Oil, Coal and Natural gas

While an oil crisis is good for spurring innovation, it takes years to affect the existing energy market. Meanwhile, world energy consumption is growing, especially in Asia.

Oil consumption is affected by manufacturing and cars. US and EU demand has leveled off the last few years for the exact reasons that it has grown in China: vehicle growth and manufacturing have flattened. China has become the world’s manufacturing plant while car sales are surging.

The Chinese car market is growing ~2M units per year. India is expected to add 1.5M units. Add in Russia and other countries and it is safe to say that 5M more cars will be on the road in 2008 than in 2007. And many of these countries subsidize oil, so there is no incentive to consume less in the face of rising oil prices.

Will reduced US and EU consumption balance out this new soaring demand? Already the US is reducing consumption, but it isn’t enough. There is less than a 1M bpd surplus in the world today. US oil consumption has fallen ~4% or ~0.8M bpd. A lot fewer planes and cars are running these days.
(http://www.eia.doe.gov/oiaf/forecasting.html)

But that 0.8M bpd is quickly eroded by new demand. A barrel of oil yields 20 gallons of gas. 5M cars on the road will consume 1 gallon a day (terrible traffic consumes a lot of oil) or roughly 0.25M bpd. Add in growth in emerging markets from manufacturing, airplane travel, and so forth, and global increases in demand reduce US surplus gains to almost zero. One refinery goes down, and any surplus disappears. One major storm in the Gulf or the North Sea, and that’s it.

Meanwhile, China imports ~150M tons of oil per year. There are only 2619 ships to go around and China is already using half of them. http://www.osg.com/oi_tankermarket.htm
Factor in the scarcity of refineries and you see a transportation process that moves crude oil to a refinery and then to local markets. The remainder service Japan and the US. Which leaves very few ships around to contract – hence my love of shipping and interest in DSX and FRO.

Getting back to oil – supply is very tight today and for the next 12 months. While dollar weakness and speculation has played a part, the reality is that underinvestment and sudden demand are the real culprits.

The real issue is electricity. Factories run on electricity. Air conditioning, hospitals, the internet, infrastructure – it all needs electricity. And coal and natural gas generate the bulk of electricity in the world.

Half of the US electricity is generated by coal. China consumes more coal than the US, Europe and Japan combined. India is better off because it produces 80% of its coal needs, but it still imports almost as much coal as the US exports. China became a coal importer as of January 2007.

Meanwhile Vietnam is slowing exports, hurting Japan. The net result is that Asian countries need coal and are having to go further afield to obtain it. Hence my love of US coal.

This is not going to stop for some time. And there are bottlenecks which create mini-shortages - like limited transportation routes and ships, like weather around East Coast or West Coast ports, and so on. DSX is a contract drybulk shipper - they pass fuel costs on to customers, so oil i snot an issue. And they are the ones who benefit from this demand.

Natural gas is in a similar shortage.
NG is used for heating, electricity generation and for fertilizer. The US consumes the most (the Gulf of Mexico provides a lot), and China comes second. China demand grew 20% last year.
http://www.bp.com/genericarticle.do?categoryId=2012968&contentId=7045418

So all roads seem to lead to China. Will a recession change things? Probably not. Even a low growth forecast will not see major surpluses in the next 12 months.

I think earnings will blow away all expectations and I like the recent pullback for an opportunity to buy oil extractors and services, NG extractors and services, coal, and shipping.