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Slow Boat to China or Junk Tales to Debunk? - The Sequel

Spurred on by Financial Sense's Jim Puplava interview of Matthew Simmons [Twilight in the Desert], I've written about the topic of shipping and crude oil - to varying degrees - over the past few weeks. Then this Bloomberg report fell out of the sky:

Shipping rates drop on high oil
Wednesday, August 17 - 2005 at 10:04

Record oil prices saw supertanker bookings for oil exports from the Middle East fall below the monthly average for 2005, which pushed shipping costs lower, according to Bloomberg report. Shipping rates for VLCCs to Asia dropped by as much as 45% in less than four weeks as the high price of crude hit demand.

Now, as a background to this piece, I would like everyone to know that I spent approximately 4 hours of a day communicating with a few professionals in the shipping trade - discussing the merits of the last piece I wrote, A Slow Boat to China or Hollywood Hubris? In that article I cited VLCC [very large crude carrier or tanker ship] data as a proxy for the Baltic Dry Index [ships that transport dry goods like iron ore or wheat for e.g.]. While the two rates [wet and dry] are highly co-related and traded in sympathy over the relevant time span, I would like to be perfectly clear that there is a difference - in much the same way that while the NASDAQ and DOW are both equity indexes, one is technology laden while the other is composed of large cap names.

*Just To Clear The Air*

While I will admit that not everyone [seemingly few in shipping] believes the Baltic Dry Index [BDI] is capable of being manipulated [very reminiscent of players in the gold market, eh?] the only part of my thesis that anyone managed to poke a hole in was my using 'net new tanker [wet] tonnage hitting the water' as a proxy for ships that would be contributors to the BDI or dry index. While I will admit, and gave some ground, that this is an apples to oranges comparison, its relevance in the overall context of the piece I wrote is of little consequence since the movement or direction in rates [for both wet and dry cargoes] was so highly co-related over the relevant time span - namely the past 6 months.

Furthermore, the world's ability to create new ships [shipyards] is very finite. Shipyards are not like Krispy Kreme donut franchises that are capable of immediately ramping output to meet demand. They require large lead time to set up and establish and order books have been "full" now for a number of years - i.e. They [ships] can only be built and enter service in Greenspan parlance - at a measured pace. Shipyards are [and have been] turning out ships as fast as they can - period. The tanker stats already cited reflect incremental net increases [new builds less ships retired/scraped] in tonnage. To suggest that an unusually large number of net new dry bulk carriers suddenly appeared out of the woodwork - causing a plunge in the BDI - is not consistent with the realities of ship building.

For the most part, folks making the assertion outlined above - also contend that China's economy is 'slowing down a lot.' My response in this regard is, "Show me the numbers." The reality, dear reader, is there are no such numbers whatsoever, to support this China Syndrome claim and there likely will not be [wishful thinking, perhaps?] - so long as China continues to grow their GDP at a 9.5% clip.

So, what now strikes me as being odd is the Bloomberg report cited in the article above.

Here's Why:

The article above emphatically states that high oil prices have hit [lessened] demand. If this is true, why is the Washington Times telling us that China is rationing oil?

Parts of China rations fuel
Aug. 9, 2005 at 2:47PM

China's most prosperous city of Guangzhou has begun rationing gasoline and diesel to cope with a fuel shortage.....

Sheeple Lining Up For Gas In China. Please Sir...May I Have Some More?

A new twist? Cars line up to buy petrol at a petrol station in Dongguan, south China's Guangdong province, August 17, 2005. China's southern manufacturing heartland of Guangdong is plagued by closed service stations, fuel rationing and hours-long gas queues. (China Daily)

Call me silly but I associate 'rationing' much more with lessening of supply, NOT demand. So what gives? Furthermore, we know from Jim Willie's fine piece of reporting that,

"...In March 2004, another Chinese state-owned oil giant Zhuhai Zhenrong Corp signed a long-term agreement with Iran for liquefied natural gas (LNG). In October 2004 a larger long-term $100 billion deal with yet another Chinese state-owned oil giant Sinopec was cut for delivery of LNG from Iran and its Yadavaran oilfield, which will provide 150 thousand barrels of oil per day. One can easily conclude that China is integrally invested in Iranian energy exploration, drilling, and production, in addition to petrochemical and natural gas infrastructure. China is now the #1 destination for Iranian oil export...."

You see, dear reader, when I couple Jim Willie's reporting above with the anecdotal words [below] of my shipping acquaintance I was just communicating with - regarding world LNG [liquid natural gas] ship order books, who told me:

"100 more LNG Ships to be built, got 300m for 1?"

Keep in mind that Natural Gas prices are at historic high nominal prices just like crude oil and world order books are full of roughly 100 new orders [new builds in the shipping trade] at 300 million a pop - to cater predominantly to the Asian trade. Now I ask, does this scenario really pass the smell test or paint a picture that Asian energy demand is waning? Well, not on my planet - not for a minute!

So What's Really Going On?

Could China be playing games [Chinese checkers, perhaps]? Maybe and likely, but what would make more sense in my mind is something a little more along these lines [chess perhaps?]:

First, I would like to refer everyone back to the Matthew Simmons interview on Peak Oil, where Simmons states,

"[if] oil demand globally [goes] to 86-88 million bpd during [this] Winter, that could easily exceed supply by 2-5 million bpd".[38:53]

When Jim Puplava asks if this might mean that $75 or $80 per barrel oil could be in the near offing, Simmons replies,

"No, no, no. Oil prices could easily go up 5-10 times."

One needs to remember that the main thrust of Simmons thesis is that cheaper fast flowing sweet crude oil will deplete first - leaving increasingly diminished supply but proportionately more costly to extract, slower flowing harder to refine heavier sour crude [more sulfur] as the only available supply at the margin.

When one looks at current total OPEC output, Simmons reveals,

"If you include all of OPEC today they basically produce somewhere between 27 and 31 [million barrels per day]. And the fact that we don't actually know that is scary.

When we juxtapose these Simmons comments against what the Chinese themselves were saying as recently as April 05,

"... Also, Sinopec Corp. Yangzi Petrochemical refinery, which has been processing both domestically produced and imported low- to medium-sulfur crude from the start, is rapidly expanding processing of high-sulfur crude to cope with increases in imports of high-sulfur crude from Saudi Arabia and other Middle East producers...."

What the above article alludes to is China's current inability to process larger amounts of heavier grades of crude oil. Then, after we take all of this and consider what the Energy Information Admin. [EIA], of the U.S. government's own Dept. of Energy has to say,

"..Refiners therefore strive to run the optimal mix (or "slate") of crudes through their refineries, depending on the refinery's equipment, the desired output mix, and the relative price of available crudes. In recent years, refiners have confronted two opposite forces -- consumers' and government mandates that increasingly required light products of higher quality (the most difficult to produce) and crude oil supply that was increasingly heavier, with higher sulfur content (the most difficult to refine)..."

In spite of all of this, Saudi Arabia continues to insist that they can pump all the oil that the world needs in spite of admissions like the following:

Opec upgrades demand estimates

Opec says world oil demand will grow by 1.57m bpd in 2006, an upward revision of the 30,000 barrels previously forecast, and that its supplies would have to offset lower than expected output from non-Opec producers. China will account for about one-fourth of total world oil demand growth next year.

Connecting Dots... It's Up, Up and Away!

The amazing thing about the facts I've gathered and highlighted above - they are all pieces of a puzzle that are available in the public domain. Being curious by nature, for the life of me, I cannot help but wonder why well heeled, well connected news gathering organizations that make claims that "they report America's business" consistently fail to connect these dots? How bout you?

I'm left with the conclusion that while China really needs the energy, they seemingly cannot refine the crude oil available to them on the world market - which currently happens to be heavy stuff from the Middle East. North American refineries are known to be better able to refine heavier crude. As The Washington Times recently reported,

"... as the world's oil thirst swells to more than 84 million barrels a day and producers struggle to keep up, the extra supply being brought onto the market, primarily by Saudi Arabia, is the heavy, sour variety. Not all refiners have the equipment to process it."

This is all highly consistent with the Simmons thesis on peak oil. This is also consistent with falling VLCC [crude tanker] rates from the Middle East to Asia - but not due to lack of demand in China - it looks like it's all about constricted or diminished supply from the Middle East. Who would bother shipping oil if they could not refine it? Perhaps Matthew Simmons should stand up and take a bow? Maybe we're already experiencing the 'thin edge of the wedge' where Peak Oil is concerned, dear reader. Better fill 'er up now while it's still cheap or better yet, buy a bike and a pair of ear muffs! It might be a long cold winter.

So, at the end of the day - ask yourself if this is a story about a garden variety market manipulation or instead one of high octane, gross negligence and lies? In a world where, increasingly, nothing really is as it seems - they both walk, talk and quack like ducks to me.

Honk your horn if you disagree.

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