Oil disaster may prove tipping point for world oil production

Jeff Rubin

What are the consequences of another Three Mile Island?

Will the unfolding environmental catastrophe from the ruptured Deepwater Horizon well in the Gulf of Mexico become deep-water oil’s equivalent to the Three Mile Island accident?

In terms of environmental degradation and economic cost, it’s already become much more. The real legacy of Three Mile Island wasn’t what happened back in 1979, though, but rather what happened, or more precisely didn’t happen, over the course of the next 40 years in the United States. Literally overnight, the near-meltdown of the reactor core changed public acceptance of nuclear power plants. No company in the U.S. has built a new one since.

Deepwater Horizon was not a producing well, nor will it likely ever be one. Hemorrhaging anywhere from 5,000 to 25,000 barrels of oil every day, the spill is already approaching the size of the discharge from the Exxon Valdez. What’s worse, BP has no way to shut it off, short of drilling a relief well to divert the pressure, which will take three months. At 25,000 barrels a day, three months means a cumulative discharge of 2.25 million barrels of oil, or 94.5 million U.S. gallons (one barrel equals 42 U.S. gallons), or roughly eight Exxon Valdez spills. Even at 5,000 barrels a day, that’s almost 20 million gallons of oil. And to top it all off, by the time a relief well can be drilled, we’ll be smack in the middle of hurricane season.

The scene of hurricane-force winds raining oil on New Orleans and the rest of America’s Gulf Coast will no doubt make for an apocalyptic image of the end of the age of oil. Unfortunately, our dependence on the stuff will survive this catastrophe, even if the fisheries in the Gulf of Mexico and the marsh ecosystems of the Mississippi Delta won’t. But what might also not survive is deep-water drilling: No company’s shareholders will be willing to accept the consequences that BP will soon have to face.

President Barack Obama has suspended his recent decision to open new offshore areas for oil development and has declared a moratorium on new drilling. You can imagine what the regulatory environment will be like after three months of the spill, just as you can imagine what those satellite photos of the Gulf of Mexico will look like.

But what you might not imagine are the implications for world oil supply. Conventional oil supply has not grown since 2005. Without a steady stream of oil from fields below the ocean floor, not only can’t world oil production grow, it can’t even stand still, since we rely on oil from new deep-water fields to replace the bulk of the four million barrels per day of global production we lose every year to depletion (out of a total of roughly 86 million barrels per day).

If the Deepwater Horizon disaster is the offshore energy industry’s Three Mile Island, then not only has world oil production already peaked, but it will also very soon start to shrink.

So if you think oil prices are high today, you ain’t seen nothing yet.

The Best And Worst Of W.Buffet's Investments

Shareholders who have stuck with Warren Buffett, 79, for the very long haul have been amply rewarded, but the ride has not always been smooth.

Warren Buffett may be the world's most famous investor, but even he doesn't get everything right.

Berkshire Hathaway Inc, the insurance company Buffett has run since 1965 and which is holding its annual meeting on Saturday in Omaha, Nebraska, owns roughly 80 companies and invests in dozens of stocks.

It is sometimes said that even the best investors might get only six out of every 10 bets right. So while shareholders who have stuck with Mr. Buffett, 79, for the very long haul have been amply rewarded, the ride has not always been smooth.

The following are a handful of Berkshire's investments over the years - the good, the bad and the unknown.

THE GOOD

• In 1976, Berkshire began accumulating an equity stake in auto insurer Geico Corp, 24 years after selling an earlier stake for US$15,259. It finished buying Geico in 1996. The acquisition brought aboard Tony Nicely, who still runs Geico and whose leadership Buffett has lavishly praised, and Lou Simpson, whom Mr. Buffett has said could replace him as Berkshire's chief investment officer but for the fact that he, too, is in his 70s. Geico has roughly tripled its U.S. auto insurance market share to 8.1% since Berkshire bought the entire company. The insurer generated about 12% of Berkshire's revenue in 2009.

• In 1989, Berkshire bought US$600-million of preferred stock in Gillette Co, the razor blade maker that had been hurt by the introduction of disposable razors. In 2005, Gillette was acquired by Procter & Gamble Co. Although it sold some Procter & Gamble shares in late 2009 to fund other investments, Berkshire at year end still held a 2.9% stake worth US$5.04-billion, and for which it had paid just US$533-million. While Mr. Buffett in his 1995 shareholder letter called Gillette "our best holding," he also said he made his "biggest mistake" by opting to buy preferred stock rather than common stock.

• Berkshire owns 200 million Coca-Cola Co shares, an 8.6% stake it had amassed by 1994. The stake was worth US$11.4-billion at year end. Berkshire paid US$1.3-billion for it.

THE BAD

• In 1993, Berkshire bought Dexter Shoe for US$433-million in stock. Eight years later, it folded the struggling company into another business. In his 2007 shareholder letter, Mr. Buffett called Dexter Shoe "the worst deal that I've made."

• In 2008, Mr. Buffett amassed a large stake in oil company ConocoPhillips, not expecting oil prices to fall by about three-fourths from their record high. Berkshire spent US$7.01-billion on Conoco shares, but has been reducing its stake. "The terrible timing of my purchase has cost Berkshire several billion dollars," Mr. Buffett said last year.

THE UNKNOWN

• Buffett has entered into derivatives contracts, most of which are essentially bets on the long-term direction of stocks and junk bonds. He has said these contracts differ from other derivatives that are "financial weapons of mass destruction" in part because of the billions of dollars of premiums he collects upfront from counterparties, and because Berkshire generally does not need to post collateral.

Berkshire has four major types of contracts:

* Berkshire has equity index "put" options tied to where the Standard & Poor's 500, Britain's FTSE 100, Europe's Euro Stoxx 50 and Japan's Nikkei 225 trade between June 2018 and January 2028. At year end, Berkshire had a US$7.31-billion paper liability on these contracts and said it could in theory owe US$37.99-billion if the indexes all went to zero.

* Berkshire has contracts tied to credit losses in higher-risk "junk" bonds, which at year end were on average expected to mature in two years. At year end, Berkshire had a US$781-million paper liability on the contracts and said it could in theory owe up to US$5.53-billion.

* Berkshire wrote credit default swaps on various companies, mostly investment-grade. At year's end, Berkshire had no liability on these contracts.

* Berkshire entered into tax-exempt bond insurance contracts structured as derivatives. At year end, Berkshire had an US$853-million liability and US$16.04-billion of potential losses. The bonds are largely secured by states' taxing and borrowing power.

* In September 2008, at the height of the financial crisis, Berkshire acquired US$5-billion of Goldman Sachs Group Inc preferred shares that throw off a 10% dividend, plus warrants to buy an equivalent amount of common stock. The warrants carry a strike price of US$115. Goldman shares closed Tuesday at US$153.04, and those warrants are well in the money.

© Thomson Reuters 2010

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