New book predicts major shock to global economy

by Scott Patterson

It's no secret the price of crude is hitting historic highs. But oil has been expensive in the past, and it has always drifted back to reasonable levels again, so there's no need to worry that things will be different this time, right?
Wrong, says Stephen Leeb, co-author of "The Oil Factor," published in February by Warner Books. Leeb, whose wife Donna contributed to the book, argues that the emergence of India and China as major consumers of fossil fuels is placing incredible pressure on a petroleum industry struggling to boost production. Indeed, just last year China moved past Japan to become the second largest consumer of oil in the world, behind the US.

As demand increases, the price of oil will skyrocket, says Leeb, reaching the staggering mark of $ 100 a barrel within a decade. OK, we know: $ 100 a barrel sounds unreasonable, even a tad nutso. But when challenged on the outlandishness of his prediction, Leeb counters that only in the past few years the price of oil has already tripled.
"If you go back to the end of 1998, oil was trading near single digits," he says. "So we've had a threefold increase in oil prices in a relatively short period of time, and I'm basically just projecting an ongoing trend."

The result, he says, will be a major shock to the global economy, and investors had better get ready, now.
"I don't think there's anything more important now for investors to be paying attention to than the price of oil," says Leeb, who's also manager of the New York-based Mega Trends Fund (MEGAX) and editor of the "Complete Investor" newsletter.
We asked Leeb how investors can protect their assets if his predictions bear out, and what the US government can do to protect the American economy from the massive escalation in oil prices he's forecasting.

Question: Is the recent spike in the price of crude oil a long-term, fundamental shift in the industry, or is this just a short-term blip?

Answer: You could say both in the sense that the price of crude oil does bounce around a lot. And I wouldn't be surprised to see it go down a little bit over the next couple of months. But it's part of a major long-term shift.
Oil prices and natural-gas prices are in major long-term uptrends, and Wall Street and America doesn't realize it yet. But we are seeing something that is a major change.

Question: In "The Oil Factor," you forecast $ 100-a-barrel crude-oil prices in the future. That seems like an extravagant number, given that prices now are historically high and they're not even one-third of that.

Answer: If you go back to the end of 1998, oil was trading near single digits. So we've had a threefold increase in oil prices in a relatively short period of time, and I'm basically just projecting an ongoing trend. I think we'll get another threefold increase, and it may happen in five or six years, or three or four years.
The overall point I'm trying to make is that oil prices are in a dramatic uptrend and are likely to remain in an uptrend for the foreseeable future.

Question: What's the global economic fallout of such high prices?

Answer: I think that if it happens in a gradual way, it will be very inflationary. If it happens in a very short timeframe, like this year, because of say a terrorist strike in Saudi Arabia or some other horrible event, it would be recessionary-slash-depressionary. It would have a horribly negative impact on the world economy.
Either way, oil is going to turn the global economy on its head. Whether it's short-term or long-term, I don’t think there's anything more important now for investors to be paying attention to than the price of oil.

Question: How can investors prepare for the shifting trends in the petroleum industry?

Answer: Investors have to roll back the clock to the 1970s. That's the closest historical comparison you can find to what's going to follow in the next 10 or 15 years. The 1970s was a very inflationary decade, in large part because you had a very sharp rise in oil prices.
It was also adecade in which the S&P 500's real total return was the worst ever, even worse than the 1930s. It was a catastrophic decade if you invested in the equivalent of index funds. But it was also a decade in which investors like Warren Buffett and Peter Lynch got very wealthy.
If you invested in real assets, whether in oil companies or gold companies or commodities, you did very well. In the next 10 to 15 years, there are going to be a lot more losers than winners. The usual rules just won't apply. If you invest in a collection of stocks that are hedged and leveraged to inflation, I think you have a chance of coming out very well indeed.

Question: What's changed in recent years that shifted the way we should view the petroleum industry?

Answer: Two major changes have happened at once. One is that our ability to increase oil production has become much more difficult. We're no longer able to increase oil production sufficiently to keep up with rising demand. We can produce a lot of oil, but our ability to increase oil production has become limited.
At the same time, the world's need for oil has been increasing rapidly. In particular, China and India right now have become emerging economies. With their emergence, 2.3 bn people between them produces wide-eyed increases in the demand for oil.

Question: Do the reserve reductions at Shell lead you to believe that total known reserves are less than the industry thinks there are?

Answer: I don't think it's a trend that's industry wide, but I think it's a sharp reminder that certainly reserves that companies have on their books are not understated and that companies are having a very difficult time replacing reserves. These reserve write-downs have come with oil prices very high, and that's exactly what you would not expect when oil prices are high.
Because when oil prices are high, oil companies are able to consider harder-to-get reserves as reserves. It reinforces the fact that oil is becoming an ever scarcer commodity. Probably a more relevant statistic is that finding and development costs across all oil companies have been rising dramatically at double-digit rates.

Question: What should the US government be doing to prepare for such a dramatic shift?

Answer: It's utterly urgent that the US government respond. The government has to embark on an absolutely massive effort to develop alternative energies. The most feasible alternative right now is wind.
Scientific study after scientific study has shown that wind is the cheapest way to generate electricity. Forgetting about environmental considerations, wind right now is cheaper than natural gas and coal for generating electricity. Putting into place a wind infrastructure in this economy would take maybe a half a trillion dollars, but it is doable, and it would take half our electric grid away from fossil fuels.
Those fossil fuels in turn could be used for other energy uses, such as powering cars. That would buy us enough time to develop more far-reaching alternatives, such as solar and hydrogen, which aren't on the horizon for the next 20 to 30 years. Wind is here and now. It's absolutely desperate that we start doing something about this.

Question: You think General Electric (GE) is a good wind-power play.

Answer: It has the largest wind assets of any company in America. They bought the Enron wind assets for a song when Enron was going bankrupt. If we do build a wind infrastructure, wind could become a multihundred-billion dollar industry, and GE would have a very big role to play in that.

Question: Oil expert Daniel Yergin has argued that fears of an oil shortage have cropped up in the past, only to fade as new technologies and new resources drive production.

Answer: He's right. In 1973 we had a fear of an oil crisis in the wake of the Arab oil embargo. In 1979, the Iranian revolution led to very high oil prices and fear of an oil crisis. In 1990, the first Persian Gulf war drove up prices. This time, it's different.
This time, we have very limited excess capacity. In all those previous incidents, the crisis came about because of political factors. Now, there's no war. It's fundamentals.
As to technology, just bear in mind that the US is the most technologically advanced country on the planet, and US production has been declining for 34 years. It peaked in 1970, despite all our technology. If it's not there, it's not there, and no matter what technology there is, you're not going to find it.

Question: Iraq has a lot of extra, untapped capacity. Won't that alleviate the situation somewhat?

Answer: There is a potential to develop more oil production in Iraq. That's not going to be something that's going to happen overnight, and it is something that the world desperately needs. But it's not going to satisfy all the excess demand that we have for oil.
Even if everything goes well in Iraq, it's still not going to be nearly enough to change the dynamics of this situation.

Question: Do you think that with declining supply, the opening up of the Arctic National Wildlife Refuge to drilling is fated to happen?

Answer: It's going to put more pressure on it, but the key thing is that, even if it was environmentally neutral and it was a no-brainer to open it up, it still wouldn't make any difference.
The amount of incremental oil you'd get there would be equivalent to putting a Band-Aid on a haemorrhage. You're talking about a small fraction of 1 % of a year's production. Virtually nothing.