Umbilical Oil - Part 2 (demand)

'Organic' Demand


It should come as no surprise that oil is the most valuable widespread global commodity in Western civilization. In relative value terms, oil has surpassed gold. A broad range of uses including energy, transportation and non-energy/material uses are, in large part, the reason for this. Industry uses just under ten percent of the refined crude oil in order to manufacture goods and services. Commercial, residential and agricultural sectors use just under thirteen percent--much of that for heating and electricity. Non-energy uses of hydrocarbons include plastics, synthetic clothing (eg. polyester), cleaning and lubricating agents, as well as binders like asphalt. Eighty percent of the asphalt refine is used for building roads. Which leads to the sector that consumes the largest volume of crude oil--transportation. Only a few modes of widespread transportation don't consume any oil; walking, cycling and electric trains are among the few examples of these. I don't have statistics on this, but the percentage of motorized vehicles that don't consume refined oil products is probably less than 1% (hybrid-electric vehicles are still powered by oil). Between cars, trucks, boats and planes, the world consumes about sixteen billion barrels of oil each year.


Industrial consumption is already at it's lows. Heating and electricity loads are unlikely to change much in the near term (alternative energy and efficieny improvements could chip away at this in the long term). Non-energy sources are also pretty static as far as demand goes; there is an obvious reluctance to return to cotton diapers and no one likes driving on gravel roads. That pretty much leaves transportation sector to the task of reducing demand.

There are essentially two ways to reduce organic demand in the transportation sector (1) improve efficiency and (2) reduce volume. Improving efficiency implies activities like purchasing new, fuel efficient airline fleets and passenger vehicles. This requires significant capital investments and thus time before it can become a reality--even if it makes economic sense to do so. Industry leaders such as GM and Tesla Motors estimate it will take ten years and lots of government subsidies before hydrocarbon-free transportation vehicles start to become competitive in the mass markets. It will take even longer (30-40 years)^* before significant market share is acquired by alternatively powered vehicles. On the volume side, while per-capita car ownership in the United States has probably peaked, passenger car ownership in emerging economies continues to skyrocket. This is part of the reason why the transport sector only amounted to 45% of total oil consumption in 1973 and is now over 61%. China and India alone would need 2 billion cars to approach the rate of car ownership that the United States has.

Given that any major initiatives to reduce dependency on oil will take time, there is really only one way to reduce near-term organic demand for oil--higher prices.

That being said, there is a level above which the price of oil will not only be self-limiting but potentially even catastrophic in contributing to a recession. In early 2008, when oil prices pushed well past $100, the transportation sector began to collapse along with the eventual low at the end of that year. This was made worse by other issues such as the subprime housing crisis, but the bottom line was that people could no longer afford to fill up their gas tanks and thus prices necessarily fell.

Given the continued weakness of the U.S. economy, along with rising unemployment expected to peak in 2010, a high enough price could contribute to another recession and result in another price collapse. This instability price point is probably above $80 and not as high as $150. Filtering out price corrections, the trend for oil prices would appear quite bullish based on supply and demand alone.

There is however, one final part to this story: the measuring stick (the dollar).

Umbilical Oil - Part 1 (supply)

Crude oil, unlike natural gas, is a commodity in much shorter supply at current prices. While a vast amount of total reserves still exist, the marginal cost of production of these reserves continues to increase. Impressive technological improvements have only partially offset the increase in finding, development and operating costs of these deeper, tighter and less permeable hydrocarbon reservoirs.


Worldwide, average recoverable oil reserves have historically been around 30-40%. In other words, for every 100 barrels of oil we find, we can only economically produce 30-40 of those. Natural gas recoveries, by comparison, have historically been in the 70-90% range. Of course, if market prices are higher, economic recovery rates also go up as energy companies can spend more capital and energy to improve efficiency. Physics and thermodynamics however, ensure that this relationship is typically a logarithmic one--doubling the oil price could, for example, only lead to 5% more recovery. On the gas side, it's much easier to move the relatively small independent methane molecule across the reservoir rock and to the wellbore than a large viscous molecule of crude oil. Two of the largest undeveloped reserves of oil in the world are deep offshore oil and unconventional resources like the oilsands. Both have the potential to produce a vast amount of oil, but it will take a lot more to fill up the gas tank if we are to rely exclusively on fuel derived from these sources.

Offshore Oil
For comparison's sake, I will compare BP's recent 'huge' Tiber oilfield find to Ghawar. Ghawar, the world's largest and most prolific developed oilfield, has produced 48% of the 131 billion barrels it's operator, Saudi Aramco, expects to recover. It has a very favorable set of geological preconditions that we have yet to find anywhere else in the world. The number of large oil discoveries is dwindling and those that have been made also have more fragile economics because of the engineering (and political) complexities involved. BP's recent Tiber oil sits 10.6 km below the ocean floor--that's more than the height of Mount Everest. It also sits in 1.2 kilometer deep water--deeper than the crush depth of the most advanced military submarines. Some submersibles and special unmanned vehicles can get this deep, but it speaks to the challenges involved. Challenges that will ensure the oil does not come out of the ground cheaply. Even when the infrastructure is in place and capital expenditures have been made, early recoverable estimates for Tiber of up to 1 billion barrels would only sustain current global oil consumption for 12 days (a thousand barrels a second is about how much the world currently consumes).

Oilsands
Unlike offshore oil, oilsands are typically very shallow and geographically accessible. It is the quality and flowability of the hydrocarbons that present challenges--the oil is too viscous to be produced using a conventional oil well scheme. The oil is typically either mined and extracted from the sands using steam, or it is produced 'in-situ' using a steam-assisted gravity drainage (SAGD) technique where high-energy steam is injected to lower the viscosity of the oil enough that it can be produced in a horizontal well. Both techniques use vast amounts of steam, which itself requires lots of energy to produce (currently most of the steam generation is produced by burning natural gas). Unlike conventional crude oil, the resulting hydrocarbon slurry then needs to be either upgraded or mixed with lighter hydrocarbons before it can be pipelined to a refinery. These processes often involve several steps such as distillation, cracking the large molecules into smaller ones, removing sulphur and heavy metals and in some cases dilution with lighter hydrocarbons (i.e. condensates). One of my textbooks from elementary school said that the oilsands would never be commercially viable. The authors were wrong--but producing the heavy oil isn't cheap by any means. Not to mention the potential of added costs due to environmental regulations and CO₂ reduction or sequestration.

"Currently oil at about $60 to $70 per bbl we think is not enough to justify some of the significant projects we are contemplating, especially on the mining side," says Jean-Michel Gires, CEO of Total E&P Canada. The energy company CEO went on to predict a sustained price of at least $85 was needed to make many these projects commercially viable.


From the supply side, it appears as though the fundamentals might support an oil price of around $80/barrel, with a continued ascent upward as the elephants* mature and decline. But that's just the supply side--stay tuned for the demand side (part 2).

*the term 'elephant' refers to a very large oil field, typically one that contains at least 100 million barrels of recoverable oil.

Swamp Gas

Swamp
-noun
5. to overwhelm, esp. to overwhelm with an excess of something: He swamped us with work. [Dictionary.com]

Swamp Gas
-noun
An organic decomposition product gas which is mostly methane, the primary component of Natural Gas.

The Natural Gas Story
As crude oil prices continue to rise to pre-recession levels, prices for natural gas, the other base hydrocarbon commodity, continue to flounder. Last week NYMEX Natural Gas futures for September fell to a seven-year low below US $3/mmBTU.

The spikes are indicative of the vast reserves of natural gas, which unlike peak oil, can come on stream relatively quickly and cheaply. Liquefied natural gas technologies have also created a 'pipeline' for inexpensive natural gas reserves that were previously stranded. Worse yet is the high price of oil, which has in recent years, been in lockstep with the Canadian dollar, meaning Canadian gas producers will get even less for molecules produced north and sold south of the border. Storage levels are near all-time highs and hundreds of cubic feet per day have been shut in awaiting higher prices. The U.S. economy remains slow to return to growth compared to emerging economies despite all the stimulus. Some analysts believe a number of small and mid-cap producers will simply need to go out of business before prices for the commodity fall back in to balance. North American workers in the Oil & Gas industry have been relying increasingly on drilling natural gas wells as oil production on the continent continues to decline from it's peak (with the exception of the oilsands and other unconvnetional reserve plays). A cool summer will likely mean a tame hurricane season and forecasts of a mild autumn will keep heating demand low. All of this has been fueling rumours that the North American Exploration and Production companies will need to begin layoffs in the fall while M&A activity will increase.


Not quite apocalypse...yet
Despite all the bearish news, it's not quite time to predict an apocalypse yet for North American producers. This could still happen, if the U.S. economy were to fall into a second recession in the next 18-24 months from a economic stimulus hangover, prices could fall towards $1/mmBTU or less. For now though, contract futures beyond December 2009 continue to be sold above $5/mmBTU, a level at which most producers can be marginally profitable. Most of the hedging contracts made in 2008 when prices peaked are now expiring, leaving buyers free to spend more on new contracts and push prices higher. A U.S. government bailout could also come in the form of tax incentives for natural gas powered vehicles, furnaces or power generation, which would also push prices upwards. We're probably near the bottom, but I wouldn't hold out on $15/mmBTU gas prices anytime soon.

Coming next is the Crude Oil story.

Tax Time

Many Canadians and Americans are wondering if taxes will go up, when they'll go up, and how they will will go up. The answer to the first (if) is quite easy, the second (when) a little more difficult and the third (how) is still on the drawing board. Nonetheless, the scribbles are happening...



If?
With unsustainable debt and deficits in Canada and the U.S., every political insider knows that taxes are going up. They just won't talk about it because it's unpopular. Furthermore, they'll try and use clever names to try and avoid the word 'tax', which has always had negative connotations. A quick look at the projected numbers (table below) makes it pretty obvious that without an unfathomable decrease in government spending, taxes are going up. An additional problem is the large projected increases in entitlement costs (pensions and health care) over the next several decades.

Fiscal Year	US Deficit*	Canada Deficit**
2008/2009	$459 billion	$9.1 billion
2009/2010	$1.7 trillion	>$50 billion (up from $33.7 billion)
2010/2011	$1.1 trillion	$13 billion (not revised)
2011/2012	$693 billion	$7.3 billion (not revised)

*Congressional Budget Office
**Canada's Economic Action Plan

When?
The economy is showing signs of reflation with commodity prices increasing. Rising Treasury yields are a clear sign that cost of borrowing cannot be held artificially low for much longer. The foreign apetite for holding U.S. debt is falling. It is "time to sell" treasuries, said Kim Heeseok. Heeseok is the head of South Korea's National Pension Service, the country's largest investor in U.S. treasuries. All of this is an indication that the answer to the question of 'when', is likely sooner rather than later.

How?
There are three general classes of options for increasing taxes:

1. Sales Taxes (Value-Added-Tax, Sales Tax, Point-of-Purchase Tax, etc.)
   This class of tax is added whenever a 'taxable' good or service is purchased. Everyone in Canada is familiar with the GST. It was the Mulroney version of a "tax shift". The next government (Chretien) promised to eliminate it and failed to deliver. Ultimately, the GST was reduced by two percentage points. While it was a popular political move, the annual government revenues were reduced by an estimated $10 billion, nearly the same amount as the current account deficit. A federal sales tax is now the leading candidate for a universal tax increase in the United States, according to sources.


2. Income Taxes
   Income taxes are levied on all legitimate forms of compensation for services rendered. The structure of these taxes is often complicated as they are often 'marginal' to allow for higher tax rates for higher income earners. Capital gains and dividends are also typically taxed, albeit at different rates than 'standard' income. There is usually little room to maneuver upwards on income tax because these rates need to be competitive in order to keep people and businesses from migrating to other regions with more favorable income tax rates. They can also be evaded in instances where stringent records of income is not kept--as is the case with many small businesses.


3. Duties, Royalties, Excises and Levies
   These are miscellaneous taxes charged towards specific items. Politicians like this type of tax because they don't necessarily have the word 'tax' in it and the amount of the tax can usually be hidden inside the cost of the item itself. For example, most people have no idea how much excise taxes are on alcohol and cigarettes. California is now considering monetizing its underground marijuana industry by legalizing and taxing the substance. The resulting potential revenues for California would be massive in this case, but this example is the exception, not the rule for this class of taxes.


4. Savings and Property Taxes
   This type of tax is the most controversial as it is a direct raid on the savings of the citizens. One common example is an estate tax--when some of the savings of a deceased person are transfered to the government instead of to their designated beneficiaries. Properties are often subject to annual taxation indefinitely despite the perceived ownership by the landowner.


5. Phantom Taxes
   This is an indirect tax that tends to be the easiest for politicians to implement without creating public backlash. That's because citizens don't even realize that their savings are being raided. It occurs when the government decides that instead of borrowing money to finance deficits, they will print it to make up the shortfall. This leads to inflation and devaluation of the currency. The effective reserves (savings accounts) of the currency holders will fall. Many people attempt to use gold and other precious metals as an inflation hedge to hold value during this decline in the purchasing power of the dollar. The only trouble with using this inflation hedge strategy is that any 'appreciation' is subject to another type of tax--a capital gains tax.

No matter what you word it, the tax man is coming. Politicians will try and evade the question because any hint of an increase is unpopular; but the question still stands.

Getting Back To Prosperity

The pace of job losses in is slowing. This is apparent looking at the 16-month payroll chart for the United States, which shows that although the economy lost jobs for the fifteenth straight month, the pace of those losses is up off it's lows. The picture in Canada is similar, although the data is reported slightly differently. There will probably be at least another 3-4 months of negative job growth but there are other signs of "green shoots". That being said much of the appreciation in equity values that we have seen this past month is due to inflation as I mentioned in the previous post. The same is true for commodity prices, which are also up sharply off their lows earlier in the year. This trend is likely to continue, and without cheap oil, the extent to which the United States economy can recover is really quite dim. While the emerging economies still have a long way to go in terms of manufacturing quality, the productive capacity and thus growth potential of these regions far exceeds that of the 'developed' nations and at a much lower labour cost.

One of the biggest delusions I've heard is that the health services sector (drug research, health care, stem cell research, and so on) will lead us out of recession. While it's true that everyone is willing to pay more for their health, the reality is that they can still only pay what they can afford. The aforementioned speculation seems to be largely based on the premise that people will pay anything for good medical treatment when practical realities dictate otherwise. Further to this, the government will need to spend less, not more, on health care costs. Even with the health care sector outperforming other sectors, it alone cannot single-handedly sustain any economy of scale.

"Well, first of all, it's our money. We paid the taxes. We're just asking for some of our money back." - Buzz Hargrove, former Canadian Auto Workers Union president on why the union should be bailed out (April 26, 2009)

The attitude of Buzz Hargrove and thousands others needs to change. Hargrove did not finish high school and yet he feels that compared to international workers, he is entitled to better pay for equal work, simply because he was born in Canada. This is an indication, unfortunately, that the 'correction' is not quite finished yet, and we'll need to see a subsidence of the corporate welfare state, reduction in entitlement expectations and a notable improvement in workforce value generation. This means better service and quality for globally competitive prices. This is where America has diverged so far away from it's founding principles in recent years. In a free economy, jobs can, and should be outsourced unless the domestic workforce provides greater competitive value. Not only is this a critical component of a free economy, but it is also critical in a free society and any protectionist government measures to artificially maintain jobs domestically will only hurt the economy in the long term. There are no shortcuts on the road back to prosperity.

The Inflation Tease

The principle of inflation in economics is actually not much different than the principle of inflation in physics. When a balloon is inflated with hot air, for example, we see a very large increase in volume without any appreciable increase in mass. Similarly, in economics, inflation represents an increase in monetary supply without the corresponding increase in the value of that money. It looks like growth at first, but like a Ponzi scheme, it’s only a matter of time before the bubble pops and a correction occurs and everyone sees what’s really there; thin air.


There is no perfect way to measure inflation, but many different indicators exist. The most commonly accepted indicator is the Consumer Price Index (CPI); a sampling of the prices of the most commonly is purchased consumable goods. Using this indicator of inflation, the CPI chart indicates a step change in slope around 1971, the year the gold-based Bretton Woods system was officially abandoned because it was preventing government from running large deficits. The average annual increase in CPI jumped to a 4.6% average annual rate of increase from a more stable 2.5%.


The cause of inflation is a significant increase in money supply. Imagine playing a game of Monopoly where the bank decides to add a zero to the end of every new note it issues. Pretty soon, the old money becomes useless and each player would be forced to raise the selling price of his or her properties to reflect this new reality. It wouldn’t be so bad if we just added a zero to the end of every note, but the way it happens usually benefits some people quite a bit more than others. The first person to pass ‘Go’, for example, would find themselves flush with cash, and would likely go out on a spending spree. By the time the player in ‘Jail’ realizes what’s going on, he will probably have sold off all of this properties for what he thought was a great price, when in fact he got ripped off. This is exactly what happens in the real world, the first people to get the increase in money supply—the large financial institutions, hedge funds, very wealthy and so on, get to spend the new money at old prices. By the time this money gets into the pockets of the middle class and the poor, prices have already increased and they simply find that their savings have been rendered worthless. This is exactly what we are seeing today—wage depreciation occurring at the same time that consumer prices are either increasing or staying flat.

It’s no surprise that central banks such as the United States Federal Reserve, a pseudo-private, pseudo-public entity which is essentially run by banks and backed by government, makes their policy that creates the biggest benefit to their friends at large financial institutions. Government, which essentially owns (but does not directly operate) the central bank, is usually complacent to this policy because inflated economies look good—at least until the bubble bursts. And yet no president including Regan has been able to successfully balance recessionary and inflationary forces since the idea of having a naturally stable currency was abandoned in 1971. This is the main argument for why central banks should be abandoned—government has proven itself incapable of maintaining a stable currency in nearly four decades since it decided it could do a better job of this than free markets could.

"I'll bet you a lot more than a penny" - Peter Schiff predicting the credit crisis and collapse of the purchasing power of the USD (2006).

This reality is often underreported by the mainstream American media. Some claim this is because the media, including many so-called experts and economists, are mislead by the way the government reports on it's monetary policy. For example, the U.S. Federal Reserve decided to stop reporting M3, the total money supply in March of 2006, claiming the data was too difficult to accurately compile. It still reports M2, which is part of the money supply, but the M3 wedge has grown from less than 5% in 1971 to over 30% of the total in February 2006 when this figure was last reported (see chart). Not everyone is fooled though. The video below shows economist Peter Schiff on major U.S. television networks predicting the subprime and credit crises in 2006 and 2007 despite being ridiculed by his naive counterparts at the time. It is also worth noting that these counterparts recommended buying equity stake in firms like Bear Sterns, Merrill Lynch and Washington Mutual, all of which became insolvent and were forced into distressed mergers with more solvent financial institutions. Each of these transactions was facilitated by either the Federal Reserve or the Treasury with some kind of taxpayer-backed debt guarantee or subsidy. Hopefully these guys stay low-key for awhile until people forget how bad their recommendations really were. Enjoy watching the video.

Swineophobia

Let me first assert that infection from the active strain of the H1N1 virus does indeed cause serious illness which does have the potential to cause death--this is indisputable. However, it is important that any and all responses by the public, health officals and government remain both appropriate and contextual rather than hasty and irrational. This particular strain is not necessarily any more virulent than that of the 'human' influenza virus. For example, with the swine flu 'epidemic' of 1976, more people died from the recklessly synthesized vaccine than from the virus itself--one of the reasons many people still fear the influenza vaccine today. It is now reported that only 19 of the deaths in Mexico to date can actually be attributed to the virus rather than the hundreds they initially thought. Preliminary research suggests the current strain has a cleavage site that may reduce it's virulence. The 'mild' virus would need to mutate further in order to cause more serious danger to the general public.^[1]

Outbreak: A disease outbreak is the occurrence of cases of disease in excess of what would normally be expected. A single case of a communicable disease [may] constitute an outbreak.

Pandemic: The emergence of a disease new to a population involving infectious agents. The disease is spread across a large geographical region and can be transmitted easily and sustainably among humans and cause serious illness.

While the Swine Flu or H1N1 virus may meet the technical World Health Organization definition for both an outbreak and a pandemic, this classification is misleading as the disease is far from widespread. Confirmed cases in Canada affect 0.00027% of the population. Mexico's confirmed infection rate is 0.00036%, while the United States has 176 confirmed cases out it's 300,000,000 people. The actual number of cases is undoubtedly greater, but even if it is one hundred times greater, the risk of infection to the general population remains insignificant at this point in time (less than one tenth of a percent). This begs the question of whether the additional $1.5 billion president Obama has asked congress for to fight this virus could be more effectively deployed for other public health issues. There's a good chance the money won't even provide any assistance to the cause before the pandemic subsides. We won't know the answer for a while yet, but few people, including government, will hesitate to ask for more money when an opportunity arises.

The 'cartoon' model of a molecular protein. The label H1N1 is derived from the two proteins found on the surface of the Swine flu virus: Hemagglutinin subtype 1 (H1) and Neuraminidase subtype 1 (N1).

This does not mean preventative measures by health authorities do not need to be taken. It can certainly make sense for large businesses, for example, to encourage employees to take paid sick leave if indeed there are reasonable grounds to suspect they are sick with any respiratory infectious agent that has a high rate of transmissibility. From a company-wide perspective, this is not just a matter of ensuring the health of it's employees, but it's also a matter of maximizing the productive capacity of the workforce. If a single employee takes two weeks off, this outcome is much less disabling to the company than if he or she returned to work and infected tens or hundreds of other employees.

The standard preventative measures to reduce the risk of infection should always be taken, whenever possible. These include handwashing and personal hygene, as well as measures to maximize your body's immune system such as adequate sleep and good nutrition. I wouldn't plan a vacation to Mexico for next week, but if you already have a trip booked and can't get a refund, deciding to proceed won't exactly mean you're facing "certain death".

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My next post will deal with Human Physiology--the impressive amount of knowledge we've accumulated on the subject and how much we still don't really know.

USA: Success or Secession?

It's pretty hard to imagine why anyone would be willing to pay a 90% income tax rate without any improvement in public services. Especially if it's to repay debt incurred by somebody else. Anyone that has the means would simply pick up and move somewhere else. Investor Jim Rogers already relocated to Singapore for this very reason; many others will follow. Naturally, it will be impossible for 300 million people to do the same. The alternative therefore, will be secession. Canada had it's own debates about secession with Quebec trying to withdraw from the country. Americans will have similar heated discussions about the legal right of American States to secede from the Union. Nonetheless it is the most probable and perhaps even inevitable outcome, particularly if economic recovery does not happen sooner rather than later. As I've said before, I think crude oil prices of no more than $20 a barrel will be necessary for sustained economic growth to occur in the United States.

The bad news is that when a country splits up, the breakup is nearly always preceded and/or succeeded by some form of civil war. Debt holders could be wiped out or suffer significant losses. The good news is that the Soviet Union, the only nuclear power to secede, was able to keep it's inventory of nuclear weapons secure and unused during the process.

The Precarious Peace

In times of abundant resources and economic wealth, living in harmony, peace and civility is a relatively simple thing to do. In times of economic hardship and resource scarcity, the instinct of survival takes over. I suppose this is why the Obama administration wants to reduce the number of active nuclear weapons in the world as futile as the effort may be. Here's a brief look at the science and the politics of nuclear armament.

The Science
Several years ago, I read a book called E=mc²: A History of The World's Most Famous Equation. In Chapter 13, author David Bodanis provides an explanation of the events that occurred, from micro to macro at 8:16am in Japan when the first nuclear weapon was used against man. It is a visceral, awesome and terrifying account of the ultimate weapon of mass destruction.

Virtually every state possessing nuclear weapons developed them as martial insurance against a potential nuclear attack from another antagonistic nation with such capabilities...

The death and destruction caused in Nagasaki and Hiroshima makes the attacks of September 11th seem rather insignificant in terms of civilian death toll, injury toll and infrastructure destruction and long-term effects such as radioactive contamination. Yet these were only fission-based weapons delivering 15-20 kilotons of TNT equivalent. Since then, thermonuclear (fusion-based) weapons have been developed which will theoretically deliver over 100 megatons of TNT-equivalent energy. Tests of high-yield bombs are typically done below theoretical maximum yield to minimize both environmental destruction and for secrecy purposes; the mushroom cloud can be seen by anyone as far as 1000 kilometers of the blast and if below-ground tests are done, the seismic signatures can be detected. Russia's Tsar Bomba, the most powerful device ever built by man was tested at about 50 megatons or 2.1×10¹⁷ Joules. It's a bit hard to grasp what a megaton of TNT means, but the image of the mushroom clouds produced below may help put it into perspective.

Fat Man (1) is the 22.5 kiloton fission bomb that was detonated in Nagasaki, Japan while Castle Bravo (2) was the 15 megaton thermonuclear fusion device tested by the U.S. in the Marshall Islands. (Image: U.S. Federal Government)

The peak temperature is about 350,000,000 degrees Celsius--a temperature for which all matter exists in a state called plasma. Steel near the blast epicenter would be instantly vapourized and there would be no forensic trace of any humans unfortunate enough to be nearby. Those far enough to survive instantaneous death would receive severe third degree burns to any soft tissue with a line of sight to the bomb. Depending on wind directions, radioactive fallout could cause hair loss for people hundreds of kilometers from the blast site. My guess is that a single high-yield thermonuclear device could eradicate 20 million people if it were detonated in the right place.

The Politics
Since Hiroshima and Nagasaki were bombed, the world has made well over 65,000 nuclear warheads of which over 10,000 are currently active (the weapons have 'expiry' dates). Ninety percent of these are held by the U.S. and Russia, with the balance in the U.K., France, China, India, Pakistan. Israel never signed the nuclear non-proliferation treaty and thus does not report on its nuclear weapons program, but is believed to possess a significant stockpile of nuclear warheads. North Korea withdrew from the treaty and is believed to have successfully conducted a nuclear weapons test. Iran and Syria are following a similar path to that of North Korea, but are not believed to possess viable nuclear warheads at this time.

Virtually every state possessing nuclear weapons developed them as martial insurance against a potential nuclear attack from another antagonistic nation with such capabilities: The USSR as a deterrent to the U.S.; the U.K. and France in response to the USSR; China to counter the U.S.; North Korea to oppose U.S. nuke stockpiles in South Korea; Pakistan to retaliate against India's tests; and Iran and Syria to retort Israel.

Hopefully each and every person with the authority to deploy these weapons will hold them as a nothing more than a deterrent and never use them. Otherwise the world will find a new peace without too many humans, if any left in it.

Copying right? The Digital Age of Consumer Media

High-speed internet, CD and DVD burners, personal video recorders, high-capacity hard drive, iPods, mp3 players, satellites and receivers made it effortless to transfer, reproduce and store trillions of bits of data at the touch of a button. Few groups, with the exception of the consumer have kept up with the technologies in their rapid state of flux.


Is 'file sharing' really stealing?!?
The entertainment industry put out an advertisement condemning the pirating of intellectual property. Their assertion is that stealing a television is the same as stealing a satellite signal. The list price of the service could be the same as a television, yet there is an important philosophical distinction. While intellectual property has apparent value, it does not have any tangible value. A person stealing a satellite signal only causes lost revenues for the provider if the thief would otherwise have paid for it. This does not make such a theft ethical; by law the violator could face penalties as if he/she stole a tangible good of equal value. It is still stealing, but it does require the distinction from someone who steals a material thing effectively removing a salable product from inventory, thus causing more apparent harm to the rightful owner. Many people continue to have little sympathy for entertainment executives and pop artists and movie stars that continue to earn millions despite the fact that it is the smaller artists that rely the most on record sales for their revenues.

The Law
The legal process is far too slow to keep up with the latest technologies and proved ineffective. By the time Napster was closed by the courts, peer-to-peer networks like Kazaa and BitTorrent were already set to take their place. The industry then went after the individuals that 'shared' the most content. This strategy had minimal success and created a PR mess in the process. Some of the violators were children using their grandparents internet account to do all their illegal downloading. People sympathize with ninety year old grandmothers accused of copyright infringement who don't even know how to write an email. The approach failed to dissuade large masses of people from downloading illegally.

The Lawmakers
The lawmakers (politicians) are part of an older generation that generally does not use or understand the technologies being used in potential copyright infringements. In 1998, President Clinton signed the Digital Millennium Copyright Act into law. Despite a modern-sounding name, the act did not provide the protections the record industry had hoped for. Less than a year later, Shawn Fanning released the original Napster that popularized 'file sharing'. Canada has yet to pass it's own version of copyright reform for the new millennium, but proposals have been tabled. A version of Bill C-61 will likely get re-introduced since the bill did not get passed before the 39th session of parliament was dissolved. The law will likely not have no more success at curbing illegal and/or unethical copying than it's American counterpart did.

While Canadian copyright laws have yet to be overhauled, the Canadian Private Copying Collective (CPCC) was created by the Federal Government in 1998 to collect and distribute royalties on blank media on behalf of music rights holders hurt by illegal copying. The tariff amounts are based on statistical data of music downloads. The table below shows current levy rates being charged to all blank CD's purchased in Canada. The proposed tax on music-based digital storage media and devices (such as iPods) was struck down by the Canadian Federal Court of Appeal on the basis that the CPCC does not have the legal authority to impose such a tariff (link). Others argue that it's unconstitutional because it is based on the presumption that consumers are not paying for the media on their digital devices. Some even argue the tariff encourages 'file sharing' because it compensates artists. It's certainly hard to believe that someone buying a digital camera should have to pay up to $10 to the record industry for their flash memory card.

	Tariff
Audio cassettes of 40 minutes or more	29¢
CD-R or CD-RW	29¢
CD-R Audio, CD-RW Audio or MiniDisc	29¢
Removable electronic memory cards over 256 MB (MMC, SD, Compact Flash, etc.)
no more than 1 GB	$2
more than 1 GB and no more than 4 GB	$5
more than 4 GB	$10
Digital Audio Recorders (iPods, mp3 players)
No more than 1 GB	$5
more than 1 GB and no more than 10 GB	$25
more than 10 GB and no more than 30 GB	$50
more than 30 GB	$75

Source: CPCC Tariff Backgrounder

The Enforcers
Without entering into the offices and living rooms of millions of private citizens, it's very difficult and in some cases impossible to monitor the massive amounts of data that gets transferred between electronic devices. In some cases, it's virtually impossible to determine who downloaded or uploaded something using an unsecured wireless network from a laptop that leaves little to no trace of itself. Recently, several police agencies complained that Blackberry's (made in Canada by RIM) are too secure--they can't intercept and monitor drug dealers who are using them. The trouble is that if security holes are deliberately built in to the devices, they become more susceptible to hackers. This extremely reliable security of the device was likely the only reason President Obama was allowed by the secret service to be the only standing president with a mobile communications device.

Asleep At The Switch
The CRTC is the "Independent public authority in charge of regulating and supervising Canadian broadcasting and telecommunications." Radio waves and satellite communications typically prove to be a very difficult thing to regulate since they pass through Canadian airspace whether the CRTC wants them to or not. Broadcast radio was not too difficult to control in urban settings because U.S. broadcast frequencies could simply be overpowered by stronger signals on the Canadian side of the border. Satellite radio did not have the same overwriting capability. During the first three years of the service, satellite radio was not officially available in Canada. Still, many Canadians were using the American service 'illegally' by registering 90210 as their zip code since the signal could be picked up even in northern parts of the country.

Another example is Pandora internet radio. The US-based service provides 'radio' stations customized to the users individual tastes. The CRTC forced the Music Genome Project (Pandora) to block its content for Canadian IP addresses in 2007. This did not stop some Canadian internet users from circumventing the block. In other cases, the blocking algorithms on the site simply do not work allowing Canadian IP addresses to access Pandora content freely (albeit violating the terms of use of the site).

It seems clear to me that everyone from lawmakers to enforcers, record industry execs to artists have a long way to go when it comes to adapting and bringing themselves into the twenty first century. The neo-luddites will lose the war against the Digital Revolution just as their counterparts lost their fight against the Industrial Revolution.

1.3 Billion Pounds of Thrust

It flies more than twice the speed of sound. Radar absorbing materials (RAM) in conjunction with fan blade design making it virtually invisible to direct radar. It's the F-22 'Raptor'. Most men marvel at one exuding 70,000 pounds of thrust let alone one fully loaded with eighty thousand pounds of bombs, missiles and cannons. An engineer gets excited like a kid in a toy store at the sight of one of the beasts you don't even hear coming, provided they're on your side. My office wall has a picture of two of them flying next to the F-15 'Eagle' they were built to replace.

On Wednesday March 25, an F-22 Raptor crashed in California killing the test pilot. The cause of the crash was not immediately known but obviously the smallest oversight becomes catastrophic at 2,500 km/h. This was by no means the most expensive crash at $140 million dollars either. About 13 months ago, a B-2 Spirit crashed in Guam just after takeoff. The two pilots ejected safely but the hull was completely destroyed at an estimated cost of $1.4 billion.

I don't think the 1.3 billion Chinese from the People's Republic realize just how powerful they are yet.

When you add up all the numbers, the United States military budget totals about $500 billion a year. While it's obvious that president Obama doesn't have much of an appetite for military spending, the United States' creditors, rather than it's citizens will effectively decide how much capital it can sustain on the military. As we've already seen China flexing it's economic muscle in the past several days just by mentioning concern about the inherent risk of their treasury holdings. The USD's universality is currently the only thing holding the United States economy back from hyperinflation in the medium term. I don't think the 1.3 billion Chinese from the People's Republic realize just how powerful they are yet. The use of military force against Iran will hinge upon China's agreement. China would likely take exception since Iran provides discounted oil in exchange for economic protection. I talked about this 'nuclear option' in previous posts (see America In Recession). Now I think this may take years instead of decades to happen. The world may need to get used to five yellow stars on red rather than fifty white stars on blue.

White Out

The White House, Wealth and the Economy

Larry Kudlow of CNBC always talks about mustard seeds in relation to the economy. The trouble is that his optimism, while refreshing, had been unrealistic over the past year. As I've said before, there is a difference between optimism, pessimism and reality. It's now becoming clear that some of those who were previously labeled pessimists are actually perpetual optimistic realists. Today however, it looks like the mustard seed is finally in the ground. It will need plenty of water, nutrients and time to grow, but the seed has been sown nonetheless. I've penned some Q&A-style perspectives below..



Isn't the market supposed to be forward-looking?!?
Many people have said the markets are forward looking and that the next 6 months are already factored in to the stock market. Obviously they were wrong if they said this three months ago. The reason they were wrong is that the stock market is not some kind of oracle but merely an indicator of economic sentiment and perception. The perception was wrong as CEO's and analysts were continually making downward revisions to their guidance leading to a negative feedback loop in the economy. The popular perception is now much closer to reality now, in my opinion, which means we are at, or near a bottom in the stock market.

What did the Obama administration have to do with the economy?
Thus far they haven't done anything measurable. The market correction paused to determine if the smart guys in the administration had a magic bullet that would stop the declines. They didn't, and when this fact became apparent, the declines resumed their course. Sporatic reactions to announcements and press releases are never a reflection of long term equity value with the very rare exception of events that act as a catalyst for catastrophic events (the Lehman Brothers failure for example).

So the Obama administration actually knows what it's doing?
Not really. In his testimony yesterday Treasury Secretary Timothy Geithner admitted that if the administration's GDP growth projections for the next decade are off, the public debt may no longer be serviceable. He emphasized that he didn't see any better alternative to the current direction given their inheritance. He's probably right and certainly transparent; but this does not inspire much confidence in their ability to fix the economic problems.

Is now the time to buy stocks?
Yes and no. One certainty is that anyone predicting a bottom will be wrong. However, my outlook several months ago was that the Dow Jones Industrial average would bottom out in the 4000-6000 range. My outlook has not changed (as it sometimes does), and the stimulus packages could help push this bottom higher than my estimate. I'd be ready to diligently put long-term investment capital to work. Traders beware of expecting large returns and high long-term growth rates. Profit taking will ensure that volatility remains in the markets for the next 3 months as the economy moves towards a rebalanced state. A structural debt problem that still exists in the United States economy should be considered very carefully.

Does this mean the economy is turning?
Yes and no. More job losses are on their way. House prices still likely have further to fall to eliminate the excess in homes. There is still more downside. When growth does resume it will not be a sudden dilation back to 2007 activity levels. On the other hand, the light at the end of the tunnel is becoming visible. Just realize that the path to get there will be a difficult one.

Every obstacle forges fortitude, every hurdle appraises fitness and every challenge tenders opportunity.

-You're smarter than you think.

Economic Stimuloids

"Suplement Me" by SMmeaLLuM [cc]

"The biggest problem with steroids is that you can only inject so much before the patient goes into cardiac arrest."

-Anonymous

Many of the smart people on Wall Street continue to call for more stimulus in response to falling investor confidence. Major executives like billionaire Mortimer Zuckerman continue to call for more stimulus. They say the current stimulus package is way too small and that Washington will need to ask the Chinese if they can borrow more money on behalf of the unborn American taxpayer before the end of the year.

The U.S. debt levels as a percentage of GDP has now has not been seen since the 1940's. The main difference between then and now is that the debt holders then were mostly domestic; it was considered patriotic to be a bond-holder of national debt. The trouble is that now the U.S. is relying on foreign creditors to buy up public debt. Should these purchasers decide they don't like something the United States is doing or consider their credit risk too high, they may simply stop buying their debt. This leaves two basic options, (1) print more money (inflate and devalue the currency), and (2) raise taxes, and several other more complex but less effective ones, such as raising interest rates.

The most likely response would include an array of the aforementioned strategies, none of which are desirable.

"It's going to take World War III to get us out of this."

- Don Luskin on the state of the economy

E-Papyrus: Reinventing Paper

The Heracles Papyrus

One of the first transportable media to carry information in the form of written language was Papyrus, which dates all the way back to the First dynasty circa 3000 B.C.E (over 5000 years ago). Modern (wood pulp-based) paper is believed to have been invented in China during the Han dynasty circa 200 C.E. We are now on the dawn of a new type of paper, plastic paper.

The idea of digital or plastic paper is not a new one, and has been hypothesized and researched for years. The problem has been figuring out how to produce something with the following four criteria:

1. Portability - If it weighs more than about 500g you may as well just carry textbooks.
2. Durability - It needs to stand up to moisture, mild G-forces and variable temperatures.
3. Cost - Few people will want to carry around a device worth thousands of dollars when they can just buy a newspaper for a dollar.
4. Ease of reading - standard screens (LCD, plasma, etc.) are not comfortable on the eyes for reading lengthy documents. That's because they have non-ideal text contrast, back-lighting and/or screen refresh rates that lead to eye strain.

With advances in material science, manufacturing and miniaturization, it looks like we are finally approaching the electronic paper era that many people erroneously thought would come with the invention of computers. The Plastic Logic eReader, Sony Reader, iRex iLiad and Amazon Kindle are just some examples of the first generation of electronic readers. It may not be long before high school and university students can carry all their textbooks on a single device.

Plastic Logic's e-Reader is to be piloted in mid-2009.

This exciting new reality won't be a boon for everyone. The forestry sector will see their demand dwindle, as will the pulp and paper mills and the printing businesses over time. The aforementioned should have time to restructure since demand for paper won't drop overnight. The intellectual property holders will need to adapt much more quickly. Within seconds, a NY-Times bestseller can make its way to thousands of internet users without proper compensation. Digital Rights Management (DRM) will likely continue to prove ineffective as it is too easy to circumvent. They will need to discover new ways to generate revenues going forward or technology will simply leave them behind. Which leads me into my next topic: intellectual property and copyright reform.

You're smarter than you think.

The TARP, optimistically..

Some philosophical context


I think it's both timely and important to note the distinction between optimism, pessimism and reality. Most people think that forgetting reality is the way to remain optimistic. This is the wrong way to approach reality. The truth is that understanding reality is the only way to manage expectations and remain optimistic. Expectations are usually met for someone who has a tangible grasp on reality. The optimist also understands that they can mold their own reality but they can't choose the clay. On the other hand, the person who does not have a tangible grasp on reality finds themselves is always disappointed by unrealistic expectations. This psychological house of cards is sometimes made even worse as they create more undue optimism to fill their void in troubled times, which can only lead to a terrible downward spiral in the end.

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TARP (tar⋅pau⋅lin) - [tahr-paw-lin, tahr-puh-lin]

-noun

a protective covering of canvas or other material waterproofed with tar, paint, or wax.

When it comes to the economy, it's clear that many people still misplace optimism with optimistic realism, despite a notable improvement in this regard in recent days and weeks. Many people still believe the purpose of the TARP (Troubled Asset Relief Program) was to increase lending and stop foreclosures. It wasn't. The purpose was simply to stabilize financial markets and stall the market correction following the failure of Lehman Brothers collapse. Major banks were failing by the week at the time, with no clear end in sight. The system was collapsing and the fall had spread to the broader market. The economists that saw the current problems of the market predicted the fair (unadulterated) value level of Dow Jones Industrial Average was (and still is) about 4,000 (Thursday's close was 8,212). The program eventually passed congress and equity markets stabilized. The .DJI has been flat since October 10, 2008, about the time it became clear that the bailout would pass in some form or another. When the Obama and Bush economic advisers realized is that the correction was about to resume it's course, with more defaults coming from the retail sector in addition to continuing subprime loan defaults, they called for the release of the second $350B bale of the TARP.

The real objective of the TARP was to diffuse the full extent of a free market correction. Without the TARP funds, the mark-to-market net worth of nearly everyone with equity would fall by about half (this includes RRSP's, 401k's, home equity, etc.). Foreclosure rates would have accelerated in the opposite direction of equity. Citibank, Bank of America, Fannie Mae, Freddie Mac, Chrysler, GM, AIG would all obviously have failed with catastrophic consequences, along with many others. The economy would need a combination of pay cuts and job cuts; if fewer people willingly took pay cuts, more people would be forced into job cuts (this still holds true despite the TARP). It's no surprise that no acting government, republican or democrat, would be willing to face such a reality and opted instead for inflationary market interference instead.

I'm not personally in favour of these bailouts unsustainable tax cuts, debt loads, deficit spending and stimulus handouts. They will ultimately just prolong and extend the natural correction as well as stagnate longer-term growth for years, perhaps even decades. Political stability will become rather precarious as it becomes clear that debts cannot and will not be repaid. The greenback will have questionable value as the dollar becomes mortgaged (also see America's Fundamentals). Nonetheless, it's important to be onside with reality. This is the only way to see the glass as being half full.


You're Richer Smarter Than You Think.
Kent Carter

America In Recession

The United States has already conceded it's title as the world's most powerful nation. Of course, it still has the World's most technically advanced military, most martial firepower and the largest and most capable nuclear arsenal. It still has the World's reigning currency, highest volume of wealthy people in the world and largest GDP (excluding the European Union).^{[1], [2], [3]}

Waning Superiority
The military superiority is a bit misleading because it hinges on America's ability to both finance and fuel the technologies. The massive energy and cost requirements of the U.S. military are becoming increasingly reliant on foreign oil and foreign debt. Even economic superiority is decreasing because of huge deficits and debt. Economic debt is, in principle, no different from social debt: an obligation requiring future reparation (usually with interest). In the decades immediately following the first two World wars, the United States was the lender, mostly to European countries in ruin, giving it unprecedented power as a recipient of Europe's future financial obligations. The United States did had large debts of its own at the time, but the debt holders were largely domestic, leaving its own citizens in control of its own destiny. In 1988, about 13% of the government debt was foreign-owned.^[4]. Currently, about half of the public U.S. debt load is owned by foreign investors. This percentage is certain to rise social security, health care and other entitlements on the rise while the GDP shrinks. The president elect forecasts trillion dollar deficits "for years to come."^[5]

Iran Example (image)
China has formed a strategic alliance with Iran. The arrangement allows China to receive Iranian oil at a discount in exchange for economic support that allows Iran to circumvent UN sanctions. In the spring of 2008, China and Russia blocked a UN Security Council resolution to increase sanctions on Iran in response to Iran's defiance of calls to abandon its uranium enrichment program. ^[6]

The 'Nuclear Option'
Knowing it cannot count on United Nations support, were the United States to decide to attack Iran unilaterally, Iran could plead with China to use its economic nuclear option in order to prevent such an attack. The economic nuclear option is the scenario where a large foreign owner of another nations public debt threatens to stop lending thus crashing the currency value of the indebted country and plunging it into economic ruin. The United States used this approach to help end the Suez Crisis in 1956. In short, president Eisenhower threatened to sell the U.S. reserves of British Pounds and Sterling Bonds and collapse the British Pound if they did not withdraw troops from the region. This tactic coupled with other pressures forced Britain to withdraw it's troops from the region and is regarded by historians as an egregious point in the decline of the British Empire.

Precarious Positions
Tactics such as the 'nuclear option' are not without significant economic risk to the powers considering it's use however. An estimated 70% of China's currency reserves are held in the U.S. dollar (the administration does not make these figures public).^[7] Trying to convert (sell) large amounts of these holdings will inevitably cause the U.S. dollar to fall, leading to a write-down of their remaining domestic currency reserves. Instead, they will likely try to divest these holdings over a period of years or decades, leading to a gradual decline in the value of the greenback rather than a violent plunge. China, India and other emerging economies are also in the rather undesirable position of having large populations but limited domestic resources. The world simply does not have enough natural resources to bring the average standard of living up to the same average level of the wealthy western nations. One of the reasons America was able to become so prosperous was that the country was awash in natural resources: coal, oil, water, minerals and fertile agricultural land. Now that those resources have mostly been exploited domestically, America has tried to create a knowledge-based economy without conceding any reduction in annual economic growth. I think the current economic environment is a reflection of the reality that the global economy was supersaturated with overpaid knowledge-based employees and thus became reliant on inflation and artificial Madoff money to provide illusory growth. Is there really nowhere to go but down? America and the rest of the world certainly face the challenge of finding real and significant growth in a globe that appears increasingly finite. What the world needs is some good ideas on how to succeed in this feat.

You're Smarter Than You Think.
-Kent Carter

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1. International Monetary Fund Report
2. CIA World Factbook
3. World Bank Statistics (2007).
4. Final Monthly Treasury Statement, U.S. Treasury (September 30, 2008).
5. Obama Predicts Years of Deficits Over $1 Trillion, Washington Post (January 7, 2009).
6. Russia, China block UN resolution on Iran; MSNBC (March 4, 2008).
7. China Losing Taste for Debt From U.S., New York Times (January 7, 2009).