An Inconvenient Truth.” There’s nothing like being lectured to pompously for an hour and a half to remind you of what it must be like to be a reader of the Australian Markets and Money sometimes. We will try not to be so Gore-like and pedantic in the future.

Gore’s movie is really a long commercial for his presidential candidacy in 2008. And to that extent, it’s pretty nauseating. It’s also condescending, using cartoon animations to explain climate change, and a computer-generated polar bear drowning in a sea without ice to show us children of the Nanny State just what we’re dealing with. But that doesn’t mean there isn’t an underlying argument to the lecture worth considering. That argument is simple: the world’s economy can’t afford to keep growing using old fossil fuels and old ways of burning them for energy.

We know a little about history and biology. But we don’t know much about science books, the French we never took, or how many parts per million of carbon dioxide are really in the air and how much they are contributing to rising temperatures on the planet. But we do know that burning pulverized coal to produce electricity produces particulate emissions in the air that turn the delicate lining of your lungs into sludgy, black, phlegm.

It was true in London in the early 19th century, Pittsburgh in the late 19th century, and it’s true in China in the early 20th century. And if we read the geopolitical tea leaves correctly, something is going to happen in the energy markets that hasn’t happened before, the real cost of emitting carbon dioxide, sulphur dioxide, and nitrous oxides into the atmosphere as a by-product of power generation is finally going to be included in the price tag.

The producer may pay in the form of a carbon tax. Or the consumer may pay in the form of higher fees per kilowatt hour as cleaner coal-burning plants are built. But someone is going to pay to keep burning coal. And the price of coal-fired electric capacity rising to combat the real or perceived threat of global warming, nuclear energy is going be front and center in 2007.

Perhaps not right away. In the logical chain of events, the energy crisis of 2007 comes down to an acronym we made up this morning: MESI. It describes what people are going to do as the energy crisis blooms like a grotesque flower this year.

“M” is for more, as in more oil and gas. This includes the exploration for more oil and gas reserves to replace those already produced. But it most likely means a bidding war for known oil and gas reserves. For example, we read this morning in the Asia Wall Street Journal that, “China, which is aggressively seeking overseas energy assets to fuel its booming economy, said Sunday that one of its biggest conglomerates has bought the Kazakhstan oil assets of a Canadian company for US$1.91 billion…China’s CITIC Group bought the oil assets of Canada’s Nations Energy Company Ltd.” It’s China’s third-largest acquisition of overseas oil assets in history and, “The Karazhanbas field in Western Kazakhstan has proven reserves of over 340 million barrels of oil.” More, sir.

“E” is for efficiency. Emissions can be reduced or existing resources depleted less quickly if we are more efficient in producing them and using them. This means more efficient extraction, enhancing recovery rates from existing and new gas and oil deposits. But it mostly means improved fuel-efficiency standards in cars and more efficient household appliances. 2007 could be the year U.S. auto-makers, facing rapid declines in market share, finally begin producing cars for a world which demands better gas mileage. At the generation level, look for improvements in the industrial capital used to produce electricity, too. And buy one of those new globes for your light fixtures, at the very least.

“S” is for substitution. When bananas went to $14 per kilogram, your editor switched to apples. Consumers, the price-sensitive ones, are not stupid. As prices rise, they begin to look for lower-priced substitute products which deliver roughly the same good or service at a lower price. In the energy markets, this means renewables and alternative energy…things like ethanol, biofuels, and wind, solar, thermal, and hydro. None of these things, mind you, even taken all together, can produce the same kind of energy we get from oil and gas with reliability and regularity. But that just means the economic model that relies on industrial-era, large-scale energy generation and transmission is being modified. And that means opportunities. We like fuel cells thee most. Which brings us to…

“I” is for innovation. Problems of scarcity and depleting resources are often accompanied by dire predictions of the end of the world as we know it. Which is true. In fact, we read today that Barclay’s Wealth in the UK has recently told high net-worth clients that, “Given the likelihood of natural resource depletion and climate change it is feasible the next decade could represent the high watermark for wealth generation.”

Wow. So the rising cost of energy inputs into the economy has reached such a level that the world is simply going to cease generating wealth at this level. Hmmn. It’s possible. There are the laws of physics to consider, which determine how much energy you can get from carbon, and how efficiently you can turn that energy into work. But thus far, human beings, when confronted with an apparently natural limit on growth do what the species does best: adapt and innovate.

Just because we’ve done it before doesn’t mean we’ll do it again this time with success. That is, just because technological innovation has improved crop yields, produced life-saving medicines, and lowered the cost of energy over the last 100 years doesn’t mean it will solve all future problems. But not all innovation is whiz-bang gadgetry.

Generally speaking, people prefer living to dying. So they adapt when they have to, whether it means inventing something newer or better, or living more conservatively and efficiently. There is a lot of fat to cut in the energy diet of the average Westerner. Some of it’s going to be trimmed in 2007.

Beyond that, we have no idea. Nuclear makes sense because once the “social cost” of carbon emissions is paid by some body, coal is not as cheap as it first appears. Neither is oil, once its geopolitical cost is counted. Nuclear is not exactly cost-free. The spent fuel must be stored. And there is always the issue of plant safety. But Australian consumers are going to pay for more energy either way: from clear-burning but more expensive coal plants, or from carbon-free nuclear plants with their radioactive by-products. Pull the lever Australia, it’s time to decide.

The markets are quiet, for now. A wire service article today says that a recent report from credit-ratings agency Standard and Poors reports that “markets had reached a permanently high plateau due to a mixture of recent technology, globalization, and prudent central banking.”

We couldn’t find proof that S&P actually used the phrase “permanently high plateau,” a phrase made infamous by Yale economist Irving Fisher, who wrote that stocks had reached a permanently high plateau…just before the stock market crashed in 1929. IN fact, S&P consultant Simon Ibbetson warns earnings and share prices could decline quite suddenly and quite a lot.

“A sudden and very largely unanticipated reversal could also occur given the natural propensity for earnings to follow cycles and the fact that declines in both earnings growth and share prices tend to be sharper than the preceding rise…Therefore, the investor that is looking forward to another year of 10 per cent plus returns should also be prepared to lock back on 2007 in 12 months’ time having lost a similar or greater amount with equanimity.”

We don’t doubt the forecast of large declines in share prices. But we doubt it will greeted with equanimity. Certainly not the kind of good cheer that the new year was welcomed with last night. But we’ll see…

Dan Denning

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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11 Comments on "The Energy Crisis of 2007"

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Lindsay Holt
1.2.2007 Well Sir, I have been a LONG TIME reader of Daily Reckoning, and today I have to respond to things. Your characterization of Al Gore’s movie is totally off … what will you do if he does not run for president ? Will you publically admit to having been wrong ? At least he is one honest politician who has spoken out on these issues and spent huge amounts of his own time in traveling the world to do so … how can you even begin to condem that, when any decent, serious, intelligent, rational and sane perspctive would… Read more »
Zeke Putnam

I’ve watched Al Gore’s presentations. Odd, I appreciated someone attempting to present an issue that is, typically, trivalized as you have done. Many millions of the people watching it don’t have the sophistication you apparently have. Far, far too many people are treating global warming and insufficient energy supplies as an issue that will be solved with simple solutions and we can all go on living happily ever after. Frankly, your thinly disguised cynicism tells where your opinions lie.

Dan, Not having been to the LaTrobe Valley, I don’t know how the brown coal units there look, but in NSW and Qld, the only thing you can see coming out of the power stations is steam from cooling towers. So in a sense, by efficient use of technology and selective coal use, Australian consumers are minimising SOx and NOx emissions already. And they still enjoy competitive electricity tariffs. CO2 is another big question, and it looks like the political imperative will demand a response in the current political cycle, even if some of us remain ‘quizical’ about the science… Read more »
stewart rendell

yuo are right , but aust. and in particular vic. govts drag there feet on biofuels. bracks election platform was for 400 million litres biofuels in the system by 2010. from where? aust. exports starch ( in the form of wheat and barley) not oil ( in the form of canola or soyabean ) therfore the fous must be on ethanol and the production of ethanol in the regional areas. let us see how all levels of govt. handle the next oil spike.

David Loneragan

Concerning China’s purchase of the Kazakhstan oil field, with “proven reserves of over 340m barrels”, I’m sure you’re aware that if the world is using 84m b/d, this represents 4 days supply, or 16 days supply for the US. I’m no expert, but it seems to me they’ll need to be seeking “overseas energy assets” a lot more aggressively than this in the future……..

jerry verducci
I was at first appalled at your article and depiction of Al Gore. Mr. “T” has an expression which best describes my second reaction to your comments-” I Pity The Fool”. But, you cant blame folks when they just dont have the common sense to comprehend the big picture. The like of Georgy Boy Bush and his henchman ‘Old Baldy’ the oil man, have blown alot of smoke up Americas wazu. The republican arch type of being on the gymmee and more interested in the ‘ the take’ than ‘ the give’, u know, me me me. You sir are… Read more »
Roderick McGahon

rebellious liberals that you are…one hint of authority and
out comes grandmother sucking eggs!!!!!

Why does everyone automatically assume a slight rise in tempatures is going to be a disaster of biblical proportions. There have been other times, in recent history mind you, where the earth has warmed and it seems there was no mass die off. See the Viking settlements in Greenland for example. There is no doubt that the tempatures have risen lately. Whether this is part of a normal cycle or not is the question. The disturbing part is how the statists like Al Gore have jumped on the subject as way to advance their personal agendas for higher office. Why… Read more »
Dagny Gromer

It took about 100 years for the oil based economy/civilization to reach its present state, and will likely take at least half that long for the decay phase. Peak Oil does not mean there will be none, rather it says production will start to decline. Econ 101 says this will drive the price up until some demand is destroyed, resulting is a lower standard of living.
The real threat is goverment response to all this, which I fear will be authoritarian and draconian.

Dan Denning, This was a real surprise coming from you as I was a former subscriber to one of your newsletters and I had a much better opnion of you. The fact that you cannot appreciate a simple fact and you demean the man who has always spent his time trying to advocate changes to protect the environment, shows that I was indeed better off cancelling. Shell recently acknowledged global warming was a real threat citing”98% of scientists agree”. But of course you have 18 phds and a brain from Krypton and hence know that we are headed for the… Read more »
JJ Joseph

Anyone with enough patience to sit through Al Gore’s nonsense on global warming has my admiration. Rarely has the world seen such unsubstantiated rubbish marketed as ‘science’, and rarely has the world seen so many gullible diletantes lining up to take it all in. My only observation is that Gore’s vain and deceitful piffle only confuses and muddies any rational discussion of energy issues, as you can plainly see from the mindless comments of his socialist claque!

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