Prepare For Asset Price Declines Of 50-75%?

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson. It is June 29^th, 2017. And today we are going to be talking with a guest that frankly should have been on this program a long time ago, and many times since. If you are at all interested in financial markets and conditions and where this is headed, this podcast is for you. We are going to be talking oil, shale oil specifically, debt, financial bubbles precious metals, with Steve St. Angelo, the prolific independent researcher and financial analyst and writer; and the operator of the excellent SRSRockReport.com website. Of course, you can find Steve’s work widely across the web as well and one part of Steve’s work that I love the most, of course, is this continued on the impacts of energy return on energy invested or EROEI. He makes it one of the most important aspects of his energy research. He ties it into the precious metals and of course, as you know, EROEI is everything in this story. Steve, I am so excited to finally have you on the program.

Steve St. Angelo: Yea, Chris. I appreciate it. I love your site. You have got the crash course. That is the starter of getting anybody up to speed on what is going on. There is so much happening now, it is going to be a great conversation.

Chris Martenson: Well, thank you. I really admire your work as well. I read it religiously. It is just top notch. Mainly, because you say things I really agree with. So Steve, let’s start here. As a means of easing into this energy return on investment topic, which we certainly want to get to – let’s begin with this opening sentence of a recent article of yours; I’m quoting now, “While the mainstream media continues to put out hype the technology will bring on abundant energy supplies for the foreseeable future. The global oil and gas industry is actually cannibalizing itself just to stay alive.” Steve, you got my attention. How is the industry cannibalizing itself?

Steve St. Angelo: This is what is interesting. If we go back to 2008 we had a lot of trouble in the housing market, in the banking industry, investment banking industry disappeared. Lehman Brothers as you know, was around since the Civil War and now it just disappeared. We had huge problems with the financial industry, with the housing market, with the auto industry. And so it was a huge bubble and it was actually imploding. Then they came in and propped it up. Now, in 2008 the energy system or the energy industry was still in pretty good shape. They were still making pretty good money. Well, after 2008 and the 0 interest rates and the massive money printing we brought on shale. Thatis when really shale starts to come on in the back end of Eagle Ford.

We started producing all this shale. What happened was the industry really didn’t make any money doing it. What they did it is they took the funds, the investment funds. They spent all this capital – the capital expenditures. If we look at their free cash flow over the last 10 years the majority of it really didn’t make any free cash flow positive. It was negative free cash flow. Then the debts increased.

Now, what has happened, the price of oil where it is over $100 from 2011, 2014, the middle of 2014; some of these shale producers actually had more debt. They increased their debt even higher during the $100 price. You would think they would be making more money at $100. Then everything really fell apart. And when the price fell below $100 in the middle of 2014 and then it really fell to a bottom in 2016 to like $29. What has happened in the price now in the $40, $50 range - this is well below what the shale industry really can make money doing, even though they say that they can produce shale oil at $20 or $30 or $40.

What they are doing now is they are totally cutting their capital expenditures. They are cutting their capital expenditures. They are cutting exploration in longer term settings like deep water and moving to more shale like in the Permian. So, what is happening now is it is like a cannibalization. They are basically living off their seed corn, which is their discoveries. They are no longer spending enough money to add more discoveries to continue growing or to continue offsetting their production. This is what I call the cannibalization of the system. We know it is happening because you may have quoted this. Last year, the global conventional oil production in the world was about 25 billion barrels. Well, they only found 2.4 billion last year. That is less than 10%. Now what is even worse than that the average for the past 15 years the global – the world oil industry has been discovering about 9 billion new barrels of oil. We are only discovering about a little more than a third of what we are consuming in conventional oil for the last 15 years. There is a lot more that is going on.

And lastly, let me say this - the EIA showed that in 2014 I think it is a 68 publicly – large publicly traded companies. Well 2014 there was about 115 billion barrels of liquid reserves and it has been steadily moving up. But what happened is, in the last two years it has fallen below 100 billion for the first time. What we are seeing now is about a 14/15% decline in reserves, oil reserves, liquid reserves of these companies. When you look at that you see a totally different market now. They are saddled with debt, which they didn’t have in 2008. This is why, Chris, I see this whole energy industry battle is cannibalizing itself, and so I think going forward I see the oil and gas industry in big trouble.

Chris Martenson: All this fantastic data. Let me just pull out this one piece. I don’t have more recent data than I can find this is a BIS report that noted that from 2006 to 2014 global oil and gas industry. This isn’t just US shale, this is global oil and gas industry debt tripled from about 1.1 trillion to about 3 trillion dollars. A tripling of debt from 2016 to 14. We as investors might say it is okay. Companies that have opportunities will go into debt. I am not an anti-debt person at all. If you have got self-liquidating productive enterprise cash flowing things to borrow against that can be good use of money. They borrowed a couple of extra trillion and now we wander over and say well, how is their output doing? There we are going to notice between 2006 and 2014 there hasn’t been a tripling of output or a doubling of output or any real noticeable increase in output across the globe. It is a few percent. We are sort of in a zone. And so I look at that massive amount of debt.

So let me just run a simple number. 3 trillion is 3,000 billion, so let’s imagine that oil is at $30 a barrel so I can just calculate that right in my head. That means that something like three years of oil production has to be sold to just pay back the debt. Now, that is troubling to me. You raised what I think is just the big red flag in all of this to focus it down back in the shale business. Tell me how many years they have had positive free cash flow after running. I mean, the shale business, it should be pretty simple there, right? And the majors are focused there now. You punch a hole in the ground. It flows very quickly, the well depletes within three years 85%.

After you run that model for a few years, you really should have a good sense of your cash flows. Should be spitting out gas like crazy. Steve, how many years has the shale industry produced positive free cash flow?

Steve St. Angelo: Well, I have seen a few charts. What is it like the top 15 of all the EMP producers. We look at them. Some of them make free cash flow throughout the years. When you average them all together, since 2009 the industry as a whole yet hasn’t made any free cash flow. And so when you look at that, you say well, it didn’t make the money it was supposed to make. When you understand that, well, what did it to their balance sheets? Like you said it has doubled and tripled the debt. What is an amazing statistic and this is what you just spoke about the debt. When you have that much debt on your balance sheet, you have to service it. And I am looking at a chart the EIA put out. Now, from 2012 to 2014 the US shale oil and gas companies, and let’s just say the oil and gas companies, Exxon Mobil is included in this, their interest payments on their debt was about 25% of their operating cash. About 25% for the last three years. When the price of oil fell below $100 in 2014 and in the last time they did this statistic was at the third quarter of 2016. It is now 75%.

They are paying, like a person that has got a credit card that cannot afford to pay down their credit card. All they are doing is paying the minimum monthly interest rate which might be $100 or $200. The energy companies now are paying, at that point in time 75% of their operating cash just to pay their interest expense. Now, if we go back to the same time in 2004 (I went back and looked at the data), we go back to 2004 and look at when the price of oil was about the same $40 or $50 their interest expense was 25%. What has changed is the debt. As you said, we have added all this debt into the energy industry and it really hasn’t been productive. It is kept, let’s say, it has kept the oil supply elevated, but it really isn’t possible.

I think going forward while some analysts think this thing will continue to like kind of go on for a while – I think there is a probability we can see a more of a quicker disintegration of the oil industry if prices don’t recover about $60 or $70. And it looks like we are not going to see a higher price until at least the next year.

Chris Martenson: You know, I was reading through chats at the bottom of an article about shale oil. I think it was the comments left under a Wall Street Journal article and somebody was like hey, I thought you guys – it was about how allegedly they are profitable at $50, now $40, now $30. They are profitable at these ridiculous numbers of dollars per barrel. There is complexity under that we can maybe get to later. But a comment under there was like I thought you guys said this was proof this industry works. You guys said there was going to be these bankruptcy filings and there weren’t. The truth is, by my last count, there were over 70 bankruptcy filings – no, I’m sorry. $70 billion worth of bankruptcy filings across 100 companies. That has kind of been flying under the radar, I think. There has been 10s of billions of losses that have accumulated in this industry already. It is not really well-known, is it?

Steve St. Angelo: No. It isn’t well-known. And then there is another excellent short put out by Bloomberg that is called the Debt Wall. It is basically, the debt is really bonds. And these are bonds that are below investment grade, because as we all know pension plans, insurance funds, or whatever mutual funds – these fund investors are trying to find yield because they need a higher yield –6 or 7 or 8% to allow the pension system or whatever fund they are investing in to actually be viable going forward. Well, they can’t get that with anything. There are 0 interest rates. They have to go with these risky assets. And one of the risky assets was shale oil and gas.

And according to this chart, there was about $27 billion of debt due in 2016. That is going to balloon to $65 billion this year. Then it shoots up to $110 billion next year by 2020; it is $230 billion and it keeps rising. BY 2022 it is $265 billion. This debt wall is this debt that is going to be due. And so now are they going to roll it over? If the interest rates rise that is not a good deal. It just becomes more expensive to service this debt. I think the issue is these companies that say they can produce oil in the Permian now for $20 or $30 or $40, it is pure nonsense. It is looking in a vacuum. It is looking at how much they can drill the well, how much gas flow they get. They are totally disregarding a lot of costs and all the debt, now. Who is going to pay the debt? Like you said there is $3 trillion in debt. You need to make a profit to pay off the debt. The companies right now are not making profits. And we can even discuss Saudi Arabia. They continue to liquidate to foreign exchange reserves because they are not making the money now. Even though they have a lower production cost than the rest of the world, they use that to finance the national government. So, they need a much higher price or they had to liquidate their reserves. They continue to do that even though the price of oil has recovered this year. It is always at $50. But they still continue to sell off reserves to offset a lower oil price.

Chris Martenson: I want to get in to Saudi Arabia in more detail in just a second, but let me back up. You said 75% of operating income for a tranche of these companies is going to debt service at this current rate. Is that right?

Steve St. Angelo: That is according to the EIA, yes.

Chris Martenson: Yea, 75% currently. And so then we have to look at the total amount of debt that is outstanding. Of course, the companies have been just issuing this wildly free financial conditions that like, are never free. I thought Greenspan was just an enormously destructive individual. I couldn’t believe what he did. And then Bernanke made him looked like a piker. And then under Yellen, it is just astonishing so these shale companies have been raising debt and equity and just having no trouble at all. Just hundreds of billions of dollars in debt and equity just flying out the door. People snapping it up. If we just take a quick example; you know the last time I actually found a number and Bloomberg by the way, has not updated this number in about a year and a half – there were $350 billion in outstanding debt in the shale industry. I just look at that and I say well, all things being equal and you look at oil prices just rounding if we call it $40 a barrel. That is not what you get at the wellhead with severances, with royalties, with da, da, da. Let’s just pretend they are getting $30 a barrel. Well at $300 billion it means their next 10 billion barrels of production is just there to service the debt, not the interest on that debt, just to pay back the principal and that is just an astonishing number.

Given that, simple math, I am flabbergasted that “investors” air quotes, I am waving them wildly, haven’t sort of figured them out. But if you look at who is in this debt, which is mostly junk rated debt, we find that the $72 billion Franklin Income Fund has got about 4% of its portfolio in energy junk debt. You look at somebody like the mainstay high yield corporate bond fund. It has got about 10% of its holdings in this high yield debt. Again, like you said, they are chasing the yield. They need it, of course, in this weird, bizarre world that the central banks have manufactured. When I look at those numbers, I just see massive losses have to be coming at some point. The only possible rescue for this would be really, really high oil prices suddenly magically appearing. Barring that – this doesn’t pencil out, does it?

Steve St. Angelo: No. I’m glad you see the things a lot of people talk about opinions and they give their idea and notions of what is going on. And it is good that you put up numbers. Because continental resources is like the poster child of the Bakken. They are one of the larger oil produces in the Bakken. Now, what is interesting about Continental Resources; it is a perfect example of what is wrong with shale oil. Like in 2007 they were paying $13 million a year for the interest expense. Fast forward to last year, they pay $321 million. That was their interest credit card payment. That is what they had to pay just to pay their interest rate - $321 million. That is a third of a billion dollars. They are forking out a third of a billion dollars. These funds you just mentioned; they are getting this kind of interest payment for their fund. They paid a third of a billion last year. The reason why they paid a third of a billion is because in 2007 Continental only had $165 million in debt. Now they got $6.5 billion.

To service that debt they pay a higher interest rate, higher yield. This is the ongoing issue. The issue is shale was really never profitable. And maybe some. Maybe a very small percentage make some money. As an industry, it was never really profitable and it wouldn’t have really grown, Chris, I don’t think, unless we had the Federal Reserve shoot interest rates down to zero and then we had all the massive QE and central bank asset purchases. Without that, I don’t think shale would have taken off. It was because of that market intervention which allowed the price of oil to go up which allowed shale oil to come online. I don’t know if that can be done again. Do you?

Chris Martenson: Oh, great question. I don’t think it can. Right now, I understand the dynamic of the industry. It makes sense the way Wall Street is rewarding by throwing money –debt and equity at the shale companies is by production growth. That is all they are really measuring. And somehow, it is not a really confusing story – but somehow the details have gotten lost.

Here is a simple analysis I run. I take somebody like I don’t know, I have done this with just a couple of them, where you say listen, what if they stopped right now? What if they just stopped? We can look at their daily production. We have to make guesses about how many wells they drilled in which vintage years 2011 on forward or whatever. Then we can apply a decline rate to those existing operations where you can say okay if we just stop this company right now. No more debt. No more equity. No more drilling new wells and we just say let it run is this – could this company - A. pay back its debt and B - if it can, what kind of return is left for the equity holders?

And Steve, I run this over and over again and unless I have something really wrong about the decline rates in the EURs the ultimate recoverable resource in a well, unless I have something really badly wrong with my numbers the answer is no. These companies are actually have negative net present values at this point. That is what I come up with.

Chris Martenson: You are right. Art Burman does a great job, he has done a really great job putting that together and it is – what is amazing to me is you get there are so many energy animals out there. And they probably work with different brokerages. I think what they are doing is they have to – they have to write the analysis that is beneficial to the company. So you see, Art is an independent he can write whatever he thinks. He is an independent. Which I am too. You get a more realistic assessment.

The system, the shale oil and from what I have seen the energy return on investment for shale oil is 5:1. I have seen it come in at different factors, different numbers it comes in at 5:1. That is at the wellhead. That is at the wellhead. You gotta move that, transport it, then you got to refine it and transport it again to the pipelines to the end product. When you start adding all that it falls even lower.

We need a much higher energy return on investment to function this very modern US economy. It just – if you look at everything the way you do, Chris. You pass all the details and you just look at it very simply kind of like Einstein’s E=mc2. It doesn’t make sense. It doesn’t work. And unfortunately, most analyst get all caught up in all the details. I see them on different blogs writing how certain companies like EOG and Pioneer, they are going to do really well in the Permian. I am thinking you are missing the whole point. The system is so far in the red they really can’t make it out. How this unfolds, I mentioned there is a few scenarios. There is a scenario that to me has a higher and higher probability that we could see a much quicker disintegration of the US and global oil industry than what is forecasted to take place over the next 15 or 20 years. It could disintegrate much quicker. I am not saying it will, but it could.

Chris Martenson: I totally agree with this and so I want to turn to energy return on energy invested and get your take on it, your words. People have heard my words around it. But in the spirit of the whole e=mc2 simplification, I’ll just point this out – the United States oil production of the cheap and easy stuff, that peaked in the early 1970’s. Hey, you know what else peaked in the early 1970’s was the ability of a single minimum wage earner to support anything that looked like a household or a lifestyle.

And so, to me, it is a very simple function. If you strip away all the other stuff about economics and tax policy and all that junk and you just say listen, really economics is just a reflection of the flow of goods and services which themselves each depend on energy as the lifeblood of that. No energy, no goods, no services. So. Just tracking net energy per capita looks like that peaked to me by my numbers somewhere in the early 70’s, mid 70’s. Wouldn’t you know it that is right about the time people can look back and say that was the last moment when lower and middle-income lifestyles were really possible without borrowing, without debt, without all that stuff. The net energy per capita starts to fall. As a consequence, the response of the system was let’s just make it easier and easier for people to borrow. It is really the same story for middle class and lower income people as we see in the shale business, which is if you can continue to borrow you can mask the trouble for a while. But at the first sign of a cold coming on and that first sneeze it all falls apart. That is 2008. And that is what has all been masked. I am just astonished that this isn’t more widely known.

Before we started recording I was telling you that I have had opportunities to try and connect energy and economy, those two dots, in front of audiences. It is mind bogglingly hard considering how mind bogglingly easy and simple those thoughts are for me to connect in my head, but in your words let’s talk about energy return on energy invested. Why is this so important for people to understand and what is it?

Steve St. Angelo: Well you know, I started investing in precious metals in the early 2000’s, but it wasn’t until 2008 that I really got interested in energy. I have always – my brain has always worked this way. I guess it is very similar to yours – I am not really that smart, but I am very inquisitive. I’ve got a very high curiosity. Anywhere I go, any job or any company that I work with I want to know everything about it.

Going down that venue you see a lot more than most people because you get to the root of the problem. The radical is the root on the energy return on investment is what allows not only plants, animals, humans, corporations and empires. That is the equation it has to be a certain amount of plus. You have to have a certain positive energy return on investment for all those systems. Whether it is a single cellular system, whether it is a human or an empire. You need a certain energy return on investment for that system to function or to move forward. When it goes below a certain number and then it starts cannibalizing itself just like the oil industry is as well as the US Empire it is the same thing. Now, we are using debt we are cannibalizing our self.

That figure you gave out about how the income peaked at about 1970’s per capita. When I interviewed Louis Arnaut about the thermodynamics of oil his figure was for globally it was in the late 1990’s. So the globe has actually peaked as well. And so now what we are doing if the net energy is falling well people can’t afford the same thing anymore. There is less and less energy getting to the market. What you do is you extend the payment. You make the payment longer or you add more debt. I mentioned this in many interviews. There is no coincidence the US debt is up 23 times since 1980 and the Dow Jones is now up 24 times and the S&P is up 22 times and the US retirement market is up 24 times. They are all up about that same ratio as the debt.

What we have is we have a totally propped up market based upon debt, because the energy isn’t producing the positive – the positive growth really. Instead of having real economic growth, we are having inflated economic growth or inflated asset values. And so the energy return on investment as it fell, it was like 30:1 in 1970 for the United States and that was still profitable. What we had to do and many people will disagree with this but offshoring or manufacturing was a way to extend the US lifestyle. We couldn’t afford the manufacturing anymore because of our oil energy return on investment. It moved over to other parts of the world where it was cheaper labor. What we did was started buying more homes, more things more stuff. Then we went into debt to do that. That has extended the US – I call the leach and spend suburban economy. I agree with you. That is what has happened to offset the falling energy return on investment.

If you look at it in face value it looks like the thing is continuing. People are moving around, buying stuff, a lot of people are traveling, but it is all based on a lot of debt. When the debt finally implodes, then the whole thing, the real nasty, face is shown to Americans. I don’t think many people are prepared for it.

Chris Martenson: I totally agree with that. I want to drill into this point because it is so important – so I’m going to quote you again. This is from an article you wrote recently and you said, “I would kindly like to remind all the precious metals investors as well as those who follow the alternative media energy is the key problem not the debt. The debt is a symptom of the falling EROI of energy. For some strange reason a lot of people still don’t get that. We must remember the following: debts equal unburned energy obligations.” Okay, let me repeat that. Debts equal unburned energy obligations. Can you explain that, please?

Steve St. Angelo: Yea, I think that is probably the most important – if I had to summarize what I do what you just read there is the most important, because I respect a lot of precious metal analysts. Peter Schiff, he was one of the few guys out there 2004, 5 and 6 he was on the mainstream financial networks talking about this whole thing was going to fall apart and they laughed at him. He basically, they say he cried wolf for three or four years. But in 2007 the whole thing fell apart. He was right. And I think only one of the hosts actually gave him credit for that.

The problem is Peter Schiff does not understand the energy. When he says we need to let the banks all fall apart, collapse and we can reboot the system I think if the banks fall apart and the whole system is rebooted we can’t grow out of this. This is not like the 1930’s depression where the US was just tapping into the great oil reserves. We are well beyond that. Here is the issue – all the assets or supposed assets which are stocks, bonds and real estate, that is where 99%, 98% of the investors invested in the market that is where they have those funds in those three assets. Those assets, like a stock, is based on net present value. It is like a timesheet. It gets its current stock price based upon future earnings.

And so, you need energy to burn in the future not only to keep that stock price elevated as well as a home price, real estate a lot of people have a 30-year mortgage where you have to work 30 years to pay that mortgage off. The whole – 98, 99% of the stocks, bonds and real estate assets out there get their value by what happens in the future. Well, if the oil becomes problematic, and it will, then all of those assets are in big trouble because actually they are energy IOUs that is the best way to describe them. They are energy IOUs. It is not – there is no large pot of gold at the end of the rainbow in a retirement account. They can’t sell the gold and give you your time. You need to burn the energy this year and next year so everybody gets a little percentage of their retirement – of this retirement savings. What happens when the oil really starts to fall apart? Then the whole thing falls apart and the values of stocks, bonds and real estate implode, because the profitable energy really isn’t there, Chris. This is where I look – the reason why I understand and really value the precious metals is because if it is a physical precious metal that is bought and paid for, it is not an energy IOU asset. It is a stored economic energy. Somebody else has to go out and do work or provide you with a good to exchange for that gold or silver coin, which is much different than a stock, bond or real estate. It gets its value by burning energy in the future. The gold and silver coin has its value because it was burned in the production of that gold and silver coin. It has innate stored value qualities.

Chris Martenson: That idea of embodied energy super important. I need to belabor this other point because it’s just – it is just this important. The current value of all these trillions of dollars of global real estate, debt and equity. They have part of their intrinsic core part of their valuation is the assumption that there is going to be future growth there. The price earnings multiple. If price to earnings isn’t one you are having some sense that this company is going to be able to grow over time whether that price earnings is 7, 10, 20, 200. There is a sense this company is going to grow.

In aggregate, you look at the PE across the price earnings across all the equities you see there is this giant collective debt the future is going to be larger than the present. What you are saying those unburned energy obligations that is contained, as well as in the debt, and it is also contained in the price earnings ratio. It is an assumption there is going to be more in the future. As you and I talked about if you don’t have energy, you don’t have economy. In fact, if you look at the relationship between economic growth and energy consumption it is a straight line. It is one of the best, tightest, most highly correlated. In fact, it is causative relationships I have in all of my economic data. It is the best one. Wow. One unit of this leads to some other units of that.

Here is the key question – which I am sure you will be able to – I will just put the softball on the tee here. What is the appropriate value for a stock and a bond market compared to today if we can all of a sudden assume that future growth goes to zero. Not even going to make a fall, just goes to zero. What happens to valuations under that circumstance, if we are being honest?

Steve St. Angelo: Honestly, I don’t know because we have never been there before. This is the issue. This is what is so fascinating. Where we came from – we came from agrarian when we moved into new areas we moved to the forests or fertile soils and that was the energy return on investment was used there to continue the economy and it wasn’t until recently we got into oil, coal, oil, natural gas, uranium and now renewables, which unfortunately will never work. We have never – we have no idea what the future is going to be like for a system that is so built upon growing energy production. To maintain the system as well as maintain the asset values I think once the world realizes growth is over and you know, we continue, as you mentioned, we continue to see more oil production. I don’t know – I think the number is 97, 98 million barrels, but unfortunately a good chunk of that is either shale, tar sands, natural gas, plant liquids, which has 50% of the energy or 60% of the energy of crude oil and it comes at 50% of the price of the crude oil. Even though we have added a lot of natural gas plant liquids, it looks nice because we can say wow, now we are producing 98 million barrels a day. Let’s say 15 or 18 million barrels of that is low quality. There is not a lot maybe you can do with some of that.

The problem is that once we realize we cannot grow that, that won’t grow anymore – the valuations and it is going to be you know, I call precious metal valuations, it is going to be like the light bulb is going to go off. I think it is going to be very quick because at some point especially if we continue with this $40 or $50 oil and I think we are because of the debt. Americans really can’t afford high oil prices. I think what is going to happen, when we start leveling off and starting to decline you are going to see more of a cliff like, let’s say, reduction in oil production. It will come in fits and starts and that is what is going to shock the markets. If you don’t have growth as what you said – you can’t have a maintaining or, let’s say, a constant oil supply because this is too much debt. You have to have a growing oil supply.

You are correct. When it starts to become actually constant and starts to decline, I think we are going to see the valuations of these assets really decline considerably. It is anyone’s guess how quickly they can fall. But according to what I have been looking at, I think we are going to see a 50% [de]crease in real estate values off the bat. I am not saying in a day that is the first wave. 30 to 50% decrease in real estate values when we start getting those crack in the markets. Then it will be like they are already at the edge of the cliff. Then it will fall down the cliff and then they will walk out and fall off the cliff again. I actually see, Chris, within the next 5 to 10 years we can easily see a 75% or more reduction in real estate values.

What does that mean for stocks and bonds? It is the same thing. If the wildcard out there and the probability that we do not have a slow burn – I think we had the slow burn for 8 years, 9 years, we start going into more rapid disintegration; you are going to see the valuations of these stocks, bonds and real estate really decline much greater than anybody has any idea.

Chris Martenson: Well, my flip answer to what are stocks and bonds worth in a world where all of a sudden the assumption goes to zero is less. I don’t know how much less. Like you, we haven’t been here before. We don’t know. There are a lot of competing things in a very complex system and it is psychological and yadda, yadda. But less. Right now, everything is priced for the world as it was last 70 years is going to be just how it is for the next 70 years. We can just increase debts, but don’t worry. Growth is going to come back and as you and I understand, the number of people who actually understand that when we say growth is going to come back we are really saying energy throughput is going to increase, and that more subtly that net energy more net energy is going to be available to the rest of society than in the past. When you dig through that, you just grub around in the data a little bit you are like this is impossible.

I know you just tossed it aside and said renewables aren’t the answer, but you know and I agree because once you look at renewables all I see is fossil fuel silently, secretly, maybe not so secretly, subsidizing the creation of the aluminum frames and the silicon cells and the giant wind towers and the concrete base with the rebar and all that stuff. That is just all diesel fuels and fossil fuels. So when we get through all of that the only question that I have to resolve at this point based on my complete analysis and based on the world that you do around energy is energy is the master resource. It is not going to be there in the future like it has been in the past. The operative question is this – who is going to eat the losses. And that is the battle, I see. You got the banks all saying not us and the government saying not us you know and of course the taxpayer ends up taking it in the shorts in most cases. That is really the gain I see unfolding at this point is who is going to eat the losses.

Given the time we have left, where we are in this already, I need to turn now to one aspect where I think somebody is trying to get somebody else to eat the losses. I think this is super important. It revolves around the idea of the petrodollar and Saudi Arabia specifically. You mentioned before Saudi Arabia’s reforms are dropping like a rock. But this Saudi IPO for Saudi Aramco. I mean that looks to me like you just have to be seriously brain dead to buy into that 5% offering valued at $2 trillion, which they are hoping to get 10% for, $200 billion. Talk about that IPO real quick, and how that ties into the petrodollar.

Steve St. Angelo: I think Saudi’s aren’t stupid. And because a lot of their stats are very private, no one really has an idea. Matt Simmons did some great work on it. Some people would say well, it didn’t come to fruition. The Saudis just are producing a lot of oil. I think the issue is the Saudis probably have a lot less reserves than the official amount. That is due to the big 1980’s where all these big Middle Eastern countries artificially increased their reserves, so they could export more. And so – and if we look at that and then there really hasn’t been much added since that inflated reserve addition. Saudis really haven’t added much more oil reserves.

If you remove that and then you say well they are producing about 10 million barrels a day plus or minus – how much are their reserves now? I have seen estimates, maybe 80 billion instead of the 170 or 160 that they think they have. I think the Saudis realize what they have there isn’t really what is officially known. And so they’ve seen the writing on the wall and I think they are trying to get something before the system really starts to disintegrate. I think Wood Mackenzie according to their analysis on the IPO they said it is really only worth 20% of the value. And that is because there is a lot of money of the oil that is going to finance the Saudi family, as well as the government, so there is not a lot leftover really for an IPO. The profit of money from that IPO.

To me, watching the Saudis continually liquidate their reserves – what is interesting officially I think according to the US Treasury, tic data there is only 100 and like 27 million dollar’s worth of US Treasuries that the Saudis have on their books. Well, you see something is wrong there. Most central banks have two thirds of their foreign exchange reserves on U.S. treasuries. Now why does Saudi Arabia only have a quarter of a little less than 500 billion – why do they only have a quarter of their reserves in U.S. Treasuries?

I have read some analysis stating one U.S. Treasury official who understands a lot about the foreign reserves of different countries said that the Saudis have probably been purchasing reserves of U.S. treasuries, but they are in other countries so they are not going to show up as reserves on their balance sheet.

The interesting thing is, Chris, I believe that Saudi Arabia is in big trouble. They are putting a lot of their – they are injecting a lot of water to produce their oil. Their oil to water ratio continues to increase. Their cut continues to increase. This is much different than shale oil. We go down with shale, we dig down 10, 15,000 feet and then we do laterals. Well, what Saudi Arabia does, they do these laterals and then when the water cut gets too high they shut that lateral off and then they drill one even higher. What they are doing is they are actually moving their laterals close to the surface. As we know with oil – oil rises. At some point in time, I think the production is just going to really collapse because this is not really sustainable.

We look at all that we look at the Wood Mackenzie saying that the IPO is probably only worth 20%. We look at the Saudis trying to say they want to move away from oil. Now why would they want to move away from oil? They were doing great for oil for the last 50 years? They realize what they have is not worth what the official market says it is worth. And so, I think we are going to see some real excitement in the global oil industry. If Saudi Arabia, like you say, if the truth comes out about we no longer have growth in the world with oil production. If we find out – if the truth comes out, which has been going on with Saudi Arabia that is a bad deal for the Kingdom that runs everything. We could see that fall apart, because there really isn’t the money there to maintain it now. That could destabilize further.

I would say, Chris, we are living in very interesting times and it is just going to get even more interesting.

Chris Martenson: Well, it is absolutely going to get interesting. Of course, it is rooted in something that went by kind of quickly earlier, where you talked about at least in 2016 only 2.4 billion barrels were found worldwide. In fact, if you take 2014, 15, 16 that is the lowest three years of oil discovery in my data set because until we get back to the 1920’s when the world didn’t really know how to explore for oil, right? I don’t know why, but the oil people, they keep insisting Steve, they say Chris, before you pump it you have to find it. We have three years of the most abysmal finds since the 20’s, which you can’t even compare the eras, and the amount of oil that is being consumed globally. And the importance of sustaining the global piles of debt and the fantasies of infinite growth and all that.

I look at that three years of low discoveries and I say there is a supply shortfall in the future based on this idea that before you pump it, you have to find it. We didn’t find it. I guess we’re not pumping it. That is the piece there.

Now, in the time we have left though we need to turn now. I got to talk about gold and silver. You do some of the best gold and silver analysis out there. And in particular, really beginning to factor in energy into this story. I think you are probably one of the – not probably – you are the only person I know about connecting energy in mining in this way. Where do we start with this? A lot of people say gold and silver like it is one word. I like to separate them because of stocks and flows. All of the gold being above ground. Silver adding this amazing industrial sets of uses and being consumed in large measure. Silver to me is a fascinating story. It is different than gold, but they share the concept of embodied energy in their production. Where would you want to start? Gold or silver, you pick – but start to help our listeners to understand why they need to understand how energy begins to tie into that story.

Steve St. Angelo: There is the Austrian school of economics that bases the economic principle of price based upon supply and demand. I used to believe that and in ways supply and demand are factors that determine the price of goods, energy a metal, a service. I am not talking land, but something that is manufactured, metal that is mined and produced as well as energy. There is supply and demand, but it is more of a short-term.

The real value or price of all of those is the cost of production. Before I get into gold and silver – if you look at the entire market and if you look at the healthcare industry. Well, let’s forget the healthcare. That was a bad example. Let’s look at auto industry. Let’s look at the restaurant industry. Let’s look at the mining industry. Let’s look at the auto. All of these industries have a margin like the supermarkets have a very low margin - 1 or 2%. There are restaurant chains out there – there aren’t supermarkets out there enjoying a 15 to 20% margin. There isn’t. The competition has regulated itself to where the market now – the margin for the supermarket industry is about 1 to 2%. All the other stuff, the 98% is the cost to maintain the system. That is the cost of production. All of it. Same thing with copper. Same thing with gold and silver. There is two different ways to value things – there is the cost of production, as well as its stored value.

Now gold and silver have been a stored value for thousands of years and money because of the energy that it takes to produce an ounce of gold and silver. I mean, nowadays people say well, energy is only like 30% of Barents cost of production. Well, that is true. But then there is like 35% goes to the employees. That is human labor. That is energy. Okay, well then 25% goes into the capital. Well, if you take all the capital and you bring it to its root cause, the energy was the underlying value that made all that capital. All of it or even the supplies like limestone. To get the limestone from the mine to the goldmine, the overriding price of that limestone that they use was to the energy.

Energy basically is the overriding cost to produce gold and silver. And right now, the cost to produce gold is about between, back to the envelope, about 1100 to 1150 and according to my analysis of the primary silver mining industry it is between 15 and 17 the industry let’s say 16. You look at the market price of silver and gold. They are trading at 73, 72:1. You look at the cost of production of gold and silver and it is about 71, 72:1. Now this was much different if we go back before the 19^th century, because most of it was done by human and animal labor.

When they pulled it out of the ground and it was 10:1, 15:1 ratio, that was the guiding principal that gave gold and silver that 10:1, 15:1 ratio. But when we brought on oil, we know there is thousands of energy slaves in a barrel of oil so it changed the dynamics. When the price of silver starts to move up much higher. And the ratio to gold, the ratio falls, what is happening, it is moving away from its commodity price mechanism which I call the cost of production. And it is moving more towards its store of value.

Those are two different things. And so, I always look – the people say gold and silver is manipulated, and I will conclude this part of it by saying, yes. They are being manipulated. They are being capped, because it is the barometer of the fiat monetary system. There is some method to the madness by the Fed and central banks. They can’t push that price too far below the cost of production. Traders are too savvy. They are too smart.

At all the time I have looked at the top two gold producers which is Barrick and Newmont from 2000 to 2015 their cost to production was always below the market price. Now silver a little more volatile. There are certain years the cost of production was a little bit higher than the market price. But not by much. So what we see there is the actual cost of production is the floor for the price of gold and silver, even though there is lots of gold out there and there is still lots of silver out there. What they are basing it upon the cost of production. And it is the same thing with most everything else. Again, cost of production is the floor. The store of value for me will start to hit gold and silver when the world realizes we don’t have growing energy production.

That is where I see this disconnect or the value of stocks, bonds and real estate is falling and where I see the precious metals taking off. There is a realization one is an energy IOU as I explained before and one is the store of economic energy.

Chris Martenson: And so, as this stored value component comes in we will see the ratio begin to close down from 70:1 to more long-term 15:1 just rounding here a bit. As it does that we would expect silver – the price of silver to climb to catch up to wherever gold happens to be when this finally dawns.

Steve St. Angelo: Yea. According to the best analysis I can find. I have looked at like three or four different - GFMS, the USGS and the CPM group there is about 2.2 billion ounces of gold out there. That is investable gold. That is not jeweler or art. That is investible gold that central banks have on their balance sheets. It is also public and private. If you multiply that by the current market price, you get about 3 trillion.

Now all the silver – this is what is interesting – even though there is a lot of silver out there moving around, it is only about $2.6 billion ounces of silver that is in investment form. Of course, as we know industry consumes all that. A lot of that is still in homes. A lot of it is in homes and different appliances that is still being used. If they are thrown out it is not really economic to take the silver out of most of the industrial silver. If we look at that, Chris, we have 2.6 billion ounces of silver compared to 2.2 billion ounces of gold. There is not much more silver. Now more silver could come on the market if the price really escalates, but at that point in time I don’t think it really will matter, because there is just not much of real physical silver and gold to get one’s hands on. According to my analysis if you add that one up it is about 3.1 trillion. And I believe that the capitalization or let’s say the assets of the world, which is real estate, stocks and bonds – is about 320 trillion.

And so basically, which the perfect percent that we all realize in the previous metal industry, gold and silver are 1% of all the assets out there. When you understand that and things start to fall apart – when just 1% of that 300+ trillion, it wakes up and moves into gold and silver. We are seeing figures that we just can’t imagine. And we don’t need to see much more than that really. I mean look what is happening in the cryptocurrency market when just $10 to $50 billion is moving into that making those prices rally crazy. Even though the precious metals has been – the sentiment has been down and sales in the west had been down. I think it is kind of like the calm before the storm. I am not going to say it happens this year. At some point in time the market will get precious metals religion. It has been the stored value for 200 years. The Americans just have fiat monetary system since 1970. They don’t understand what is really going on.

And unfortunately, there is not many people who are prepared for the future.

Chris Martenson: Sometimes you get amnesia when somebody purposely clubs you on the head, so I think the American financial amnesia around gold and silver is because the mainstream media is doing a really heroic job of propagandizing anti precious metal sentiment. It is just amazing to me every time gold is down it gets shellacked by something. Wall Street Journal has a gleeful headline - investors move away. You know, whoever these mysterious investors are that unload you know, 12,000 contracts at 2:58 in the morning. Whatever. Just seeing that, I think people have really been. It is not just western. It is really, specifically United States. There is a very different gold and silver sentiment when I go to Europe and talk to people there. Obviously, very different in Asia. I think people living in the United States you need to understand that you live in a regime where your thoughts about precious metals are actively being managed by people who I would consider to be world class manipulators of opinion. That is as gentle as I am going to put that phrase. It has been going on for a while.

You said it before – gold and silver are the barometers of the state of the fiat money system. Anybody who peels back the covers on that looks at the one plus – one and a half trillion dollars the central bank balance sheet expansion. This year, in 2017, by the halfway mark. We are going to have you mentioned a 3 trillion market roughly for gold and silver. Heck, the central banks of Japan and the ECB are going to put out 3 trillion new freshly printed dollars into the system this year if they stay on track. Crazy times. Amazing times. Steve, thank you so much for taking data to it. I think it is the only way to stay grounded in this ridiculous. Keep a journal everybody. This is the most amazing period of social engineering, wealth transfer and reckless monetary experimentation ever in human history. And you need data to help maintain your bearings in such a crazy time.

Steve, we are out of time for today. I want to do this again. I want to dive more deeply into each one of these subjects, plus some others we have come up with. Before we go, please tell people how to follow your work.

Steve St. Angelo: Chris, really enjoyed it. And you were right. If the ECB and Bank of Japan purchases 3 trillion those assets that they purchased could have purchased all the gold invested in the world in a year. In two central banks. Just insane.

Really enjoyed the conversation. If anybody is interested to learn – I put out two to three articles a week. Sometimes more at the SRSrockreport.com. I do have a few paid reports out there. I put a report out called the Silver Chart Report. And I break down the silver industry and mark it in five different segments. I don’t think there is a single report out there that provides detail in the silver industry and market. People are more than welcome to come check out. I try to put out as much original information – and I agree with you. There is a lot of opinion out there. There is a lot of speculation out there. But if we can focus on the changing data, focus on the changing facts, it gives us an idea on how things are changing and unraveling.

I really enjoyed the conversation, Chris and look forward to doing it again.

Chris Martenson: Thank you much and talk to you next time.