Sunday, May 27, 2012

Additional Views on US Energy Independence

Should the US pursue a policy of  energy independence?

Today I am continuing a discussion began in last week’s blog about the economics of  international energy policies.  I offered opinions about these topics prompting a response from my long-time friend and adviser, Dr. Philip M. Neches,  the founder of Teradata, who has spent a great deal of time studying the Energy sector.  Phil Neches received his BS, MS, and PhD from the California Institute of Technology;  he is a successful entrepreneur, writes a thoughtful blog and sits with me as a trustee of  Caltech. 

Last week a portion of my blog explored an Adam Smith-inspired hypothesis that would have the US buy up and deplete as much of the world’s oil as possible, using its own production and reserves for long-term international competitive advantage.  Berkshire-Hathaway’s Charlie Munger, among others, have also discussed this approach.

Oil pricing as a factor

Phil Neches began his response by indicating that he thinks my analysis of oil did not take price sufficiently into account.  He writes, “Yes, the US depends less on imported oil than major economic competitors, but that matters only in the extreme.  In the more ordinary course of business, it will take several more decades of consumption for oil to actually become scarce,  and, as you point out, that can be stretched out by more efficient use.”

He continues, “The short term issue with pricing is not as much about the ultimate depletion of world oil reserves but by the imbalance between demand, which can shift quickly with economic circumstances, and supply, which can only change slowly through expensive development of fields, refining capacity, and transport. Bad actors can make quick changes in supply, and this causes the risk perceived, correctly I think, by the general public and politicians of all stripes.”

US Strategic Petroleum Reserve

Last week I buffered my position with the fact that the US Strategic Petroleum Reserve provided some solace for future emergencies.  Phil offered an offsetting  point I had not mentioned, that today’s military depends upon the civilian economy much more than in the past.  As Phil states, “If the civilian economy is crippled, the military may still be able to operate, but will be far less effective.”

Natural gas

I am mostly in agreement with Phil when he writes that “The most obvious strategy for the US is to encourage substitution of natural gas for oil and coal.”   He continues,  “the biggest win is in electricity generation, for a number of reasons: 

First, it would permit early retirement of the dirtiest coal burning plants.   From a Pareto analysis standpoint, this is the best thing we could do to reduce not only carbon emissions, but other pollutants.

Second, gas-fired plants can be sited closer to loads, stretching out the investment in the distribution network.  This is important because there is more capital tied up in distribution networks than in generating capacity.

Third, to the extent that people adopt electric vehicles (either plug-in hybrids or all-electrics), then demand from the transport sector can shift away from oil.”

My thanks to Phil Neches for his additions to this conversation

Investment implications

Careful long-term focused investments should be considered to take advantage of the transportation of oil, gas and coal. The use of energy will go up, adjusting for the cyclically of the global economy. As long as the sources of energy are distant to its users, energy in some form will have to be transported. In the intermediate time period that would include ocean-borne oil, gas and coal. In addition, land-based pipelines and railroads will still have good payloads. I suspect that these thoughts are behind the disproportionate current and future capital expenditures in these areas by Berkshire Hathaway* and other large capital investors. Currently many of these stocks are down from recent peaks because the level of shipments and prices are down. I cannot accurately predict when they will go up, but I believe they will as the world recovers and we move toward rational energy independence.
Disclosure: I personally own a position in Berkshire Hathaway, as does the private financial services fund that I manage.

Historical context

In the United States we celebrate Memorial Day on Monday, May 28th.  Officially the holiday was started to recognize the death of so many Union (Northern) forces in the Civil War, which some still call the War Between the States. Over time the holiday was combined with a similar day of remembrance for the fallen Confederate soldiers.  For the US, the Civil War was responsible for more total deaths than any war before or since.  In addition to the many domestic causes of the American Civil War, economic forces, particularly international trade, played an incendiary role. As European harmony deteriorates, this holiday weekend I am reminded of the curse of one citizen/nation fighting another on the basis of economic interests and tariffs.


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