A Melman Minute — February 20, 2008

What goes up quickly quite often comes down just as fast. We are referring to yesterday’s powerful commodity price increases, many of which are in reversing mode this A.M. In early trading, gold has fallen by about US$7.00 (all figures US$) to spot $922; silver is down 22 cents to near $17.15; palladium and platinum have reversed very sharply and crude oil is down by about $1.00 to near $99.00 per barrel. However, it should be noted that all long-term uptrends in those commodities are still intact.

Every so often, we get to see two important stories that seem to combine together to highlight a growing problem. That is the case today with new information coming out of China to support the case for ever-growing demand for fuel while another story, this one out of Alberta, points to future supply difficulties for the same commodities.

As noted yesterday, China continues to grow rapidly, with economic expansion continuing at an impressive 9-10% per annum, far in excess of what could be considered a normal range. Today, we note a very specific feature of that economic growth, one which has truly important implications for the world’s petroleum supply/demand equation. We are referring to the growth of the Chinese suburbs.

According to Bill Powell, writing for “Time” magazine” out of Shanghai, a new and powerful trend has come into existence in China during the past very few years. Millions of Chinese who had headed into urban areas such as Shanghai from poverty-ridden rural towns and villages to improve their standard of living have now reversed direction and are buying homes in newly-created suburbs, trying to escape the growing problems of major cities such as smog, crime, lack of free space, etc. In fact, the situation is analogous to that of America and Canada in the period after World War Two when our suburbs came into existence for many of the same reasons.

Living space at comparative costs is another important consideration. For example, in Shanghai itself, a 1,000 square foot apartment costs the same as a new, 2,400 square foot single residence in suburban areas. Powell estimates that as many as five million people, roughly the same figure as the entire population of the Greater Toronto Area, will move from central Shanghai to the suburbs over the next ten years.

The demand for raw materials to construct so many large homes, plus new shopping facilities, new medical facilities, new transportation networks and new suburban-based industries is likely to be tremendous and constitutes yet another demand on the natural resource world’s production capacity. However, of perhaps even greater importance is the huge increment of new growth in the demand for gasoline, heating oil, natural gas and other petroleum complex products.

Automobile usage is probably the single most important fuel consideration. The number of autos on China’s roads has grown from virtually none just a few years ago to 12,000,000 at present - and the rate of ownership is growing at 26% per year. At that rate, within three years, there will be more than 20,000,000 autos on China’s roads - and, thanks to this trend toward suburbanization, they will be driving more miles (or kilometers) than ever before.

At the same time as this huge leap forward in demand is becoming apparent, one of the few areas providing more energy each year, the Alberta tar sands, are coming under severe environmental pressure. According to a recent story in the Financial Post, outrage over what has been perceived as Canada’s despicable environmental performance related to the tar sands has been growing by leaps and bounds in European environmental communities. Britain’s famed newspaper, the “Times of London” referred to oil sands production as “this filthy habit” and another British paper described the investment by British Petroleum (BP) in the oil sands as, “Canadian wilderness set to be invaded by BP in an oil project dubbed ‘the greatest environmental crime in history’.” The Boston Globe simply referred to the oil sands production as “the new dirty energy.”

It is becoming apparent that the international environmental movement - and we have seen the strength of its power in recent years - has now turned the full force of its attention on Alberta’s oil fields.

While the industry is fighting back, pointing out strong technical advances to reduce its environmental footprint in a number of ways, the accusations are so emotionally charged and so varied that some impact on future production seems inevitable.

It is ironic that while petroleum production is declining from many Western sources such as the North Slope of Alaska, North Sea, Mexico and Venezuela, the one source of energy that is growing and under the control of a truly friendly government power is now coming under attack.

The combination of these two forces - China’s growing demands and the environmental condemnation of the tar sands - seems to be yet another potent indication of future price increases for crude, heating oil and gasoline. Heating oil seems particularly vulnerable as the space heating requirement of China’s residences expands steadily - and the accompanying chart shows that the price of that commodity is now at record levels.

Financial markets this AM opened lower in Toronto and New York with each indexes down more than 100 points initially. Both markets then recovered moderately with the Dow down about 65 points and the TSX off about 50 by 7:30 AM PST.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

← All A Melman Minute