The Return of Peak Oil

There has not been much talk of crude production hitting its peak during this recession. The evidence now is real. Investors will need to examine the proof carefully.

According to Marshall Adkins with Raymond James, global oil production peaked in the first quarter of 2008. What is the evidence? OPEC oil production reached a high point in the first quarter of last year, while non-OPEC production peaked even earlier in 2007. Worldwide, total oil production rose to its highest level to date in 1Q2008 (approx. 79.3mmbpd).

Mr. Adkins explains, "It is entirely intuitive to conclude that if both OPEC and non-OPEC production posted declines against the backdrop of $100 plus oil, when the obvious economic incentive was to pump full blast, those declines had to have come for involuntary reasons, such as the inherent geological limits of oil fields."

Marshall Adkins is right on with his reasoning. Why would countries or companies curb production when they could make so much money by producing more oil?

Energy demands have declined, but the reality is they will eventually come back. The supply of oil will then be inadequate to sustain the increased demand.

The fundamental reality is that oil is scarce . Oil producers will be hard pressed to keep up with future demand. E&P companies will be drilling everywhere possible. However, because most drillers cut exploration and production during the recession, they will be behind the demand supply curve. Investors will continue to see the price of crude going higher for years to come.

Scrap Cap and Trade

Under the guise of regulating industries that generate greenhouse gases, the Obama administration is aggressively pushing an approach called, "Cap and Trade".

The idea is to limit the amount of emissions a company produces. A noble idea. The problem is the method Washington is seeking to implement.

The plan being promoted would require companies to purchase emission credits should they exceed their capped emission limit. The Congressional Budget Office is projecting revenues generated from this proposed bill at a minimum of $50 billion per year, and could quite easily reach $300 billion.

With those kind of revenue dollars at stake, look for the Obama administration to push hard for this legislation. They will then be able to use this backdoor tax on business to pursue their other societal agendas.

The greater concern with this type of legislation is that it will add cost to doing business for any company involved with fossil fuels. Although there appears to be signs of economic recovery, the economy is still stagnant and experiencing lots of pain. American companies will find themselves at a disadvantage as it will become necessary to pass on these additional costs to consumers.

Companies consuming fossil fuels will be more than willing to adapt to new energy sources when the market place provides the new alternatives. Until viable new technologies emerge, it is best that Washington not do further damage to a highly fragile economy by enacting "Cap and Trade".

The 10 Year Note Is Our Inflation Canary in the Cave

Crude futures are up 80% from their $32 low this year. The main drivers of this upward trend has been a combination of increased demand from China, and investors using crude as a hedge against inflation.

China's economic stimulus package is focused heavily on infrastructure spending. Huge government projects to build roads, pipelines and bridges, helped drive the Baltic Dry Index up over 100% to its current 2211. China is also storing vast amounts of crude at what they perceive are low prices.

Investors in crude are also driving prices higher as they seek protection from certain coming inflation. The 10 year treasury yield is now up to 3.3% from 2.5% just a few weeks ago.

A 6% yield on the 10 year note is when things will get very interesting. Investors will find equities not worth the risk, if they can lock in a 6% return by owning debt. Also, should interest rates continue their climb, the US Treasury will find it even more expensive to cover the budget deficit. This will lead to more purchase of debt by the Treasury to try to hold interest rates down. The printing of money in this fashion will lead to higher inflation, which will continue to support higher crude prices.

Proposed Transaction Taxation Bill

Traders are in the cross hairs of newly proposed congressional legislative bill proposals. The greatest harm could come from bill H.R. 1068, better known as, "Let Wall Street Pay for Wall Street's Bailout Act of 2009".

This bill would put a 0.25 percent tax on all securities transactions as a means to pay for the Troubled Tax Asset Relief Program (TARP). The proposal claims $150 billion a year could be raised. The bill goes on to state that the tax would have a negligible effect on the average investor.

In reality taxes have to be paid by someone. Robert Green rightly assessed in Active Trader, April 2009, "Ultimately , the financial-transaction tax could put thousands of traders out of business overnight...Entire Wall Street firms may simply shut down their proprietary trading desks, further drying up liquidity and making the U.S. markets less appealing to the rest of the world."

Less liquidity in the energy complex futures markets will mean greater volatility swings in crude, diesel and gasoline spot and futures prices. Individual traders, trading groups and hedge funds will move their trading away from US markets to more liquid foreign markets.

TARP eventually needs to be paid off. However, taxing transactions will not be the intelligent method to dispose of this liability.