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 January 2009 

Lt. Gen. Lawrence P. Farrell, Jr., USAF (Ret)Erratic Oil Market Should Not Derail U.S. Energy Goals 

January 2009 

by Lt. Gen. Lawrence P. Farrell, Jr., USAF (Ret) 

A perfect storm of economic downturn and plummeting oil prices is posing a serious threat to the nation’s quest for energy independence.

But even in these troubled times, it is important to stay focused on our long-term goals and not let the oil market frenzy cloud our judgment. Oil prices may be down today, but they will be back up. The United States should not delay its move to renewable energy just because green projects are too expensive right now compared to fossil fuels.

Relevant to this discussion are recent studies by the Energy Information Administration. EIA estimates that world petroleum demand will have fallen by an average of 50,000 barrels per day in 2008 and that this decrease will average 450,000 barrels per day in 2009. This marks the first time in 30 years that world petroleum consumption will have declined in two consecutive years.

Along with all of the above, the average price of oil for 2008 will come in around $100 per barrel while the average price for 2009 will come in about $51 per barrel.

In this environment, one might expect the future price of oil to remain low and continue downward. But this is not necessarily true. Bloomberg reported earlier this month that the premium — the industry term for this premium is “contango” — between the current price of oil and futures prices is the largest spread in 12 years. For example, traders who bought oil at $40.81 Dec. 5 could sell futures contracts at $54.65 for delivery in Dec. 2009, a gain of 34 percent. All they have to do is store it for a year.  

After storage and financing costs are figured in, the gain could be 11 percent, Bloomberg noted. That would explain the increased demand worldwide for any tanker or other storage capability for petroleum. Stockpiling this crude could provide higher returns than any other investment at the present time. So the strategy is pump, buy, sell forward and store for future deliveries. EIA backs this up by pointing out that inventories are well above historic levels and are projected to remain so through 2009.

There would seem to be a contradiction between EIA’s projections of falling demand and Bloomberg’s forecast of futures prices rising in the face of falling demand. These conflicting signals are the very problems  — which have been reported in this magazine — that bedevil the development of alternative forms of energy. New energy development depends greatly on stable, predictable prices for conventional energy to benchmark the financial comparisons that will guide investment decisions. Obviously this has not been possible in the petroleum market of 2008 and beyond.

Add to all this OPEC’s determination to continue to reduce output, and the future of price stability is quite uncertain. This is bad news for the United States and the Defense Department as they attempt to reduce consumption of traditional fuels and move to renewable forms of energy. Not only is the incentive undercut in the short term but the investment motivation for the long term disappears.  

Therein lies the opportunity for the U.S. government to override the normal decision process by directing existing streams of spending toward green programs — by buying and supporting the development of all hybrids for transportation. Federal and state governments not only buy lots of vehicles, but also use and acquire large numbers of facilities. Why not mandate that future acquisition of facilities require that they be “net zero” buildings, which would reduce consumption of conventional forms of energy to zero by efficient design and construction and the use of renewables. This is easier than it initially seems. There are many examples worldwide of buildings that meet these criteria.

The wildcard in all this prediction of price and demand lies not in the world’s major powers but in developing countries, especially the giants such as China and India. They will be the big consumers in the future and account for the highest demand growth. The major uncertainty is how long their economies will remain depressed in the current financial slump. But one thing is certain: growth will return, demand will climb and prices will once again rise.  
EIA projects only modest growth in renewable forms of energy out to 2030. We need to speed that up.  

The incoming administration appears committed to renewable energy development and greater efficiency. The current economic challenges, the restructuring of the U.S. automobile industry and the new administration’s determination to do something in energy, might present the right combination of incentive and commitment to move forward meaningfully on the energy front.
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