Big Oil Economics: The Greatest Welfare Scam Ever!

Have you ever noticed that when gas prices shoot up, local news reporters like to recite laundry lists of things we can do to save money at the pump?

I'm sure you've heard them all by now

• Don't speed
• Keep your tires properly inflated
• Get a hybrid car

My favorite was one that involved staggering your work hours in an effort to avoid peak rush hours.

I don't know about you, but I don't know a lot of folks that really have that option. Not that any of this really matters, anyway.

The bottom line is, we're running out of cheap oil. This is a sinking ship being held together by duct tape and misguided optimism. And no amount of tire inflating or work hour modifications can change that.
Where did all the oil go?
Twenty years ago, there were fifteen oil fields that had the capacity to produce more than one million barrels per day. Today, only four can produce that much. And there hasn't been one significant new discovery (one where production is economically feasible, anyway) in decades.

As a result, global supplies are falling well short of demand. And this is not a trend that will ease up anytime soon — if ever.

So not surprisingly — since oil accounts for 90 percent of the energy we use today for transportation — investors that aren't blinded by complacency, are investing appropriately

They're taking long-term positions today, in the companies that will provide tomorrow's alternative transportation technologies.

We'll get into the specifics of some of these companies next week. But before that, I think it's important that we fully understand why there is little long-term value in oil.

The myth of cheap oil
From exploration to extraction to consumption, there is no doubt that oil has been an absolute nightmare. The global impact on our environment has been nothing short of devastating.

But what about the economic impact?

Certainly there are those that will tell you oil is an economic home run. And nothing can come close. After all, there are no other commercially-available transportation fuels available to us right now that can do the job of oil. And the refrains of "cheaper than alternatives" can often be deafening.

The only problem with that argument is that oil is NOT cheaper than alternatives. Not when you analyze the cost of oil without leaving anything out.

The numbers they don't want you to see
Back in 2000, there was a Department of Energy study which found that supply disruptions, price hikes and loss of wealth suffered through oil market upheavals have cost the U.S. economy around $7 trillion (in 1998 dollars) over the thirty years from 1970 to 2000. The study focused on macroeconomic adjustment costs, the potential loss of GDP and wealth transfer. What it didn't include, however, were the military, strategic and political costs associated with U.S. and world dependence on oil imports. These costs, however, were recognized by a former Reagan White House alum and 12-year member of the National Petroleum Council, Milton Copulos.

After taking into account the direct and indirect costs of oil, the economic costs of oil supply disruption and military expenditures, he estimated the true cost of oil at around $480 a barrel—a far cry from today's price of around $130 a barrel.

Of course we can't forget the subsidies either. While Big Oil sympathizers like to call out the renewable energy industry for being reliant upon subsidies, they do a great job at keeping their own subsidies well-hidden.

A study by the International Center for Technology Assessment analyzed petroleum industry subsidies, including the percentage depletion allowance and tax-funded programs that directly subsidize oil production and consumption.

It assessed up to $17.8 billion per year in tax subsidies, plus government program subsidies (such as R&D; programs and environmental cleanup) of between $38 billion and $114.6 billion per year.

Oil's flawed business model
One of the more interesting studies on this topic came from the U.K.'s New Economics Foundation, back in 2006. It analyzed the cost of climate change related to the production of CO2 from burning oil and gas.

Using a government estimate of $35 per ton of CO2, the study found that the emissions costs from BP's oil business—from production to burning the fuel -- resulted in a damage bill of $51 billion a year. At the time, BP's profit was only $19 billion. That puts the whole operation in the red!

Of course, as of now, that cost gets passed on to the environment and the tax payer. There is no accountability here, folks. But there will be. And that's going to be a major game-changer.

Sure, there are those naysayers and deniers who will continue to debate climate change until every last ice cap has melted — demanding 100% certainty before they're willing to concede.

But let's face it. That's really nothing more than a stall tactic. Though I believe retired General Gordon R. Sullivan, former Army chief of staff, hit the nail on the head when he said:

"Climate Change is a national security issue. We found that climate instability will lead to instability in geopolitics and impact American military operations around the world. People are saying they want to be perfectly convinced about climate science projections. But speaking as a soldier, we never have 100 percent certainty. If you wait until you have 100 percent certainty, something bad is going to happen on the battlefield."

In the meantime, even if we don't include the carbon emissions costs, oil still falls short of being "cheap."

Let's review:

• $7 trillion in supply disruption costs, price hikes and loss of wealth suffered through market upheavals.
• $480 a barrel when accounting for oil supply disruptions and military expenditures.
• $17.8 billion in tax subsidies and between $38 billion and $114.6 billion in government program subsidies.

And let me leave you with another hidden subsidy that should really put a burn in your belly. It's the hidden subsidy of leasing public lands to oil companies for next to nothing — thereby assigning little value to the oil extracted from the ground, and compensating the public absolutely nothing for the loss of natural capital.

The oil business, without major economic support, is flawed. It's one of the biggest welfare rip-offs ever to exist. And as supplies continue to disappear, and climate change legislation continues to present operational challenges for oil companies, the playing field will continue to level out. This will enable a more competitive business environment, which will ultimately favor transportation technologies that do not rely upon oil.

Next week, I will tell you more about these technologies and how to invest appropriately.

To a new way of life, and a new generation of wealth

Tags: Economics | Oil | Peak Oil