Those of you who read our E-news will recall that our premier issue carried an article about oil prices called “A Perfect Storm”. It is ironic that back in June when I wrote this piece I would choose a name that has come to mean so much with regards to energy prices, energy supplies and two monster hurricanes which were both physically described by the media, at one time or another, as “perfect storms”.

Everyone knows, generally, what has happened to the country’s energy infrastructure in the last month. However, not everyone may realize why. Let’s look into “why” and then we’ll see exactly what our energy picture is like as the month of September, 2005 draws to a close.

Although the American petroleum industry got its start in places like Parkersburg, West Virginia and Oil City, Pennsylvania in the 1700’s, it grew up on January 10, 1901 when wildcatters drilling at a place called Spindletop, Texas brought in a gusher that created a huge oil “lake” before it could be contained.

The Spindletop oil field lay just north of Houston in an area now known as Humble, Texas. As it turns out, much of Texas, Louisiana and the floor of the Gulf of Mexico is laden with oil and natural gas. Beginning around 1900, the petroleum industry in that area provided the nation with oil & gas to fight two world wars, develop industries both for wartime and peacetime production of goods, build roads, and, of course, help create a love affair between its people and a device called the automobile.

By 1910 the automobile industry was well underway And usage of petroleum began to skyrocket NAFTC Photo

In 1910, global demand for petroleum stood at about 500,000 bbl/day. Today that figure is well over 80 million bbl/day. The United States alone consumes about 22 million bbl/day, which constitutes over 25% of global consumption. To meet this demand, the floor of the Gulf is literally carpeted with oil and gas wells which supply roughly a quarter of our nation’s fossil energy.

Of course, despite these massive sources of energy we are not self sufficient. We lost our energy independence around 1976 when we were only using about 9mm/bbl/day of oil! In fact, today we are importing over 60% of our petroleum and about 4% of our natural gas to keep pace with the demands of a growing economy and an expanding population. As much of our imported oil comes from Venezuela, the natural Gulf seaports at New Orleans and Galveston Bay are closest to petroleum from south America, so that is where the supertankers go to offload their oil. Naturally, this is where the refineries are built, and the refined products of petroleum, as well as natural gas, are then delivered to the nation via a complex network of pipelines, barges and tanker trucks.

As a result, the heart of our nation’s fossil energy production and refining is the rim of the Gulf of Mexico, from Galveston Texas to Mobile, Alabama.

This nexus of energy is the same area visited by two powerful hurricanes. Certainly Katrina was the more vicious of the two and it hit hard. Offshore platforms had to be shut down. Onshore refineries were also shut down. Offloading facilities for the tankers bringing us our foreign oil were also closed. The bottom line is this: Katrina and Rita have effectively shut down about 30% of our fossil energy production. Some of this lost production will come back relatively quickly-a matter of days to a few weeks. Some will take longer. The strategic petroleum reserve, also located in Louisiana, has been made available by Presidential order and can help provide crude. Before Katrina, our nation’s refineries were already operating at close to capacity just to meet the daily demand for gasoline and distillates. (Distillates are forms of kerosene fuels which include diesel, jet fuel and heating oil). When Katrina struck, fast and without much warning, we lost significant refining capacity. The flow of gasoline and distillates to distributors simply stopped. No one knew when the flow might begin again. This is what caused the momentary price spike. After a few days of staggering prices four things happened:

• Some refining capacity was quickly restored and refined fuels started to flow again.
• Assurances from other nations that they would send refined product to the US eased the supply fears of the market
• Demand eased as the effects of high prices did their work in dampening consumption
• Demand also eased simply because millions of people displaced by these storms were not driving to work or using energy to run their homes and businesses. This is especially true in the case of Rita which caused the evacuation of millions of people and the virtual economic shutdown of the nation’s fourth largest city.

A petroleum tank farm near New Orleans lies under water following Hurricane Katrina NAFTC Graphic

Why haven’t prices jumped back up after Rita? Because gasoline demand has declined and crude stocks are actually quite high. So, for the time being, refined product is generally available. In fact, the price of crude oil on the global market has declined at the beginning of the week following Rita.

If gasoline stocks have bottomed out and begin to recover, as is likely, and a surplus of crude remains on the global market, as is also likely, then we should be able to hope for some stability in the market for awhile. That said, if our energy infrastructure takes another big hit all bets are off. Also, keep in mind that by “stability in the market” I mean stability at around $60.00/bbl for petroleum. It appears, based on oil futures, that this is the new benchmark for petroleum, not $28.00 or $40.00 as in the past.

In conclusion, let’s examine the net effects to date of our “perfect energy storm”:

• As of the last week of September, 2005, NO OIL is being produced in the Gulf of Mexico. Some natural gas is flowing, but no oil. This oil will, for the time being, be replaced by drawing down the strategic petroleum reserve.
• Staggering increases in fuel prices helped to tip two of America’s major airlines, Delta & Northwest, into bankruptcy court this month.
• Boeing is delaying some orders for aircraft because of the uncertain future of the airline industry
• Automakers are being forced to offer deep discounts to sell light trucks and large cars. Until recently, light trucks were their biggest sellers and most profitable products.
• Automakers are announcing that more and more hybrids will be introduced to the market. Light duty diesels are also beginning to gain market share.
• Despite assurances to the contrary, the Saudis do not appear to be able to significantly increase production. In other words, their taps are already wide open. As their major fields begin to fill with water from excessive pumping, more and more water is coming up the wellhead with the crude. This diminishes the yield from their wells and also increases the costs of their production.
• Billions of dollars of damage have been done to our Gulf energy assets. Until these assets are fully repaired, short term increases in the cost of energy are inevitable.

NAFTC graphic What happens to crude oil? 70% Diesel fuel and Heating oil 13% gasoline 10% solvents and lubricants 4% plastics 3% other petrochemicals

Some good news: (The silver lining in the storm clouds)

• Oil is among the most fungible of energy commodities. As a result, the cost of all other forms of energy is tied to it. Higher oil prices mean that all other forms of energy can command higher prices as well. This includes the alternative and renewable fuels that do not come from fossil sources. As investors realize that the new benchmark for oil will remain at the $60.00 level, their money will begin to flow into alternatives such as biodiesel, ethanol, gas to liquids and even nuclear power. It is nuclear power from which that ultimate fuel, hydrogen, can be easily obtained.

To follow this projection without new sources of energy, global oil production would have to more than double in the next 40 years. Where is it going to come from? NAFTC graphic