PEAK OIL FEARS AND HYPE, PART 2
Tuesday, May 30, 2006
Let’s accept the idea that the era of cheap oil may be over. But also accept Austin Kiplinger’s premise (see last week’s Crier column) that the problem itself— the U.S. seen as held hostage to rising global energy demand and unreliable sources — suggests new trends. As an investor, you may wish to consider wealth-preservation and growth strategies within energy independence trends.
With high oil and gas prices, companies that are developing alternative technologies are being chased as investment opportunities. It seems that anything to do with energy, metals, or the environment is “in.” Hyping stock promoters are not far behind, especially on the Internet, touting small and often unprofitable companies with a soon-to-make-you-rich breakthrough technology or process. One money manager warned that “going green” with a new energy-efficient environmentally-friendly technology is fast becoming “the new ‘dot.com’” money-go-round.
There are, however, solid and positive trends. The U.S. has sufficient coal reserves to meet current demand for 200 years. New technology allows coal to be burned more cleanly as a viable source of electrical generation, with better environmental protections. Mines are opening in the Western U.S., Ohio, Kentucky, and Central Appalachia, adding jobs at good wages. Research continues relative to coal gasification, the process of transforming coal into clean-burning gas.
Again, at the risk of recalling the dot.com craze, “energy tech” is hot, as alternative fuel technologies attract increasing levels of venture capital funding. VC money is aimed at renewable energies (e.g., ethanol from cornstalks in addition to corn, grasses, wood chips, sugar cane), as well as solar, geothermal, and wind power, and the making of existing energy technology and infrastructure cleaner and more efficient.
Marc Sumerlin, a global economic consultant, notes that high oil prices have encouraged a new class of entrepreneurs and scientists, who are being funded in the quest for technological advancements. “Nanotechnology is improving battery life, which will make hybrid cars and solar electricity more realistic.” Sumerlin points to biotechnology and new processing advancements as spurring change quicker than people foresee. Over three short years in Brazil, sales of new cars that can run on high-content sugarcane-based fuel has risen from 4% to 67%. Ethanol in Brazil is priced competitively with gasoline. (Wall Street Journal, 1/10/06).
The U.S. could also be on the verge of an oil shale boom. The Green River Formation holds 16,000 square miles of oil shale, in barren stretches of Colorado, Utah, and Wyoming. The federal government controls 80% of this oil resource. Of the estimated 2 trillion barrels of proven reserves in the formation, between 800 billion and 1.6 trillion barrels are recoverable. Alberta, Canada, oil sands have been a bonanza for investors and President Bush recently signed an executive order to open up the previously restricted Green River Formation.
Surging demand for deep water drilling technology and infrastructure is also being spurred by high prices. Undersea prospects are being pursued in areas in the Gulf of Mexico, North Atlantic, Southeast Asia, West and North Africa, Canada, and Brazil.
In a world populated by screaming pessimists and equally-opinionated optimists, it is hard for investors to know what to think. We do know that past forecasts of peak oil have not been reliable, since human ingenuity has intervened to increase recoverable supply. Proven world reserves of oil, 762 billion barrels in 1984, are now estimated at 1,189 billion barrels.
Canadian economist Pierre Lemieux notes that “the history of the oil industry is replete with exaggerated demand forecasts, pessimistic supply limitations and sky-high prices. The median forecast of experts polled by the International Energy Workshop in January 1986 was for crude oil prices of $240 by 2005 (in today’s dollars). Four years earlier, the median forecast for 2000 was $400.” In late-April, 2006, NYMEX Light Sweet Crude prices exceeded $75 a barrel, midst widespread expectations of $80. Oil would have to reach $97.55 bbl. in 2006 inflation-adjusted dollars to equal the price spike at the end of the 1970s. In 2002, respected analysts saw oil prices as averaging $23 bbl. over the long run. Betting heavily on any forecast is a roll of the dice.
Pessimistic forecasts of a repeat of the “stagflation” of the 1970s appear unlikely. Global currency and bond traders are quick to punish any government that tries to inflate its way out of a squeeze with easy money policies. Globalization and technology will make the difference this go-round.
We can expect the emerging economies, especially China, to continue to increase the demand for raw materials, with concomitant price pressures, while restraining overall inflation by cranking out low cost and highly competitive consumer goods. Rising productivity due to technological advancements has allowed our economy to absorb rising energy and commodity prices overall, despite strains on less efficient energy-intensive sectors like legacy airline companies.
Increasingly, investors and financial advisors are seeking to hedge client portfolios with products designed to ride the commodities curve. Despite the hype surrounding oil, gold, silver, or other strategic commodities, investors who are not speculators are probably better off in ETFs, mutual funds, or partnerships that track a diversified basket of commodities or futures contracts. When the hype level increases, as it has with the jump in metal prices, investors are urged to resist the siren song of quick riches and to maintain prudent diversification based on a defined risk profile within a customized Investment Policy, while exploring the addition of new asset classes. Large pension and endowment funds have embraced “opportunistic” and alternative investment classes en masse, and individual investors are seeking education.
To borrow a line from the 1966 Stephen Stills/Buffalo Springfield song, “There’s something happening here, what it is ain’t exactly clear…” What may be clear is that the investment themes surrounding “going green” and “less dependence on oil” have legs.
British Petroleum has been touting a new business focused on alternative energy — solar, wind, hydrogen, and natural gas power activities. GE has “gone green,” pushing windmills, photovoltaic power, coal, desalination and water treatment, nuclear power, and more fuel-efficient marine, aircraft, and locomotive engines.
Commercial banks such as Citigroup, ANZ Bank, and Royal Bank of Canada are adding renewable energy investments to loan portfolios. Goldman Sachs has a stake in a wind power venture in Texas. Large and mid-sized utilities, and global corporations like Siemens, Sharp, Royal Dutch Shell, and Sanyo, are making investments and acquisitions in clean energy resources.
Nuclear generation is back on the table. Currently 103 nuclear plants supply 20% of U.S. electricity. No new plants have been ordered in the U.S. in over 25 years. The 2005 Energy Policy Act contained provisions to ease the way for new plants with updated technology. Nuclear equipment designers and suppliers and the architectural and engineering firms that will build plants are being eyed by money managers.
Hydrogen fuel cell applications are declining in cost as performance improves, attracting firms like Motorola, Toshiba, Sanyo, Bic, big automakers, Siemens, Delphi, Chevron Texaco, BP, Shell, and a host of innovative small companies.
“Cold fusion,” while still highly experimental, offers the potential for cheap and virtually unlimited power for electricity generation, transportation, space flight, and home heating. “Hot fusion” research is continuing with the International Thermonuclear Experimental Reactor to be constructed in France. A similar reactor is to be built in China.
None of these trends suggests immediate nirvana and investors must consider energy disruptions, higher costs, inflation, market volatility, terrorism, and other destabilizing factors. For retirees in the distribution phase relative to their portfolios, cash reserves equal to one to three years of targeted monthly cash flow may be appropriate to allow equity portfolios to recover untapped during severe downturns. “Cash is no longer trash” in a rising interest rate environment, and increasingly innovative banking and cash management tools are being are being incorporated into planning strategies.
The trend toward “green” is more than economic. It is a fundamental premise in the War on Terror, a factor in national security. Money is in motion across a wide array of fronts. Myths of impending doom serve a purpose in spurring progress, as Austin Kiplinger recognized. The lesson of the last 200 years is that the future has always proven to be brighter than the naysayers would have people believe. The difference today is that technological progress comes at us faster and faster. Yes, creative destruction is a brutal reality that, too, must be dealt with individually relative to career decisions.
“Peak oil” is not a disaster in the making. It is a major opportunity.
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