The Long View
I'm a mid-60's guy, married to the same girl and fortunate to be the father of two wonderful individuals who are now steaming off in their own directions. Long ago I wanted to be a writer but instead I went to B-school and eventually I managed to accumulate a bit of capital. Like many others, I now try to make that capital work hard so I can play. And I've become a writer.
I manage family-related assets employing standard
ways to achieve income, safety and diversification. Since 2004, my
investment work (and, indeed, a lot of my life) has focussed on energy
because it is in a transformative period. The combination of rapid
industrialization in emerging economies and the coming of Peak Oil
is changing everything in our world, not least the values of companies
that are particularly impacted by energy costs. All the accounts I
manage contain energy-related stocks, but one in particular, called
the EIS (Energy Investment Strategies) account, which has been aimed
at achieving long term capital gains since it was formed in 1996,
contains only Peak Oil investments. This account is the "proof
of the pudding" for the Peak Oil investment strategies discussed
here, so its results are being made public.
Most of my reasons for "going public"
have to do with trying to become a better investor. Better discipline
is first and most important. Holding myself to the higher standard
of public observation and feedback challenges my assumptions and sharpens
my logic and helps me organize my thoughts and my information more
rigorously. Secondly, I may gain better access to information by virtue
of being a journalist of sorts. Thirdly, I get new ideas and improve
my own ideas from readers' comments and questions. Hopefully the site
will prove entertaining and useful to like-minded investors. Plus,
it just turns me on to write about what I think is the most powerful
trend that will exist during the rest of my life, the transition during
the next fifty years from a largely petroleum-based economy toward
an almost exclusively electric-based economy. It's a great story of
politics, money, technology, and human emotions, not the least of
which is greed. It contains all the drama of human existence - as
seen increasingly in blockbuster movies.
My investing style has always featured a concentration
in one or a few sectors with powerful growth dynamics. For many years
I focused in the area of my prior business experience, cable television.
I built and operated a cable company from 1975 through 1996, when
I sold the last piece of it. I became a “professional”
investor out of necessity in 1989, having sold some cable TV assets.
Starting in 1996, when the EIS account was first funded, investing
became our only source of income.
My early investing years seemed not to have any general organizing
philosophy. But a recent analysis showed that my investment decisions
have always been guided by a set of beliefs that I now call “Tsunami
Investing.” It consists of concentrating on economic sectors
that are experiencing long term significant growth that relate to
my background and skillsets. Not all businesses are comprehensible
to me. For example, biotechnology is in a long term growth trend and
probably will be for many decades to come. But I cannot evaluate the
sciences of biotechnology. The same is true of the huge computer and
internet industries. When I have invested in such fields, I have generally
lost money.
On the other hand, luck has allowed me to directly participated in
three industries from their infancy through to their maturity - mobile
homes, cable television, and cellular telephony. Each has had enormous
impact on investors and on society. Investors who participated in
them over long time periods — say, a decade or longer - created
significant personal wealth. Each industry benefited from a super-powerful,
long-term trend, a “Tsunami. Participating in these businesses
has shaped my investment outlook and convinced me that Tsunami Investing
offers superior rewards at surprisingly low risk levels.
The risks of Tsunami Investing are macro-economic, effecting nearly
all investors, and not particular to a given Tsunami. When all stocks
decline, Tsunami stocks decline too, regardless of their excellent
long term prospects. In fact, Tsunami stocks often decline more rapidly
than the market as a whole during general market downturns. To mitigate
this risk one should avoid becoming too leveraged. Leverage is unnecessary
for achieving excellent returns when one is invested in business that
themselves have outstanding growth potential. And leverage can cause
such emotional reactions when the portfolio undergoes its inevitable
periods of decline that you can lose your whole position. This is
a lesson I have learned through much painful experience.
One of the benefits of the energy Tsunami is the great breadth and
the enormous scope of energy-related businesses and therefore the
opportunity to diversify to some extent while still maintaining the
energy theme. On the other hand, since most energy-related companies
will be effected in the same way by changes in the prices of oil and
natural gas, investments outside the energy area are also required
to obtain true diversification.
If you can find a sector undergoing a long term
trend, you are by definition looking at a potential investment opportunity.
If that sector is one of the most import in all of the economy, and
if its growth is based on a scientific certainty and if the price
to earnings multiples of many stocks in that industry are reasonable,
you have identified an enormous opportunity. That’s why I began
to focus on energy.
In 2004, it dawned on me that the world will run short of oil one
day, probably within the foreseeable future. If that was true, the
implications were enormous. I became a student of energy. I read books
and blogs and news reports — everything I could find —
to learn about the history and technologies of producing and distributing
energy. My interest level grew with my knowledge of the field —
to the point that energy is now one of the primary lenses through
which I view both investments and the world at large.
The best ways to invest in the energy space came into focus slowly.
I began to buy companies that produce oil and gas. Then I discovered
opportunities in industries that provide equipment and supplies for
the discovery, drilling, maintenance, and optimization of oil and
gas harvesting. Eventually alternative energy companies, and those
in various energy conservation businesses presented themselves. I
became aware of the multitude of interlocking relationships between
energy and the total economy. Over time I became convinced that the
changing energy mix is the most powerful investment Tsunami likely
to present itself during my lifetime, perhaps ever, more powerful
than were mobile homes, cable television, or cellular telephony -
nearly comparable with the power of the Internet itself.
Scarcity pricing serves to determine who gets it
and who does not. Oil is starting to become scarce, which is why,
as the world’s need for oil begins to exceed the world’s
ability to produce it, the price of oil — instead of simply
reflecting the costs of production — reflects a degree of scarcity
value. Right now — June of 2007 — it is a fairly mild
degree of scarcity. But already we have seen nearly a tripling of
oil prices over the past three years.
Natural gas is also in the process of becoming scarce but it operates
differently from oil. There is a global market for oil. The price
for a given grade of oil differs from one place in the world to another
only by the fairly minor costs of shipping and handling. The markets
for natural gas, however are regional ones because it is difficult
to ship overseas. To ship natural gas between continents generally
requires an expensive and environmentally hazardous process of liquefaction
at very low temperature. The resultant Liquid Natural Gas, LNG, is
transported on special ships. At the destination it is re-gassified.
Therefore, the cost of LNG can be high and the capacity to increase
LNG in the short term, because it requires special infrastructure,
is limited.
The long term price vectors for natural gas production
in North America point toward growing scarcity. Gas wells decline
at a very rapid rates.. For many years, the price of natural gas was
in the range of $2 per million cubic feet (“mcf”) but
it spiked to $14 after hurricane Katrina, and is now in a range of
$6— $8. While a great deal of new U.S. exploration and development
in recent years, based on the suddenly higher gas prices, has produced
a bulge in U.S. natural gas production, this glut is expected to be
temporary. The longer term supply problems include the fact that Canadian
gas, which has been a large part of U.S. supplies, is declining rather
steeply while the demand for gas in Canada to help produce oil from
oil sands is increasing, as is demand in the U.S. for agricultural
purposes and for the production of ethanol. Therefore, even if natural
gas seems plentiful now and may seem even more so if weather patterns
are benign in the near term, eventually North American natural gas
will become quite scarce. That may well happen within the next five
years.
Gas production is increasing in Russia and the Middle East and LNG
imports to North American are increasing too. The U.S. has a great
deal of spare LNG port capacity compared with current LNG imports
but compared with our total natural gas usage our LNG port capacity
is fairly limited. Plus we must bid against the Europeans and Asians
for LNG, which can make it even more expensive compared with domestic
production. So the likelihood is that as time goes on and North American
natural gas production peaks and begins to decline in not-too-many
years, the price of natural gas in North America is due for substantial
increases.
The Energy Future Is Actually Fairly Obvious
Over the next fifty to one hundred years, oil and
natural gas will become so scarce that they will be uneconomical for
most purposes. In their place we will use some coal, but global warming
considerations will limit coal use. So we will ultimately have to
rely on renewable energy sources — wind, solar, hydro, and geothermal
energy, all of which are used to produce electricity. And all of which,
fortunately, are plentiful. Their use is currently limited only by
our lack of technical knowledge, but clearly that will come with time.
In short, we will trend from a mixed economy dependent on petroleum
and electricity to one almost totally dependent on electricity, some
of which might be used to manufacture liquid or hydrogen fuels.
During this transition process we will develop technologies allowing
for vastly more efficient energy use so we can consume far less energy
to accomplish the same tasks. For example, we’ll drive cars
that get at least 100 miles per gallon of liquid fuel, probably within
the next ten years. We can see the way to do that just by incorporating
a hybrid diesel power train that is nearly available now and adding
an electric plug. That is a five-times multiple of efficiency that
will let us live just as we do today but with a gas price of about
$15 per gallon and an oil price of about $250 per barrel. Far greater
automotive efficiencies may well be possible with further technology
development.
Increases in electrical efficiency will also be astounding. For example
lightbulbs will migrate from today’s incandescents to light-emitting-diodes
(LED’s), now used for specialty applications, with an energy
savings of possibly up to 95%. The purchasing costs of the bulbs will
be higher at first but those prices will come down and, combined with
the payback based on longer lives and lower operating costs, will
cause LED’s to become the standard choice within ten years.
Virtually every office, factory and home will become a small generator
of electricity through solar photovoltaic transformation. That will
free some of our electric generating capacity to help power newly
electrified trains and other mass transit vehicles. And those electric
generating plants will be powered increasingly by wind and by a technology
called “concentrating solar,” which uses mirrors to focus
the sun’s rays on a liquid-to-steam assembly, so that the electricity
itself is actually produced by an old fashioned steam generator. Back
to the future. Such plants exist now, more are being built now, and
they are getting more economical every year. I am also a believer
in the efficacy and safety of nuclear power plants. Nuclear will gain
market share, particularly beyond the borders of the U.S.
It is not clear at this time exactly how air and sea transportation
will be powered after the age of petroleum has passed. Airplanes may
use a bio-fuel produced from plant or animal inputs with a conversion
process powered by electricity. For shipping, there may be some combination
of these sorts of fuels with wind (maybe it will be called a “sailboat”)
and/or possibly small nuclear powerplants. The U.S. Navy loves its
nuclear powered submarines and aircraft carriers, which have wonderful
records of safety and effectiveness. The Navy will probably forge
new mini-nuclear technologies that will find their way into commercial
shipping.
The wind and solar powered future that will eventuate in 25 - 75 years
will be much “greener” than was the fossil fuel era because
it will include very little burning of fossil fuels. If, by that fine
day, the earth has not already heated up beyond repair, I suspect
humans will eventually experience once again the climate of pre-industrial
society. In the meantime, I suspect that the limited availability
of oil, natural gas and even coal, which will cause such industrial
angst, will be seen as a happy condition for mitigating the trends
of global warming.
If I sound like Pangloss, it is only because I
have not yet discussed the hard part, the transition from the fairly
stable fossil fuel based energy world we have today to the better
and also stable renewable fuels future. The transition is the rub.
Actually, to be more precise, it is the Rapid Transition that is the
problem. We are already in the early stages of transition. We are
generating new synthetic fuels, new technologies for solar and wind
power, new ways to conserve. But this is slow work now because the
perceived need is small. After all, we are still buying more gasoline
each year, and gasoline is still cheap in the US compared with Europe
or even compared with a cup of coffee. A cup of gasoline costs only
about 20 cents compared with several dollars for certain cups of coffee.
So we are not motivated to change rapidly. But at some point, after
we see that Peak Oil is here, the price of energy will go into a “hockey
stick” phase of escalation, and that escalation will engender the
period of Rapid Transition, which will probably not be fun.
A few years ago a group of military planning experts modeled the transition
from the coming of Peak Oil to the stable future. They wrote up the
results in a document called The
Hirsh Report. The Hirsch Report concluded that the transition
will take about 20 years if it begins before oil production actually
peaks. The closer to the peak we are before we get serious about transitioning,
the longer the transition will take and the more difficult it will
be. That's because the transition itself will require a lot of energy
to replace our car and truck fleet and build urban and inter-urban
rail transportation.
Congress is debating a new Energy Bill now in the summer of 2007.
Proposals center on either trying to drill more oil or trying to develop
alternative liquid fuels. Neither of these efforts will give us a
viable long term solution because new oil or bioi-fuels can't be produced
fast enough or in great enough quantity to make much of a difference
to the coming oil scarcity. Only substantial conservation actions
can work substantially and fairly quickly. Unfortunately, at this
time, even with $3 gasoline, the necessary price signals to make conservation
happen rapidly are absent. The implied policy now is to wait for the
market to tell us when we have a very serious problem. But when such
a price signal does occur, when oil, say, suddenly jumps to $250 a
barrel, say, it will be far too late for us to make the adjustments
without huge economic pain and many more years of effort than would
be needed if we started the transition sooner. Therefore, what we
need now are actions like a substantial and permanent tax on gasoline
and more tax incentives for people to buy high fuel efficiency cars
instead of large gas guzzlers.
There is starting to be nearly as much written
about Peak Oil as about Shakespeare or the Bible. Not quite, but almost.
If you are just starting to read about it, a search of Wikipedia
might be worthwhile. My study of the subject has focused on what I
think an investor needs to know, and this is summarized below. If
you are new to this concept, I recommend you plow through it. If you
are an expert, you might still consider my critique of some current
thinking about the proximity of the peak.
Oil (and all fossil fuels) occur in finite amounts on planet earth.
Therefore, assuming demand continues to expand rather than diminish,
some point in time will occur when the rate at which they can be extracted
will peak and thereafter can only decline. That is the point to which
“Peak Oil” refers.
In contrast, “renewable energy” refers to solar,
wind, hydro, and geothermal sources for generating electricity, all
of which are dependent on the recurring energy we get from the sun
or from heat stored underground. Their supply, in theory, is virtually
infinite and their production can be expanded almost infinitely so
long as the planet remains roughly as it is today climatically. In
addition, there are what I call “hybrid renewables”, which refers
to products like ethanol, and hydrogen. These depend in some ways
on a renewable input such as corn or cellulose, but also require a
substantial input of processing that, at least at present, consumes
a good deal of fossil fuels.
At the present time we extract about 85 million barrels per day (mb/d)
of oil, including oil from oil sands and from natural gas liquids
(a rapidly growing category that refers to liquids that are recovered
as a byproduct of extracting natural gas). What the study of Peak
Oil attempts to do is to project how far (if at all) that amount of
production can grow. Analysts then compare such projected future production
with their estimate of future needs to see when we might run into
real problems.
But Peak Oil is geological concept - referring only to the physical
limitations of oil production. In the real world, both demand and
supply are subject to substantial impacts from technological and/or
political developments. Most Peak Oil commentators omit such considerations,
but that could be dangerous from an investment perspective. If peace
were suddenly to break out in Iraq, it could increase oil production
by possibly over 3 million b/d over a number of year. The same could
be said about Nigeria. Venezuela also has a substantial capacity to
increase oil production, but there the problem is obviously political
incompetence rather than chaos.
Technology can impact both supply and demand for oil. The speed at
which a given oil deposit can be extracted and what sorts of mineral
deposits can be used as a source of oil are effected by technology.
For example, the oil sands in Canada and Venezuela are now considered
a major source of oil in the world, but only ten years ago, before
the technology for turning the oil sands into oil were perfected,
and before the price of oil was high enough to make the higher cost
oil sands production profitable, the oil sands were not considered
to be a reliable source of oil.
New ways to pressurize oil fields from underneath
have been developed using gas and water injection to bring the oil
up to the surface faster (and empty the reservoir more completely).
This increases the speed at which oil is recovered and the amount
that can be ultimately recovered. New drilling technologies, particularly
using a set of horizontal pipes in addition to vertical ones have
also enhanced the amount and speed of recovery. These new techniques
for oil extraction are known as Enhanced Oil Recovery (“EOR”) and
are often cited as a reason why peak oil will not soon occur.
Technological developments are also key to the demand for oil. What
if we all drove cars that got 100 miles to the gallon? What if a new
cellulosic ethanol technique costing pennies and not using food inputs
were developed and were much cleaner and cheaper than gasoline? In
either case, demand for oil could drop significantly. In fact, compared
with the 1950's we have already benefited enormously from technology
in terms of energy efficiency. That trend will certainly continue.
The question is whether the benefits flowing from future technological
developments will be incremental, as in the past, or game-changing.
If the latter, it could be a very long time before we find out when
Peak Oil will be reached.
The part of the Peak Oil debate that has not been mentioned so far
is probably the most interesting because it is not well understood
by the public and it is the most predictable part. It is the concept
of decline. M. King Hubbert, a geologist for Shell Oil, developed
the theory of Peak Oil in the ‘50's based on mathematical projections
of decline, which is the fact that the production rate of any given
oil field tends to increase for a while, then reach it’s maximum output
(the “Peak”) and then decline. He predicted that the U.S. would peak
in 1970 and guess what? He was right on the money.
Predictions of the growth and decline rates for an individual oil
field were fairly straightforward if you are a mathematician and you
operated in Hubbert’s era. But the oil world has changed since Hubbert
was around because of new understandings and new technologies. EOR’s,
as mentioned above will enable a field to produce more oil at a higher
rate and for a longer time than was the case in Hubbert’s day. But
the flip side of using EOR to increase production is that decline
rates operate on steroids when they come AFTER the positive impacts
of EOR have run their course. If you jack up production from a field
by pressurizing it and using horizontal drilling techniques, then
when it finally does start to decline, the rate of decline will be
far faster than otherwise would have been the case. If in Hubbert’s
time, a normal oil field might start to decline at 4%-6% per year,
a field in modern times, after the application of EOR, might decline
at 15%.
In fact, that is exactly what is happening to the Cantarell field
in Mexico, one of the five largest fields in the world. Cantarell
supplies 60% of Mexico’s oil. In the ‘90's it’s production was jacked
up through gas pressurization from a little over 1 mb/d to about 2.4
mb/d in 2004. But in 2005 it began to decline. Production was down
by 15% in 2006 and is estimated to be down 20% in 2007. Mexico could
be facing a financial disaster within just a few years.
Some people believe that the Ghawar field in Saudi Arabia (“KSA”)
has peaked now. This field has produced 5 mb/d of oil for many decades.
It is the largest field in the world and accounts for about half of
KSA production capacity, although in recent months KSA production
has declined “voluntarily” to about 8.7mb/d. Some analysts believe
that KSA’s reduced production is not totally voluntary, but rather
is a function of the declining production of Ghawar. We may find out
fairly soon because analysts predict that oil demand during the winter
of 2007 - 2008 will reach 88 mb/d, which is 3 mb/d more than the world
has ever produced previously.
Most of the world’s oil fields are in decline. As mentioned, the U.S.
began to decline in 1970. It now imports about 14 mb/d of the 21 mb/d
that it uses. China, which exported oil until a few years ago now
imports about 4 mb/d and is estimated to need 20 mb/d of imports by
2020. In addition, 62 other countries in the world are in decline,
meaning they produce less oil now than in their peak year of production.
More importantly, all of the five largest oil fields in the world
are in decline with the possible exception of Ghawar in KSA, which
is not ascertainable with current data.
What about new discoveries of oil? We read about large fields being
discovered in the Gulf of Mexico and China recently. Yes, there are
new discoveries announced all the time. In addition there are still
large parts of the world that are not well explored. Experts believe
that much oil lies under the Arctic ice mass. But the salient fact
in regard to discoveries is that oil discoveries peaked in the early
1960's and have declined steadily. It is therefore highly unlikely
that new discoveries could be large enough to offset the decline rate
for existing fields during coming years.
A second important point about new discoveries is that the vast majority
are coming offshore. Underwater oil fields tend to decline sooner
and faster than land based fields. That is because the drilling equipment
required to work far offshore is so much more expensive and the conditions
are so inhospitable and therefore expensive that drilling companies
cannot afford to keep the equipment and men in place to do the painstaking
EOR work need to keep fields from declining earlier. Since so much
of the new oil we are bringing up now is deepwater offshore oil, the
rapid decline rates for deep offshore oil tends to reduce the amount
of new oil available to offset declines from other existing fields.
The point of this discussion of decline rates is that they indicate
a high likelihood that the global production of oil will soon peak.
Experts believe that the production of “light, sweat crude” oil, the
most valuable oil and the oil that’s price is quoted in the news,
has already peaked. But there are other, less valuable grades of oil
that are still in a growth mode. Both Saudi Arabia and Canada are
increasing production of heavy, sour crude.
When do I believe that oil production, in the sense of all products
that can be refined into liquid fuels for transportation, will peak?
Well there now seems to be 1 or 2 mb/d of spare oil capacity. The
annual growth of demand going forward is projected at 1.5 mb/d. So
you might think we will peak in about a year. But new oil production
could still outpace decline rates. There are many new oil fields coming
on stream between now and 2009 based on a great deal of drilling and
exploration work that has been done since oil prices began rising
in 2004. Also some major fields in the Caspian Sea are growing their
production. Also, the production of ethanol and bio-fuels is rising
around the world and an increasing amount of liquid fuel is being
produced from Natural Gas Liquids, a by-product of the production
of natural gas. Also improved technologies are succeeding in producing
more oil for longer periods from many more old fields than has been
expected. And finally, the higher price of oil is causing more oil
to be developed in smaller fields that are ancillary to existing fields.
On the other hand, decline rates are growing. It is estimated that
the world is now losing about 3.3 mb/d each year from the decline
of existing fields. So to keep producing more, we need to grow production
by more than that.
Based on the work of Chris Skrebowski, who tracks
all major oil projects in the world, it seems that production will
be able to grow, net of declines, through 2009 or 2010, after which
the backlog of new oil fields coming on stream becomes much smaller.
On the other hand, oil hoarding is becoming more of a factor, plus
new projects tend to slip and of late they seem to be slipping more.
Therefore, I expect Peak Oil to be sometime in the 2008 - 2010 time
frame, absent significant oil production growth in Iraq, Nigeria,
and, to a less degree, Venezuela. If by some miracle, peace breaks
out in Iraq and/or Nigeria in the next few years, the global peak
oil production could be deferred perhaps two or three more years.
After that, I would expect the increasing amount of decline to overpower
even new oil in Iraq and Nigeria.
Whether in 2007 through 2009 the world can grow it’s oil production
enough to both overcome the decline of 3.3 mb/d and supply1.5 mb/d
of new demand is a different question. In other words, we may face
a significant scarcity well before we reach Peak Oil. I suspect we
are already in such a period now. I will not be at all surprised if
the price of oil exceeds its historical high this year and gets near
to $90 per barrel. Of course, if there is a hot war in Iran, the price
of oil would skyrocket. All said and done, it seems that one cannot
look forward too many years - possibly fewer than two years and probably
fewer than five years - without seeing a need for much more oil than
the world could possibly produce even if there were no political or
military issues that artificially restrict production.
That forecast assumes the continuing growth of the global economy.
Some think that such growth is likely to be at least as fast in the
future as it has in recent years and maybe even faster. For example,
if the Chinese were to use as much oil per capita as the Mexicans
do today, their demand for oil would be 5 mb/d greater than it is
today. That fact, I think, provides an important perspective. To me,
taking all forces into account, it is very hard to believe that the
price of oil over the next five years is likely to do anything but
rise significantly, absent a global depression.
One quickly learns that just as politics is key
to energy production, so is energy is key to politics. We wonder whether
oil is one of the driving motives underlying American foreign policy
(or French or Russian policy for that matter). And we also see a potential
impact of oil pricing on military policy and military capabilities.
For example, the U.S. Air Force uses 1% of all the oil used by the
U.S. The military has been studying (meaning worrying about) energy
for the past several years and it is now managing an emergency program
for alternative fuel development for military usage.
How will America or other countries project force throughout the world
when the price of oil rises dramatically ? With scarcity of petroleum
fuels, it certainly will not be as easy to project military power
to distant lands. Will energy costs eat a hole in military budgets
so large that the only possible solution is geographical pull-back?
How will that effect Europe? China? The United States? Will it put
Russia, as an energy exporter, at an increasing advantage? Does it
increase the fears of Middle Eastern countries like Saudi Arabia of
being attacked and invaded for their oil?
This website is not about politics per se. On the other hand, the
realities of war and peace on earth have had much to do with the price
of oil and even natural gas. So it is important for an energy investor
to avoid political naivete. Some parts of my outlook on near term
energy prices have key political inputs, of necessity, particularly
as it relates to hoarding oil, or "resource nationalism",
as hoarding is now known in diplomatic discussions.
Finally, I must note that as oil becomes more scarce, the poor will
be the main victims - both poor people in general and poor countries
in particular. Some African countries today are doing without fuel
because at $65 oil is no longer affordable. No doubt some poor people
in America - and all over the world - are even now facing hardships
for the same reason. These are people who’s very poverty prevents
them from taking the defensive measures (buying a more fuel efficient
car, for example) that the more affluent will increasingly use to
offset higher energy prices. During the Rapid Transition, the most
affected victims will be poor people and poor countries. That presents
the world with another set of political problems. Viewing politics
through the perspective of energy is far from an academic exercise,
especially for the poor.
Energy Investment Implications
Today (June, 2007), we are in a period of manageable
energy stability and gradually increasing energy prices. This environment
should continue to allow for global economic growth with only slightly
greater inflation due to higher energy and food prices. So, all other
things equal, stocks should continue to offer worthwhile returns until
we reach an inflection point in energy prices which will signal the
start of the Rapid Transition period.
Prior to that time, we may see huge bull runs for “energy stocks”,
followed perhaps by dramatic retrenchments. Such cycles certainly
occurred during all the prior Tsunamis that I witnessed in mobile
homes, cable television and cellular telephony. It is likely to be
even more pronounced for energy, since energy is a much larger Tsunami.
In this environment, portfolio managers should be conservative in
their use of leverage and remember that an energy portfolio is inherently
more volatile in the short term than the market as a whole because
energy prices are set by commodity traders, and therefore can fluctuate
substantially and quickly.
The good news is that within an energy portfolio one can choose among
companies in a wide variety of industries. In addition to those mentioned
earlier (energy and alternative energy producers and suppliers to
such companies plus companies benefiting from energy conservation),
one can look at agriculture, which is now connected to energy both
as a heavy energy user and as a supplier of ethanol, and companies
in fields like shipping that are part of the infrastructure of globalization.
The trend toward globalization is integral to the energy tsunami because
it is the growth of China, India and similar countries, caused by
globalization, that is behind the growth in the demand for energy.
This growing demand is hastening the arrival of Peak Oil and is causing
the initial mild scarcities in energy that we are now seeing.
Making predictions is hard, especially about the future, as Yogi once said. Nonetheless, I have an idea that as oil prices sea-saw upwards to new heights and as the public gradually begins to understand and believe the Peak Oil story, investors will devote increasing percentages of their equity portfolios to energy stocks. Energy stocks will continue to outperform the market, just as they have during the past three years. Over time, they will become like the "Nifty Fifty" stocks of the 1970's. If that happens, it will be only a matter of time before energy stocks will have a severe correction, along with all stocks. That will probably occur during the early stages of the Rapid Transition period. Economic dislocations may be extreme and it may be a very difficult time for financial markets. The stock market may not be the best place to be invested. Cash may be better, or for the more sophisticated, possibly direct investments in commodities or futures.
There may be as much as five to ten years of financial
turmoil during the early years of the Rapid Transition. But eventually,
the economic sun will shine again as the world adds new energy sources,
adjusts its behavior to restricted availability of oil, and discovers
new technologies for energy efficiency. It will then be safe to go
back in the water, but energy may not continue as a Tsunami. It may
then be time to concentrate one's equity investments somewhere else.