Zaks Investment Advisory Service

Natural Gas and Coal Prices, Energy Efficiency and Some Energy Alternatives

In our last program, we started talking about oil. We told you about the changes in oil prices over the past 60 years. If you missed that program, you can find it in the Radio section of our site. Oil, of course, is tremendously important to our economy. But as we know, it is not the only source of energy. Every year, besides oil, we consume billions of cubic meters of natural gas and millions of tons of coal.

The various sources may be compared by the amounts of energy they deliver. The Energy Information Administration (EIA), one of the agencies within our government’s Department of Energy, collects statistics in the energy field. According to EIA data, we consumed about 40 quadrillion Btu (British thermal units) of oil in 2005. We are less interested in absolute figures than relative ones, so instead of using the quite forgettable “40 quadrillion Btu,” we will just say that we consumed “40 units of energy” of oil. That same year, we consumed 22 units of energy of natural gas and about 23 units of coal. Our entire nuclear energy industry produced about eight units, our hydroelectric power stations – less than three. We thus consume oil the most, but natural gas and coal combined supply us with more energy than oil does. Let us take a look at what happened to the prices on natural gas and coal. Natural gas prices have risen in a similar fashion to those of oil (you may find charts mapping the price changes on our site here). However, if since 1947 oil prices increased in real, i.e. adjusted for inflation, terms by about a factor of four, than those on natural gas increased 13-fold. The picture is very different with coal. In 1949 (which is the year the EIA started compiling coal data) the real price of coal was higher than it is today!

Why do we fail to react as emotionally to the rise in natural gas price as we do with oil? After all, these growing prices very much concern us, the consumers. Recall how payments to Peoples Gas jumped a couple of years ago. None of us like it, of course, but at least all this money stays inside the US economy: we import a relatively small amount of natural gas. But when oil prices grow, this turns out doubly bad: first, in practical terms oil price increase delivers an additional tax on the economy, and second, this tax ends up getting collected by countries that are not terribly friendly to us.

However interesting the story of changing oil and natural has prices might been, it does not give us the full picture. The fact of the matter is that our economy has changed immensely over the past 30 years – in part because oil, on average, became more expensive. After World War II, cheap oil helped turn the United States into an automobile civilization with a system of suburbs. By the 1970s, the US economy was largely dependent on oil – which is why its rise in price in the late-1970s delivered such a serious shock. Now, however, our economy is much less reliant on oil (and energy on the whole). We have turned into a post-industrial country, and services (be they financial or telecommunications) are more important to us than oil. The following data confirm this: according to the US Department of Energy, in order to produce one dollar of gross national product in 1970, our economy had to spend a certain amount of energy – 17,300 Btu. In 2005, in order to produce $1 of GDP, we needed to spend half as much energy. According to forecasts, producing $1 of GDP in 2030 will require just 65 percent of the energy needed today, i.e. about one-third of the energy spent in 1970. We can examine our oil dependence from a different standpoint, too: according to estimates of the same Department of Energy, until the 1973-74 embargo, the United States spent eight percent of its gross domestic product on energy, five percent of which was consumed by oil. After the embargo and the oil price boom, we spent 14 percent of our GDP on our energy needs in 1981, eight percent on oil alone. But in 2004, we spent seven percent of GDP on all energy, and four percent on oil, i.e. half of what we were spending in 1981. The Department of Energy predicts that we will spend even less in 2030: five percent on all energy expenses and three percent on oil. The two tendencies work in the same direction: new technologies are helping us become more efficient, and many of the more energy-intensive industries are relocating to the developing countries – and first among them, China.

Is there an alternative to the traditional energy sources: oil, gas and coal? Potentially, yes, but we are unlikely to switch to them any time soon. One of these sources is already being used: the oil sands of Alberta, Canada. Theoretically, there is more oil in Alberta than any other country save for Saudi Arabia. The problem is that it is expensive to recover. The sand is first refined into coal tar, which is then heated and processed into synthetic oil. The final product costs about $40 per barrel. In Iraq and Saudi Arabia, meanwhile, the production of one barrel of oil costs $1! For comparison: in Mexico and Russia, producing one barrel costs about $8, in the North Sea – $12, and Texas – $20. So even extracting fairly expensive Texas oil costs half the price of the Canadian sands.

Our time is up. Next time, we will talk about other alternative energy sources and try to sneak a peak into the future. I would like to remind our listeners that on the Portfolios page of our site www.zaksinvest.com, we provide information about three model portfolios, and compare their performance to that of the market. Compare the return of your investments to our model portfolios. If you do not know what the return of your portfolio is, contact us and we will calculate it for you. This was Sergey Zaks. Thank you for your attention and until next time.