Sunday, February 20, 2011

Investing in view of the Export Land Model

A few weeks ago, Erik Townsend, a previous frequent contributor at Chris Martensen’s and at Jim Puplava's websites, released a pair of videos titled, Peak Oil Explained for Investors (video 1 of 2) and  Peak Oil Speculative Trading Strategies (video 2 of 2).

Part 1 gives a nice introduction to the concept of peak oil, common misconceptions, and Erik’s perspective on why a number alternative means of generating energy will likely, at least in the short term, fall short.  Part 2 discusses possible speculative investment scenarios that can take advantage of the present market under pricing of oil, including taking advantage of price up or down turns in or investing in alternative energy industries.  Some of the investment schemes Erik describes are quite complex and would only be suitable for advanced professional investors, but other could be used by any investor.  I would highly recommend watching both these videos, even if you are not an investor type.  The videos are completely free and Erik is not selling anything. 

You can watch the videos at Erik’s website or download the higher quality MPEG4 video files.  If you do decide to download them, be warned that these are big files.  Also, if you have an older computer, like mine, you might have trouble playing them.  I found that the freely available VLC media player worked well for this purpose.

Erik’s presentations caused me to think, in a new light, about my previous articles about the Export Land Model analysis for the USA and the earlier supporting article on the production and consumption trends for the USA’s top ten export sources. 

If there few people that understand the implications of peak oil, then even fewer understand the implications of declining oil exports.   Global oil exports will likely decline at an even faster rate than post-peak oil production rates decline.  An exporting country’s declining net exports can be due to one or both of declining oil production rates and increasing domestic consumption.  A combination of declining production rates and increasing consumption rates means that the rate of decline in exports will be the sum of these two rates. 

I didn’t find much on the internet discussing implications of the Export Land Model on investing.  I only found one article by David Galland, What the Export Land Model Means for Energy Prices (guess what, they go up).  While this article nicely explains what the export land model is, in my opinion, it falls short by not considering how declining net exports will specifically affect the economies of different countries depending on what type of oil importer or oil exporter they are.

I believe that the Export Land Model analysis could be useful in predicting how different countries will fare in the face of zero net export.  This might create some interesting investment ideas, which I briefly explore below, for five different classes of countries:

Net petroleum exporters with no end in sight.
Canada and Brazil are examples of countries with increasing production and signs of flat or declining domestic consumption going forward.  I therefore expect exports from these countries to increase in the coming years, and this should greatly benefit their economies in general, and in the petroleum sector in particular.  Especially if the price of oil spikes, these country’s economies would boom. Moreover, both of these countries are stable politically as compared to a number of other exporting nations, and therefore, stable oil production is more reliable. 

One problem with Canada is that it's economy is so closely tied to the USA's; if the USA goes into a recession or depression, then so will Canada's.  It's energy sector might stay strong, so long as the government doesn't tax it too heavily.

Present small exporters with a large speculative upside potential in production
Angola  and Iraq are examples of countries with low domestic consumption and the potential for spectacularly large increases in production over present production rates—160% for Angola and 400-500% for Iraq compared to present levels. 

I class this upside as speculative because there are real risks of civil war in both of these countries.  Additionally, for the production rate increase to be realized in the next 5-15 years there have to be sustained large year-over-year increases in the production rate (20-30%.yr), which I think will be challenging to pull off in such politically unstable countries. 

Present exporters rapidly headed towards ex-exporter status
There are several present exporters that I would put in this class, and based on my modeling, I can make an estimate of the year when they will transition from being a net exporter to ex-exporters:  Mexico (2014), Venezuela (2022), Saudi Arabia, Russia (both 2023), Algeria (2030),  and Nigeria (2039).  With the exception of Russia, which I expect to have flat to declining consumption going forwards, these are countries with both declining production and increasing consumption rates.  

I predict troubles ahead for countries like Mexico and Venezuela that are just few years away from hitting zero net exports and whose domestic economies are heavily dependent on income from the oil industry.  I would avoid investing in these countries, unless there is some way of shorting domestic industries or foreign industries that are heavily dependent on continued oil imports from these countries.  One possible negative play would be those Caribbean refineries that import Venezuela’s and Mexico’s oil and then re-export it to the USA. 

I have the same concern with Russia and Saudi Arabia.  Maybe new oil production technologies and new arctic oil drilling will allow Saudi Arabia and Russia, respectively, to delay the time of net zero exports, but I would like to see more evidence of a changing trend in exports, before I believe it. 

Net importers that still have significant domestic production
The USA, UK and China are all examples of many countries that are not totally reliant on petroleum exports and therefore could still carry on if (when) global net exports reaches zero.  If these countries could no longer import petroleum, I predict that the extent of the decline in their economies (% decline in GDP) would be roughly proportional the ensuing relative decrease in petroleum consumption (% decline in dQ/dt).

I wrote more about this here in the context of the USA, but the principle is probably generally applicable. 

For instance, for the USA if because of falling imports, petroleum consumption decreases by 40% (see Figure 3 here) then I think that the GDP would decline in proportion. 

The economies of these countries will be hurt badly by net zero exports, but it would not be a total economic collapse for them.  However, to the extent that most of the OECD countries in the world fall into this class, the size of economic contraction would set off a world-wide recession that would probably last several years as populations adapt to the new realities of decreased oil consumption.  

Countries totally reliant on petroleum imports
As I pointed out here, Japan and South Korea are examples of countries that import nearly all of their petroleum, and have no significant domestic production.  Net exports going to zero should scare the hell out of the governments and population in these, and similarly import-dependent, countries. 

There are signs that Japan is aware of the economic threat of a short term disruption in exports (see Japan’s 2010 Annual Report on Energy noting Japan’s high dependency on oil passing through transportation choke points).  Japan appears to be moving to nuclear energy, to mitigate their dependency on oil, with plans to nine new nuclear power plants by 2020 and more than 14 by 2030, although I think that this will be too little too late.  I don’t find similar signs of an awakening from South Korea. 

Net zero exports would devastate the economies of these types of countries, in my opinion.  And a simultaneous recession in the other OECD countries would make it worse, because Japan’s and S Korea’s exports of manufactured goods would also get hammered.  I imagine Japan and South Korea having to adapt in the same manner as in the "special period" of Cuba when, after the Soviet Union collapsed, Cuba's petroleum imports dropped ninety percent.  It will probably be worse for Japan and Korea, in that Cuba actually produces some oil domestically.  For instance, using EIA data, Cuba produces more petroleum than Japan and S Korea combined but consumes less than 1/20 and 1/10 that of Japan and S Korea, respectively.  Moreover, after the shock, Cuba was able to import oil from another source: Venezuela.  In 2009 Venezuela exported about 100,000 bpd to Cuba at a discounted price (see Venezuela's Oil-Based Economy).  Japan and South Korea may not be so fortunate in a time of net zero exports.  

Then we have the issue of North Korea.  North Korea's traditional oil import sources from Soviet Union/Russia, China and Iran have been in steady decline for over a decade, as has its domestic coal production (Economy of North Korea; N. Korea's shrinking oil imports reflect economic hardships).  I expect that at some point this energy choke will spell war between North and South Korea, or more hopefully, regime change in the North.  But then South Korea will inherit the energy mess. 

And what about other less developed countries that are totally dependent on imported oil with no domestic production?  Other than Cuba's special period I do not have an example to give, but I’m sure there are many.  I would not want to be invested in (or maybe even located in) an underdeveloped country that is also totally dependent on oil imports when global net exports go to zero. 


  1. Thank you so much for all of the fine posts you have made on this issue. It really helps one get a better understanding.

    One variable your anlysis overlooks, however, is the effect of worldwide unrest and revolution on oil exporters and even the importers. Take Libya for instance. The brewing civil war there threatens to shut down their oil production altogether. Just today it was reported that Ghadaffi is threatening to sabotage the country's production as a threat to the rebels. If the country should become an ungovernable failed state like Somalia and sees all exports permanently cease, that will sap the exports of other exporters even faster.

    The huge black swan in this scenario is Saudi Arabia. It has been rumored that the regime there has rigged the oil fields for major sabotage if their position is threatened.

    Then you have the potential political effects in the U.S. No way the population or elites here are going to accept an 89% drop in standard of living as you spectulate without lashing out at both internal and external enemies.

    What you have written is a receipe for potential worldwide conflagration, which I think is already in its initial stages. In such an environment, it may not be safe to invest ANYWHERE.

  2. Some great comments Bill, thank you.

    Models have smooth curves (I least the ones I like do) and therefore they can't anticipate black swans like the unrest, revolution and regime changes currently in the North Africa and Middle East, or the market's reaction to them. I see this as one of many system failures that the world will have over the next twenty years.

    The market certainly did not account for the impact of this unrest, as evidenced by the spike in oil prices over the last few days. Some well positioned speculators familiar with peak oil are making money out of this now, I'm sure. A number Erik Townsend's strategies described in the videos are directed to profiting from these sorts of short term moves.

    My article, however, is trying to take a longer term view by considering what countries are the best bets to invest in view of peal oil and the Export Land Model. You might think that this amounts to betting on the best horse in the glue factory, and maybe it is, but I don't expect a smooth ride down.

    I am no investment advisor, but, I do not advocate entering into any sort of stock or commodity investment like this until you have paid off all your debts and accumulated enough reserves of food, cash and gold to sustain yourself for at least a year. However, there are many people with money accumulated in self-directed IRAs, RRSPs, etc..., and are not ready to cash out and take the early tax hit today. Perhaps being aware of peak oil and the Export Land Model can help with these investments.

    Spiking oil prices will depress the economy and decrease consumption and production. As the economy partially recovers, consumption goes up, and, production will try to increase to match this. When it can't, we go into another recession, and so on. Erik's second video had a nice representation of this—a mirror image of the periods of expansion and recessions when we were on the growth side of the oil production curve. I expect that the undulations in production and consumption to add plenty of noise to the declining export curve. It will not be smooth, but I see no way to model this.

    Libya is an important producer at 1.8 mbd petroleum in 2009 (according to the EIA). But that's only about 2% of world production. The rising fear now is cascading civil unrest in multiple other countries in these regions and the impact this will have on exports.

    I'm sure that the Kingdom of Saudi Arabia is watching closely. I would expect them to put down any rebellion even harsher than we've seen in Iran or Libya. But if Saudi Arabia fall into domestic rebellion, and, that causes petroleum production to fall I expect the OECD countries will have to get involved to restore the flow. The USA is not nearly as dependent on Libyan or Saudi Arabian oil as Europe and East Asia, so it would be interesting to see what, the EU's, China's, Japan's, reaction would be if the USA held back.

    Could the USA really afford to open up a third theater of engagement in Libya or Saudi Arabia? I have my doubts. I think that there would have to be a rapid deployment from Iraq and Afghanistan. But, if the USA pulled out of Iraq, how likely is it that the anticipated boom in production would still occur? Thinking of it in terms of ERoEI, would the a net benefit be greater than 1:1? I wonder.

    The 89% drop is among my worst case scenarios that I discussed, and if that happened rapidly over a few years, then I think the USA and the rest of world will become desperate. War, rationing, marshal law etc... are all likely scenarios. But what if this decline is stretched out over 20 years? My belief is that we will just muddle through and adapt to this, but I can't discount that war(s) would not be part of an administration's strategy to deflect attention away from the reasons behind your declining standard of living.

  3. CW - thanks for your thoughtful response. I never would have taken you for an optimist, but the "muddle through and adapt" theory is definitely the optimistic point of view. I look at the Wisconsin protests, with neither side having a clue about what is really happening to them, as an example of why I just don't see it happening that way. The U.S. population is too heavily armed, is too doped up on both legal and illegal drugs and has too large of a sense of entitlement to go quietly. I agree with author Charles Bowden that the current conditions in Juarez, Mexico, with its horrific breakdown in public safety, are coming to large swaths of America soon.

    That said, there may be isolated rural pockets where people can hunker down, adapt and live a more sustainable lifestyle. And as you said, paying off debt and accumulating reserves of food, cash and precious metals is the smartest move for nearly everybody, even if most people don't think of those things as investments. :)


Your comments, questions and suggestions are welcome! However, comments with cursing or ad hominem attacks will be removed.