Energy and the Economy Jude Wanniski May 3, 2001

George Yates, a client and former president of the Independent Petroleum Association of America (IPAA), called yesterday to talk about energy and the economy. He understands the deflationary component of the cross-currents rippling through the financial markets and the real economy, only because he has been through these cycles with us before. IPAA became a Polyconomics client in 1978, one of our first. In the mid-1970s, when the oil price was soaring, he recalls, people he knew would stop him in the street in Albuquerque or track him down, asking him if he could use another $30 million to wildcat. “Capital was coming out of their ears,” he says. Now, the energy industry has been so beaten up that even with high oil prices relative to gold and other commodities, capital just now is coming out of the woodwork. Where the majors traditionally relied upon independents to take the risk of exploration, they now are forced to play that role themselves, financing independents. The swings in the oil price have become too much for the little guys to handle, which is why we will continue to have energy problems until we fix the dollar/gold price so that capital is not misdirected.

Yates recalls that in 1981, there were 1 million workers in the U.S. oil industry. By 1997, the number was down to 330,000, as the oil price had fallen and it became more difficult to persuade the government to allow drilling on public and private lands, where the environmentalists discovered one “endangered species” or another. When the deflation hit in 1997 and oil went to $10 a barrel in 1998, another 50,000 oilfield workers left for other jobs. Last fall, when alarm began spreading about high prices because the world industry had run out of capacity, the number was down to 280,000 workers. The industry has since recruited 35,000, a good number of those at the gates of prisons, he says, the only place where recruiters can find able-bodied men. The crash in oil that followed gold’s decline not only bankrupted thousands of independents, but hundreds of the drill rigs they had been using went into scrap. There are now only 1100 available.

Because prices of crude oil and natural gas are now off their winter highs, we are being lulled into thinking the worst is over, but he believes once the summer heats up, prices will climb again. “We used to be able to catch up with surprise shortages in 18 months, at most,” he says. The hole we have dug this time will take several years, he thinks. And the greenies are going to fight development of new supplies every step of the way. “They do not want to preserve the environment, they want to stop growth.” As happy as he was with Vice President Dick Cheney’s outline of a national energy plan to develop supply, he was horrified that the administration let stand a last-minute Clinton order closing access roads to 50 million acres of public lands. Yates explains that the country has become so used to natural gas for conversion to electricity that when there is a surge in demand, natural gas prices will soar as they did last winter, topping $10 mcf from less than $3. With winter over and summer not begun, the price is down to $4.20 or so, but wait until the air-conditioners kick in. Yes, you can import costly liquefied natural gas, but that would impose perpetually high energy costs. The fact is, even though 2.5 million of the 3.2 million oil and gas wells drilled on earth have been drilled in the oil patch of the United States, there is still an enormous amount of unexplored public lands, not parkland, but raw public land that Yates believes should be auctioned off. How many New York Times editorial writers know that 95% of Nevada is owned by the state or the federal government, as is 80% of New Mexico? This was the direct result of the Eastern Establishment at the turn of the 20th century halting the sales of public lands in the west in order to keep European emigrant workers from migrating to the west. Concurrently, an exodus from Europe because of WWI led to a tightening of immigration laws. There really is no good reason for keeping much of the western lands in government hands.

Another solution to our energy needs, in which I have been unable to get anyone interested over the last 25 years, is to encourage the national governments of the world to give their citizens the subsurface ownership to the surface property they own. No other country in the world now does so, although it would clearly lead to extensive exploration by wildcatters everywhere it is tried. I have been pushing the idea with the Bush administration and have had a few nibbles, getting their attention when I point out that if Colombia, for example, suddenly did this, the ordinary people of Colombia would be digging underground for the abundance of mineral wealth that exists there instead of planting coca plants above ground to produce cocaine for the drug trade. The reason I can never get any political traction with this idea is that it would upset the world’s status quo, bigtime. Sometime in the near future, this dam will break, because of the energy needs of 6 billion people. They cannot wait around for the United States to restore some sanity to the international monetary system as a means of once again getting ahead of the energy curve.

George Yates has been a lonely supporter of this idea over the years I have known him, but more or less has given up on it happening in his lifetime or mine. In our conversation yesterday, he was at least encouraged to see the dollar price of gold inching up from its lows, as he understands the connection between yellow gold and black gold and knows that either gold comes up in price or oil goes down, and oil only goes down in a world recession. Alas, I had to point out to him that gathering weakness in the U.S. economy may be causing a marginal decline in the demand for liquidity, which may cause gold to inch its way up by a few dollars if the Federal Reserve does nothing to drain it off with the sale of bonds. This will not “solve” the problem, although a crisis of some sort might cause the Fed to flood the system with liquidity, as in 1982’s deflation.

In our client conference call yesterday (a very lively session that I recommend you listen to on replay, if you were not with us), I noted the op-ed in the WSJournal yesterday by Tom Bray, out of Detroit, suggesting that the clearing of bulging auto inventories by the Big Three was an indication there may be no recession after all. We think the GDP statistics may not qualify what happens later in the year as an official recession -- two quarters of less than zero growth. That is because the monetary deflation has been caused by positive fiscal policies. Nevertheless, the deflation will continue alongside these higher energy prices, and when the 2002 autos arrive in the showrooms, we wonder how many buyers there might be. The futures market now is guessing that the Federal Reserve will cut only another 50 bps from the funds rate, on the idea that the worst is over, but if consumers are forced to pull in their horns, so will producers, and so will investors. Our clients asked several questions in the conference call on what kind of objective indicators to watch for. I could only say that policy change of this kind only will take place because of “fear.” That will lead to public discussion of these issues, which is not now taking place. Supply-side opinion leaders should be leading the discussion, but most argue that lower interest rates will solve the problem, which we do not believe.