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Bruce Baker From: [email protected] Sent: Sunday, 25 May 2008 10:44 AM To: [email protected] Subject: mauldin - What the Export Land Model Means for Energy Prices What the Export Land Model Means for Energy Prices Posted May 19 2008, 05:10 PM by John Mauldin Goldman Sachs recently forecasted that oil would be at $141 a barrel by the end of the year, and rising to $200 a barrel in the not too distant future. I have seen other forecasts calling for oil to slip significantly under $100 a barrel before starting yet another bull market. I have written for years that we are not going to run out of oil or energy, just cheap oil. I was just in South Africa, where much of their gas and diesel comes from coal gasification. At one time this was an expensive way to make gas, and South Africans had to pay more for their gas than the rest of the world. Now, it is getting close to "par" to the cost of gas in the US, and is cheaper than gas in Europe. In this week's Outside the Box, my friend David Galland at Casey Research presents some very troubling thoughts on why oil may rise higher than we think in the next few years. Many of the countries from which the US gets its oil are seeing production fall, not rise. Some of it is political ineptitude, but much of it is from oil production peaking. Yes, we can move to coal gasification, and the US has centuries of coal for such purposes, but building such plants takes time and capital and political will, the latter of which is in short supply. In the meantime, and until we get a full-blown crisis, oil is going to continue on its path to $200 and higher. But such a rise will not only make gasoline prices higher, it will make a host of new technologies competitive for the first time. The shift in how we make energy is inevitable. As a quick aside, if we would start a project to build a massive nuclear infrastructure, such as in France, which produces 80% of its energy from nuclear, while at the same time pushing ahead in a Manhattan-type project the development of electric cars (or some hybrid), we could reduce our dependence on foreign oil and lower travel costs by the middle to the end of the next decade. And the environment would be cleaner and safer. We are headed to such a future. It would be nice if we did it sooner rather than wait for a real crisis. But in the meantime, the price of oil is going to rise and opportunities for investors will rise along with it. My friends at Casey Research publish an excellent newsletter highlighting the opportunities not just in exploration companies but in all manner of energy-related firms. As David writes: "The good news is that there are no shortage of high-quality energy-related investments available ... in coal, heavy oil, LNG, photovoltaics, natural gas consolidators, "run of river" hydroelectric, uranium and small to mid-cap oil companies with the potential for significant near-term gains in reserves or production." 1 They have agreed to give my readers a risk-free three-month trial to the Casey Energy Speculator. If you like the research you read below and want more of it, you can click on this link and subscribe . And now let's see one of the main reasons why the price of oil is going up. John Mauldin, Editor Outside the Box What the Export Land Model Means for Energy Prices By David Galland, Managing Director Casey Research - Casey Energy Speculator Jeffrey Brown is someone you should know. That's because he can help you understand today's high energy prices and that, as an investor, can make you a lot of money. I'll introduce to you to Jeff Brown in a moment. But first, as it's relevant to the discussion, I want to touch on an important concept related to investing in challenging times. You might call it "the Davy Crockett principle" in honor of something that American icon said during the War of 1812: "Be sure you are right and then go ahead." Simply, it's critical to step away from all the noise and clutter that pa sses for knowledge on the financial talk shows, and take the time to be very sure you are investing in close concert with a powerful unfolding trend. That accomplished, come what may, you'll come out okay once the dust has settled. And the earlier you can get on board with a trend, the more money you can make. In fact, Casey Research chief economist Bud Conrad has shown how, by making just four trades over the last four decades -- into exactly the right sector at the beginning of a strong new trend -- you could have turned $35 into $150,000. Or $350 into $1,500,000 ... or $3,500 into $15 million. And that assumes you don't use leverage. Toss in some options or futures and the returns run exponentially higher. Here's the chart. 2 While it is unlikely anyone actually made those exact trades, it is a certainty that many investors got in early on one or more of those big moves. (Interestingly, replacing the last trade -- the move into crude -- with gold produces a final number of $131,496. Proving there is more than one path to the top.) The key point I'm trying to make is simple: focusing your investments on big trends is a big leg up in your quest for investment success. By then digging in to find the right opportunities, whether they be in commodities or undervalued companies that benefit from those trends, assures you earn returns that are well above average. More importantl y, in the context of the current market environment, the combination of the right investment in the right trend makes your portfolio bullet-proof. Which brings me to the work being done by Jeffrey Brown, a professional geoscientist with an avid academic and professional interest in something called the Export Land Model . Turning off the Taps You don't have to have an awful lot of gray hair to remember the excitement around England's massive North Sea oil fields. While discovered in 1969, it wasn't until well into the 1980s, on the back of surging oil prices, that the fields came into full production. Turning up the taps, the United Kingdom (as well as Norway and Germany, who also have North Sea production) became a significant exporter of oil. But then, in 1999, something happened: the UK's North Sea production hit peak ... that tipping point after which reservoirs go into decline, setting in motion both reduced production and progressively higher costs related to extracting the remaining oil. While the experience of North Sea oil production provides yet another useful example of the validity of the Peak Oil theory, what concerns us today is a critical but usually overlooked aspect of the discussion, exports. At the time the North Sea peaked in 1999, the U.K. was exporting 1 million barrels of oil per day. By August 2004, it had become a net importer. What happened to cause the situation to turn around so quickly? 3 The Export Land Model To understand the importance of exports when discussing peak oil, ask yourself the question, "What's more important: the fact that global oil production is falling ... or that the oil-exporting nations are cutting off their exports?" While the two questions are clearly linked, it is the nuance of the export question that clearly matters the most. Especially if you live in a country such as the US, which currently imports about 70% of its oil. Which brings us to the Export Land Model (or ELM, as I will refer to it from here). The basic thesis expressed by Jeff Brown and other students of the ELM is that, to fully appreciate the impact of peak oil, you cannot look only at the production declines so presciently anticipated by MK Hubbard in 1956. You also have to look at the rate of local consumption and the effect of that consumption on the ability of a country to export its oil. The following ELM graph looks at both sides of the equation, and the result as it applies to exports: As you can see, for illustrative purposes the ELM assumes that, after a country's oil production hits peak it will decline at a rate 5% annually, at the same time that local consumption increases by 2.5%. The dotted red line then shows the impact those two metrics will have on the ability of the country to export its excess production. Using these assumptions, the ELM shows that exports reach zero in 9 years. Real-world data shows that the metrics used in the ELM are quite conservative. The chart below plots the hypothetical ELM against the actual data from the United Kingdom and Indonesia. While the ELM forecast hypothesizes 9 years between peak to the end of exports, Indonesia's exports ceased 7 years after peak, and the UK's exports stopped just 6 years after peak. 4 The important take-away here is not that the UK and Indonesia are no longer receiving the oil export income of the good old days -- that is entirely a localized concern. Rather it is that the global market is now deprived of those exports; between UK and Indonesia alone, the change over just the last decade amounts to a swing in the wrong direction of a total of 2 million barrels per day.

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