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Tuesday, August 25, 2009

The Biggest Game Changer of Them All

These days, the news is all abuzz about the proposed health care bill. Others say we should really be concerned about our huge budget deficits or our weak economy. The shrewd talk about the future or lack there of for the US dollar and, many kind people worry about the survival of the Social Security and Medicare systems.

All of them are serious challenges for our country and, to our industry. But to me, the biggest issue facing us over the next few years is not mentioned much these days. It is energy.

When gasoline briefly touched $4.00 per gallon at the pump last year it was THE headline news item in America. Then suddenly, oil fell from $147 a barrel back to $35 and people ignored it. You may not have noticed with all the collateral noise about, but a barrel of oil is now hovering at around $75 right now; more than double what it was some months ago.

Most analysts agree that the price of oil over the next several years is headed much, much higher. The most articulate proponents of this forecast are a group known as “Peak Oil” theorists. Their argument, in a nutshell, is that virtually every oil field in the world is now in irreversible decline. The PEAK means that the 85 million barrel that we produce each day now is close to the maximum that the world with current technologies can handle. Demand is a bit quieter now with the world wide economic struggles but, once we snap back into prosperity, hungry consumers across the world will satisfy their unquenchable thirst for oil at higher prices.

Critics of Peak Oil try to paint them as a motley bunch of wild eyed embarrassments who say that the world is running out of oil tomorrow. If you read them, you find that they really just say that we have reached the pinnacle of production. Over the next few years production will decline maybe by as little as 1-2 million barrels of oil per day each year. They never say that the world will run out of oil. I would say that it is a good bet that my grandchildren’s grandchildren will be using oil based products. It will, however, be hard to find and incredibly expensive compared to what we pay today.

And, remember, we do not control world demand anymore. In 1973, during the infamous gas lines in the US, most oil was consumed by the US, Canada, Japan, the then USSR, and Western Europe. Now, China and India, the Middle East, South America, even parts of Africa, are displaying a rapidly growing desire for oil. Can you blame them? They want to live as we have the past hundred years.

The western world’s economic growth and the 20th century was largely built on the back of cheap oil. That era is coming to a close. If it comes very gradually, we will be okay. Should it come quickly, with an oil shock like last year that then stays permanently high, we will be in for some serious dislocations.

What will happen if the spike is swift and semi-permanent? A few things that you do not see written up in the popular press including:

1) At $6 per gallon gasoline, your major legacy airlines (US Airways, Delta, and United) will go bankrupt. When gas prices were benign, fuel costs were 13% of an airline’s expenses. Now they are about 30%. If we go to $6 at the pump, it will be over 60% of an airline’s expense. They cannot do that and survive. How about a government bailout for the big airlines? It is possible, of course, but I don’t know how many more bailouts our country and taxpayers can stand. US Airways would appear to be toast fairly soon.
2) Many people drive SUV’s because they claim that they have to. They are transporting kids to sports programs or their own comfort level requires lots of room. Well, if you have a long commute, can you afford to triple your expenditure for gasoline? A few can but most of America cannot.
3) Cities will rebound as people will have to live nearer work than now. This, long term, is a big positive for America.
4) With major airlines down, trains should make a big comeback. If we build some of the high speed trains currently in place in Europe and Japan that go over 200 miles per hour, we can solve some of the transportation problems. And, it may be faster than some current trips. When you fly now, you have to arrive at the airport early, park your car, go through security, and then you may sit on the runway for a long time or suffer a significant delay. (As someone who logged 200,000+ miles per year for a long time, I know of what I write!). On the train, you arrive at the station, get on board, take off close to on time most often, and arrive in center city at your destination.
5) School buses currently get anywhere from 6-9 miles per gallon. Municipalities are financially strained right now. If gasoline soars, many more kids may walk to school. Some school systems may opt for a 4 day week or a shorter school year. Big mistake—we need a longer school year if our children are to be able to stay globally competitive.
6) I love to buy internationally. It is wonderful to eat some orange roughy that was caught and flash-frozen in the trawler off the coast of New Zealand and wash it down with a glass of an incomparable New Zealand Sauvignon Blanc. I do it now because, as the cost of transport rises, I may not be able to afford or willing to spend what it will cost to consume that way in a few years.

If any of this sounds alarmist, remember I am not saying that it will happen overnight or next year. But, it seems inevitable when you look at the data carefully. When I talk with thoughtful people about this issue, they are largely in denial. Here are a few real life comments to me:

a) “Someone will do something.” Who? Dick Nixon talked about energy independence in his 1973 State of the Union Address! Not much has been done since and nations hostile to us control much of the world’s supply. Al Gore, Mr. Green himself, was Vice President of the US for eight years. Nothing much happened even in 1993-1994 when the Democrats controlled both houses of congress. Perhaps the fact that oil prices fell for most of the 1990’s is the reason.
b) “The Canadian oil sands will bail us out”. Canada does have vast amounts of bitumen, a thick, goopy tar like substance that, at great expense, can be converted into low quality crude oil. But, to generate a barrel of oil out of the Athabasca tar sands (their real name) requires a use of natural gas and water that is about the energy equivalent of 2/3 of a barrel of oil. And their best hope is to be producing 5 millions barrels a day by 2020. If the rest of the world is in decline, that will help but not come close to solving the problem.
c) “The Saudis will merely turn on the faucet.” Saudi Arabia is not a stable nation so there is a geo-political problem. Many observers note that they cannot ramp up production as they once did. Some say that they are injecting water into their wells daily which indicates that the well is starting to play out and the water helps them extract some hard to get crude.
d) “People will just get smaller cars.” A great idea but it takes about 10 years to turn over the US car fleet. If you buy a car soon, make sure you get one with good mileage. I drive a Prius and gasoline prices are something I do not fear because I get 50 Miles per Gallon and sometimes more.
e) A brilliant executive whom I have tremendous respect for agrees with me but said “Necessity is the mother of invention. When prices spike and stay there, the US will get mobilized.” I agree that windmills and solar panels will be sprouting up all over the place as people see energy as a threat to their lifestyles. But it will take many years to implement a conversion to other energy uses. In the meantime, things could get very uncomfortable. I was speaking to an old acquaintance that lives in a swanky home outside Phoenix. He is fairly well off and mentioned that his air-conditioning bill was $800 last month. What does he do if it goes to $2,400? Would anyone buy his white elephant of a house? Can he turn the thermostat to 92 degrees to save money?
f) “Drill, baby, drill. All we need to do is open up the Alaskan National Wildlife Reserve know as ANWAR” Well, there may be huge oil deposits there; maybe not. Environmentalists have a problem with opening up the ANWAR but set that aside for a moment. If we started drilling tomorrow, we might not see a single barrel from the ANWAR until 2016 or 2017. In the meantime, we should be in a real crunch by then. Hope is truly not a strategy.
g) “You worry too much. We can just plant all of the Midwest with corn and ethanol will come to the rescue as it did in Brazil.” This is a favorite of congressman and Senators in farm states. The truth is that most scientists say that to produce a barrel of oil from ethanol takes approximately a barrel of refined oil or natural gas equivalent. Many see ethanol as an agricultural subsidy. How did it work in Brazil? That is sugar cane based ethanol that only needs one third the energy that corn based ethanol does for production. Also, if we divert too much acreage to corn, the prices of other agricultural products will rise.

Our media world would be affected as well. TV would probably still be in decline as would newspapers who have not gone digital. Remember, if people are spending a lot more on energy they cannot spend as they do now on discretionary items. So there will be fewer advertisers to prop up TV stations. Small town papers would probably get an up tick as many more would work closer to home. Radio could be a sleeper. If the big conglomerates sell off properties to locals, stations could have a comeback especially if they feature more local artists or music. Magazines will struggle mightily and outdoor will get a lot more local and remain the last mass medium. Digital will continue to grow but more slowly than today.

Ad agencies and media sales organizations will have a problem. If airfares soar you cannot see clients nearly as often as you do now. Some agencies have built their service model on relying on cheap airfares (relax, Southwest will survive!). Video conferencing will finally hits its stride as a business tool but stubborn older clients may go with local agencies whose team they can see regularly in person. Sales reps will not be able to try to work their magic on media buyers and planners. The business will be a lot less fun, for sure.

There will be positives. If people drive less and the driving they do is in far more efficient vehicles, our air will get cleaner. The cost of transport will force us to eat a lot more locally grown produce which will be fresher and far more nutricious. Neighborhoods may thrive as people will see each other more often and connect as their grandparents once did. And here is a shocker. The American industrial base may have something of a comeback as the cost of transporting something from the Philippines may negate the labor cost saving by producing off shore. So, some factories may re-open here at home!

If we walk more and drive less, we will look and feel better and maybe even drop a few pounds. That will lower the cost of health care.

All I ask is that you think about this issue for the long term and maybe position your life accordingly. If you live in a McMansion, 20-40 miles from a major city, you might want to consider selling it as soon housing snaps back. Make sure your next car is a gas miser. Install energy saving devices at home. Consider moving closer to work (I know this is not easy as schools may be poor there).

Finally, fulfill a dream or two now. Like many of my generation, I have a “bucket list” of places that I want to visit across the world. Until last year, I always thought that I would methodically knock one off each year. Now, my list has more urgency. If I want to go to let us say, Singapore, I should do it soon. If I wait 5-6 years, the airfare might be $4,000 and the US dollar might not buy much by then relative to the Singapore dollar.

Will all of this happen? I think that it could and the longer policymakers do not act, the worse it will be. It will not occur all at once and prices will not go straight up, but we are facing a problem bigger than all others out there.

Our life is about to change. But, if we handle it right, perhaps our satisfactions might actually increase.

If you would like to contact Don Cole directly, you may reach him at dcolemedia@gmail.com


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