Energy Tsunami On The Way
By Jim Gillespie Ph.D.
Of the approximately 300 articles I've written on the subject of real estate, this one could be the most important one.
If you've never heard the term "Peak Oil" before you're definitely not alone. I estimate that less then one in twenty people in North America have ever heard of this term before, and know of its implications.
I've been following this subject quite intensely for about a year now, and I've known that there would probably come a time when I'd need to write an article about it. And then, ten days ago, while addressing a conference on the subject, Matt Simmons dropped the following bombshell on the audience that had me decide that now was definitely the time to write the article:
"We could be looking at $10.00 a gallon gas this winter."
Before you say something like, "There's no way that could happen," let me explain to you who Matt Simmons is. He's the founder of Simmons and Company International, an investment banking firm specializing in the energy industry that's acted as a financial advisor for over 60 billion dollars in transactions, including 385 merger and acquisition transactions. Simmons and Company International is also considered to be one of the most important investment banking companies for oil drilling in the Middle East. In addition, Matt is a member of the prestigious Council of Foreign Relations, which means he meets regularly with former U.S. Presidents and foreign dignitaries from all around the world to plan out global strategy, and he's also an energy advisor to President George Bush. And finally, in addition to all this, he's the author of the book, "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy," which was released in May of this year.
OK, now that I've explained to you who Matt Simmons is and mentioned his quote on what may happen with the price of gasoline in the months ahead, let me now explain to you what the term "Peak Oil" means.
When oil fields are new, and petroleum is beginning to be extracted from them, they continue to produce increased amounts of petroleum every year until the production from the field reaches its peak level.
Then after this peak amount of production is achieved, the field will only be able to produce lesser and lesser amounts of petroleum every year thereafter. This is the very nature of the petroleum extraction process.
So in 1970, the petroleum production from our own oil fields here in the United States reached their peak levels of production. And after that year we've been only able to extract lesser and lesser amounts of petroleum from our domestic fields, making us far more dependent on foreign countries for our petroleum. But along the way, our demand for petroleum has increased considerably, making us even more dependent on importing our needed oil from foreign countries.
Fortunately for us in recent decades, foreign countries, primarily from the Middle East, have been willing and able to supply us with the petroleum we've needed to run our economy. But because of the nature of how oil fields peak in their levels of production over time and then go into decline, this may no longer be possible.
There are many petroleum experts who now feel that Saudi Arabia may be peaking in their levels of petroleum production right now, and if this is true it means that global petroleum production is also peaking. This is because there have been no major discoveries of new oil fields in the world since the 1960s, and since the petroleum companies have been searching everywhere for over 35 years to find new fields, it's unlikely that any new major oil fields are still left to be discovered.
So even though we still have approximately 50 percent of the world's known oil reserves still underground in these fields that have already been discovered, the aging of these fields themselves, combined with the technology available for extracting the petroleum from them, means that the world is about to experience a time when decreasing amounts of petroleum will be available every year as compared with the increasing amounts that we've always had available up until now. So in taking what you've previously learned about the basic economics of supply and demand, if you have a product with continually increasing demand, and a corresponding supply of that same product that is continually shrinking in quantity, what is the likely result going to be in terms of the market price for that product?
Now in recent years we've been dealing with a substantially increased demand from around the world for petroleum. Countries that didn't use much petroleum years ago are now becoming more westernized, and their demands for petroleum have skyrocketed, too. So now when you factor-in this continually growing demand for petroleum along with our own, combined with what looks like a continually shrinking supply of petroleum beginning in the months ahead, you'll probably get an idea of just how high the price of gasoline can go.
But up until right now we've been fortunate in that the rising gasoline prices we've been experiencing have been due primarily to increased world demand for petroleum amid a rising and/or peaking supply of world petroleum at the same time. But once it becomes clear that the same quantities of petroleum are no longer going to be available to all of us and will in fact be shrinking, our lives could change very quickly.
And in having seen a number of interviews over the past year with Matt Simmons on this subject, I can tell you that he appears to be a man who is very sincere in his concern about what all of this could mean to our world economies. He's been a crusader on this subject for years now along with top petroleum geologists, but until recently they've had a tough time getting anyone including the petroleum companies to listen to them. But people are now beginning to listen to them more and more.
And incidentally, I learned about Matt's quote regarding the potential $10.00 a gallon gasoline prices in the coming months in an article written by Jeanne Klobnak-Ball on the From the Wilderness website. If you're not familiar with From the Wilderness, they've developed such a solid reputation in recent years for uncovering important national and international news stories that their e-newsletter and printed newsletter are now read by both the House and Senate Intelligence Committees of the United States Congress.
So in moving forward, the ramifications of all this are so unbelievably huge that it's not easy to discuss all of them in this article. But I'm going to do my best for you here. You see petroleum, and its fossil fuel cousin natural gas, which is also going through its own levels of depletion, are necessary for so very many things that we've come to enjoy in our lives:
* The gasoline to drive our cars
* The energy for heating and air conditioning our homes and offices
* The energy to manufacture almost every product in existence
* The energy to distribute almost every single product and transport it from the factory to the warehouses, to the retail stores, and finally into our homes and offices
* The ingredients in many of the finished products we see, including any products that contain plastic
* The fertilizers and pesticides necessary to grow fruit and vegetables ... It's because of the use of petroleum and natural gas products that we've been able to grow 40 or more times the amount of food from an acre of farm land as compared with what we could grow 100-150 years ago
So when you look at all this, what do you think a substantial rise in the cost of petroleum could mean to real estate values, profitability in businesses, our national and global economies, and our own personal lifestyles?
With a substantial rise in the cost of petroleum:
* What would happen to the costs of production and distribution for businesses on a worldwide basis?
* What would happen to employment levels for the workforce?
* What would happen to people's savings and finances while dealing with higher energy costs for their own homes and higher gasoline prices for their own transportation?
And I have to tell you here that I don't enjoy looking at this potential scenario at all. I'm really a "glass is half full" kind of guy, always looking for the positive things about life. But I can tell you that I have studied this subject intensely for about a year now, have read countless articles on it, have listened to audio CDs about it, and have watched DVD interviews with the world's top experts on it. And the scenario painted by all of these experts is far from being anything like a great one for any of us to imagine.
But I feel it's important as someone who reads my articles to tell you what I've studied on this subject, and then allow you to do your own additional research and draw your own conclusions from it.
Personally I hope this all never comes to pass, but I have to pay attention to the warning signs that I'm learning from the people who are far greater experts on this subject than I am.
And when it comes, the subject of replacing petroleum with alternative forms of energy, the immediate future does not look rosy there either. For one, I had always heard about the promising future of hydrogen as an alternative energy source, and then I did my own homework on the subject. It turns out that it takes the energy from six gallons of gasoline to create one gallon of hydrogen suitable for burning as a motor fuel. So hydrogen is not an option for us right now.
Second, we've heard a lot recently on the subject of using biodiesel as an alternative source of fuel instead of petroleum. We've even heard about people running their cars and trucks on biodiesel, too.
But some of the problems with biodiesel are:
* We don't have enough land in the right climate to grow the quantity of crops that will be necessary to replace the amounts of petroleum that will no longer to be available for us
* Growing the crops necessary for biodiesel and putting them through the chemical process required to transform them into biodiesel fuel will in itself consume large amounts of petroleum and natural gas
And the other arenas that include hydroelectric power, wind power, solar energy, and nuclear energy all have substantial limitations when it comes to being able to replace the energy that will no longer be available to us from petroleum also.
Okay, so what does all of this mean to you as someone in real estate? Well keep in mind we're really in uncharted waters here. It's not like we can look to the past and learn from all the times something similar to this has happened to us. This is a very unique and unprecedented event in our lifetimes, and in world history, too. But here are my thoughts on what this could mean to all of us who are in real estate:
1. The values of homes and residential rental properties in and closer to major cities will probably do better in the long run versus those located farther away in the suburbs. Especially when compared with those suburbs that have a high percentage of their population who commute a great distance to major cities for their jobs. This is because the cost of commuting could become so expensive that people will do whatever it takes to live closer to the city rather than spend so much money on gas and sit in traffic.
2. Office buildings will experience a major increase in heating and air conditioning costs, especially those located in areas with severe winters or very hot summers. Landlords of these buildings could experience a substantial loss in their profits if their leases don't call for their tenants to pay for any increases in heating and air conditioning expenses. And conversely tenants who will be paying for these increased expenses themselves will find this solidly biting into their own profits.
3. Commercial and industrial properties closer to the major cities will do much better than those in the suburbs. With more people living closer to the major cities, commercial space in these areas will command even more of a premium in the future when compared with commercial space in the suburbs.
4. There will be a need for a much greater amount of housing near the central business districts of major cities. People will want to live closer to where they work and they'll also want to be within walking distance to both shopping and entertainment. This will create a demand for revitalizing central business districts and creating a more neighborhood-friendly environment with shopping, entertainment, and restaurants all nearby.
5. Industrial businesses will transition away from shipping and receiving their goods by truck and towards shipping and receiving them by rail which will be more economical for them. And as a result we'll see a surge in demand for rail-served manufacturing and warehouse buildings, and those buildings without rail will sit vacant for longer periods of time and command less rent when they're finally leased.
So while in recent years owning a rail-served building may not have meant much to your prospective tenants, you may very well have a functionally obsolete building on your hands years down the road no matter what kind of condition it's in and how high the ceilings are if your prospective tenants can't ship by rail.
6. Manufacturing businesses that already have substantial energy costs right now will be hit very hard with the coming increases in these costs and will find it increasingly difficult to remain profitable. In addition, I'm hearing from agents all over the country that their markets are cooling down now and listings aren't moving as fast as they were months ago. In looking over the past 25 years in our industry, through three economic up cycles and two down ones, this is exactly the way the down cycles have begun in the past.
In both situations there was a gradual cooling off period where buyers were no longer willing to pay the higher prices, but sellers still wanted to get the higher prices anyway. And when you're talking about selling commercial or investment properties with owners who don't need to sell them if they don't want to, this can become very frustrating when you're an agent. But if you study Peak Oil and become very knowledgeable about it, you may be able to persuade your owners that they may be far better off selling their property now at the best price they can get for it, rather than waiting and taking their chances one or more years down the road.
And in saying this to you, the real estate world was full of owners during the last two recessions who really wished they had sold their property 2-3 years earlier while times were still good. Remind your owners of this, show them the underlying warning signs of where your market could be headed, including the potential problems with Peak Oil, and you just might convince them that they could turn out to be market timing geniuses if they move forward and sell right now.
One thing I find interesting about Matt Simmons mentioning the possibility of us experiencing $10.00 a gallon gasoline prices in the months ahead is the fact that about two years ago he mentioned that he saw the price of gasoline eventually rising up to be about $7.00/gallon, but that it would take a number of years for this to happen. Well the price of gasoline has risen substantially over the past two years, but we're still at about $3.00 a gallon right now, a full $4.00 a gallon short of that $7.00 figure.
So I have to believe that for a man of his stature in the petroleum industry to revise his estimate upward by $3.00 a gallon at this time, he must be seeing some very strong indicators in the marketplace that are causing him to do so. People with his reputation don't make predictions like this unless they feel there's a solid reason to do it. And in looking at the price of gasoline, even if it rises up to $4.00 to $5.00 a gallon over the next 12-18 months, the impact this could have on our economy and on our real estate markets could be huge.
And in moving forward, there's a quote I heard from the great hockey player Wayne Gretzky years ago that I've always thought was appropriate to apply to the most successful people in business. When asked what made him so much better than all the other players in the game he replied, "Most players skate to where the puck is. But I skate to where the puck is going to be."
As an expert agent advising your clients, you want to be able to tell them where the puck is going to be in real estate. The future may not always look rosy, but the better you are at recognizing where the market is headed, and the better you are at persuasively communicating this to your clients, the better off your clients will be and the more money you'll make in the process.
So do some Internet searches under the term "Peak Oil" and do your own research. While I certainly hope that these experts are wrong and that we'll be experiencing great economic times for many years to come, I must tell you that the case they're making is very compelling. So much so that I've heard of at least two major real estate investment companies who are now making changes to their portfolios because they see it coming also.
But do your own homework, draw your own conclusions, then take the appropriate action to ensure that you're doing everything possible to always succeed in the biggest way you can in your real estate market.