Significant Messages: Warren Buffett to Step Down by End of Year, Other Berkshire Insights, and Tariffs won't deliver - Weekly Blog # 887

 

Mike Lipper’s Monday Morning Musings

 

Significant Messages: Warren Buffett to

Step Down by End of Year, Other Berkshire

Insights, and Tariffs won't deliver

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

                             

You have probably already heard that Warren Buffett will step down as CEO of Berkshire Hathaway by the end of the year. Warren announced this to thunderous applause at Berkshire's annual meeting on Saturday afternoon. I am not surprised. At the meeting, which is the first we have not attended in many years, his answers to many questions were more statesman like, recognizing the scope of problems facing both the country and the rest of the globe. He referred to his Father's only political defeat as a Republican Congressman and subsequent re-election. Greg Able spoke purposely, answering an increasing number of questions. He will succeed Warren as CEO.

 

The following brief comments were delivered at the meeting largely in chronological order.

1. Berkshire expects the relationship with Japanese trading companies to likely lead to more Japanese acquisitions, probably in Yen.
2. Berkshire was in discussion for a $10 billion deal recently. Buffett indicated that he thought with Abel as CEO larger deals are likely, with more communication between the units.
3. Currently, the companies are not using AI for Real Estate and they are behind in using it for GEICO.
4. There is a global push for weaker currencies, which is a negative.
5. Life Insurance is different from the Property/Casualty insurance Private Equity is using.
6. Berkshire's stock price has fallen 50% three different times.
7. In the latest quarter, the prices of 21 subsidiaries rose and 29 declined.
8. There were no repurchases of stock.
9. Warren pays more attention to balance sheets than income statements. He is particularly interested in generation of free cash flow. He also believes quality starts from the top. There was quite a discussion about utilities, coal, and fires. The various states and political interests need to decide what they will authorize.

 

Tariffs Are Not the Answer

Far too many people believe that imposing Tariffs on various items of world trade will solve the problems of individual countries. George Calhoun, a Director at the Stevens Institute of Technology and a contributor to Forbes Magazine, raises critical questions in two articles in Forbes. (George and I serve on a board committee at the Stevens Institute.) For brevity purposes I will briefly review the first part of his second article:

 

Will higher tariffs cause inflation?

Prices will rise.

 

Alternative view:

Currency shifts neutralize price increases

 

Mitigating factors: Caveats, Fudges, & Assumptions'

There are at least 14 various measures of annualized inflation.

 

Is it really inflation?

"High prices are not the same as inflation"

There is confusion between the rate of change and the level of prices. (I may include the perception that there is no change in the quality of product or service and time of delivery.)

 

Tariffs affect only a small portion of the "The Consumer's Basket"

(Does substitution change the value of the product?)

 

(I am happy to send the second half of George's article to any subscriber.)

 

The Trump Angle

From the very first time the President introduced the use of tariffs to correct the imbalance of world trade, I believed he was doing it to force negotiations. It is already clear he will change the size of barriers, due to the manipulation of currencies. (See currency shifts above.)

Only the most senior officers can deal with these types of items.

 

 

Question: As usual I would like to hear your views.

 

 

 

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Not Much - Weekly Blog # 726

 

Mike Lipper’s Monday Morning Musings

Not Much

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Anyone who has served guard duty instinctively senses some of their most dangerous moments being described as “not much happening”, just before dangerous things happen. This is my gut feeling looking at the US stock market activity last week. (Both the government bond and commodities markets moved under the strain of adjusting to supply shortages, including Russian Uranium.)

Calibrating “Not Much”

The main function of this blog is to assist investors in their thinking about long-term investments, typically extending from five years to multiple lifetimes. With that as a framework, the guiding math becomes clear. On the downside there is always the potential for a 100% loss, excluding any additional leverage losses or legal settlements. My long-term objective is multiples of the potential 100% loss, or to quote the great stock portfolio manager Peter Lynch, “ten baggers”. (Peter learned and worked for the late Ned Johnson, who died this week. Ned was the second CEO of Fidelity Management & Research. Ned was more than just a first-class money manager; he was a good selector of talent and found new ways to invest and market investments globally. Ned changed the investment business around the world. His daughter Abby, the third member of the Johnson family to be the CEO, is going even further.) 

If one gains multiples of loss positions it doesn’t take long to produce a satisfactory return, it just takes patience to ride out multiple-year periods. 

Every Journey Begins with The First Step

The first step begins with direction, chosen or not, and a small distance. With rare exception, first steps are consequential to the result, except when beginning a march to a meaningful end. It is this exception that drives me to focus on what happens each week. Most things don’t materially matter, but some do in the short and long-term. This is the reason I spend a lot of time and energy pouring over what happens. I will share my reactions to the surface elements of an inconclusive week.

Short to Long-Term Implications

• The NYSE up-volume dropped to 13.7 million shares from 20 million shares the week before, while the NASDAQ up-volume rose to 15.4 million shares from 10 million shares the prior week. Downside volume was essentially the same level each week. (I suspect some of the up-volume in the prior week was short-covering to curtail losses. In the second week the selection process favored tech stocks.)
• There has been some extreme performance year-to-date, with Commodities enjoying the best performance since 1915 (WWI) and bonds the worst since 1941 (WWII). 
• In the last 16 years, $2.6 Trillion went into bonds and only $ 1.85 Trillion went into stocks.

(Looking at the last two items raises the question as to whether the US dollar can retain its privileged position of being able to borrow globally in its own currency? It may be determined by where critical commodity resources are found.)

• The price of coal has risen to $330 per ton from $80.50 at the end of 2020. Little in the way of energy capacity is planned to come on stream before 2025. The call to end global trade and production is the opposite of what Adam Smith wrote about at the time of The American Revolution. There will likely be multiple sources of critical supply when sought, but at increased cost.
• East Coast US ports have been less busy recently. I suspect inventories have been restocked. Retail sales have also slowed or have been priced too high.
• Goldman Sachs and others have discussed an increased risk of a policy-induced recession 
• There is no doubt we have entered a global food shortage period, driven by the absence of supply from Russia/Ukraine, and others due to insufficient investment. Food prices will be going up partially due to a labor shortage.

Many of these noted problems are already impacting our markets, as others will in the future. Never-the-less, after this period of contraction it will eventually lead to a period of expansion and opportunity, if patient. The cyclical will turn to a favorable phase, allowing us to use our brains, capital, and patience to ride out the storm.

Help is on the way. 

  

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2022/03/relative-or-payout-returns-in-periods.html 

https://mikelipper.blogspot.com/2022/03/building-your-future-winning-portfolio.html

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

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Best Bet: More Sweaters and Parkas vs Overcoats - Weekly Blog # 708

 

Mike Lipper’s Monday Morning Musings

Best Bet: More Sweaters and Parkas vs Overcoats

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

I don’t like to lose bets, especially investments bets. That being said, I am highly confident those in the northern hemisphere will suffer a colder winter than expected. The streams of cold weather from Asia which flow over North America and Europe are moving south this year and will bring a colder winter to the US. (This contradicts “global warming” or climate change predictions.) The second and preventable driver is the need for politicians to be re-elected.

The only game that counts in Washington DC is getting elected, which importantly is based on money deployed from all sources. Despite food prices reflecting rising transportation costs, the central government is determined to hurt the states supplying energy for heating. Three states in particular are being targeted: Wyoming, West Virginia, and Texas. The first two are the leading exporters of coal to the rest of the nation, with Texas being the leading exporter of oil and gas. (Natural Gas is a major source of heating for much of the northern portions of the country.) These three states have significant Republican majorities, both in terms of votes and more importantly political contributions.) 

The game of war often relies on misleading the enemy regarding your intensions. In Washington this is done by a friendly media focusing on stimulus, even though it is a major contributor to inflation. While inflation is the cruelest tax on the poor, those in power believe the loss of some votes in the city districts won’t endanger the city progressives.

There are already a lot of predictions regarding the sharp rise in the cost of heating this winter. Landlords, already having difficulty collecting rents, may cut the amount of heat. Non-profits, including government bodies without actual or equivalent “rainy-day” funds, may face similar problems. Schools in low-income areas may similarly have shortages of students, teachers, and administrators.

Many of the aggrieved or their representatives will appeal to the media for help in sweaters (inside) or parkas (outside). Those appearing in overcoats will be considered tone-deaf, no matter how well intentioned.

Faulty Responses

Many of the shivering responders shown on television will emphasize the spike in heating costs causing an increase in “common colds”. The number of non-workers will be blamed on “acts of God”, due to shifts in northern wind blasts. They will not likely admit that part of the problem was self-administered, either out of The White House or Capitol Hill. By curtailing the capital generation of energy producing industries the government has caused the US to be an energy importer. It is no longer the net energy producer and exporter it was two years ago. They did this by causing pipelines to close, or not be built at all. Furthermore, in a stretched global market for oil, bureaucrats are increasing the industry’s burden by holding price investigations.

Multiple Year Transitory

As is often the case, economists look at the top-down government numbers of goods produced or shipped for problems, not the services or labor required. In their calculation of supply chain shortages, they fail to recognize the nature of the labor shortage. Not only are entry level workers missing, skilled workers and competent/trustworthy supervisory employees in service functions are also in short supply. (A good bit of these absences can be attributed to "educational" sector unions from pre-nursery through PhD programs.) These issues will not be addressed in the coming cold winter.

Long-Term, the Federal Reserve is Trapped

The favorite tactic of those in Washington is to change the rules if they are losing. Members of Congress are trying to make various economic/government financial agencies into social arbiters, including the Fed. Neither the Fed nor their supervised banks are equipped or authorized to perform these functions.

To the extent central governments want to spend a lot of others’ capital on controlling climate conditions, they will sponsor increased spending. This will result in both the Fed and the debt market increasing global debt massively. One wonders whether present low interest rates will become generational lows. Will higher rates drastically change the allocation of credit to the detriment of consumers at the low end?

Causes of Inflation

Inflation is caused by having too much money and borrowing power relative to the level of goods and services on offer. By itself it would be self-correcting through changes in price, including foreign exchange. However, when central banks create more money than their economies can immediately use, it leads to inflation. This is exactly what has been happening, so much of the current inflation has been caused by stimulus (bribes) payments. Thus, governments are a source of inflation.

Investing Choices

Perhaps the only wise reason to own securities today is the belief that the managers of some companies will be able to grow dividends above average inflation after taxes. 

If you have other reasons let us know. 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/11/lessons-from-london-mistakes-repeated.html

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

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Investment Lessons of the Week

Previously I have written about the eventual trap of arrogance. Most politicians, and many investors will not admit to making critical mistakes. I try to be different. The only thing I promise each of our accounts is that I might make mistakes that hopefully I correct before there is too much pain. My main defense against arrogance is that I try to learn something new every single day. I have suggested this pattern to my children and grandchildren. The power of the new idea, new view, and new approach is that it forces one to relate the new with the old - and that becomes a challenge to many of our beliefs. Just this week, I have knowingly been exposed to at least five new elements to my thinking. All of these have a global context.

Logistics lead, but need to be interpreted

Last week I commented in my blog about what I learned from our visit to Mount Vernon. First, that steamship volume was increasing and that I saw many trucks from logistics companies going south on the Interstate Highway. This week a friend of mine noted that in September, the Baltic Dry Index moved from 662 to 778. What was even more encouraging is that the spot rate for the largest-sized vehicles carrying dry cargo (for example, iron ore) skyrocketed from around 2000 to 7600 this week. I believe the surge noted in iron ore shipments is due to the announced efforts to build many subway systems throughout Chinese cities. (As someone who for most of my life lived in and around New York City, the idea of relieving the roads of the clogging, expensive, and pollution generating car traffic seems to be a great idea.) To me the materially-increased infrastructure investment in China is a very practical stimulus that will use imported iron ore to make steel in local Chinese mills, a very intelligent way to address its economic slowdown.

A careful searcher for truth will almost always find some contradictory evidence. One of the oldest of all technical (market) indicators is the belief that the Dow Jones Industrial Average cannot make and hold new high levels if the Dow Jones Transportation  Average (which used to be composed of just railroads) does not confirm by making its own new high. The belief is that if the two indexes diverge they will have to find a bottom before there can be a successful sustained new high. This week the Norfolk Southern Corp. lowered its expectation for the current year’s earnings. The Dow Jones Transports declined on this news. The decline’s impact on the industrials needs to be put into perspective. The railroad is one of the largest shippers of coal in the country. Just as governments can attempt to make companies grow; e.g., solar and wind power, it can force lower sales of others. The Obama administration, along with much lower natural gas prices, is making coal an unattractive fuel for our electric utilities. Fuel for the electric utilities is not being delivered by train, but by pipelines, barges and other vehicles. Thus, as of this week I believe that we are seeing some resurgence in industrial activity, which the stock market is already discounting.

Cash to stock is becoming an easier switch

Last week I attended two investment focused meetings. In the first a large regional bank gathered some of its best potential and actual investment clients to a private lunch to hear my views on investing. They would not have taken time from their busy day if they were not already investing in equities or considering it. In our conversations they recognized that long-term they needed to be significantly exposed to the world of stocks, perhaps through funds. Everyone at the lunch could recite, in detail, their concerns about the stock market, but they still came and stayed for two hours.  One evening last week I was at a post-meeting dinner for a board on which I sit. At one point during the long dinner, a very successful second generation Wall Streeter leaned over to me to tell me he had not bought a common stock for his own account for over two years and now he was ready to buy. I suggested that he call a mutual friend of ours with whom he had successful business dealings, to help him reenter the market. He noted on his pocket pad to call our friend in the morning. These two instances suggest to me that the historic pattern of people coming into the stock market as it goes up is holding. While some of the easy money has already been made in the low volume markets, there will be opportunities at higher prices.

‘Tis the season to be “Vixed”

Many commentators have spent much time noting that there appears to be a low level of fear expressed in the options on the S&P 500 as captured in a traded index with the symbol of VIX, (CBOE Market Volatility Index). If one reads Randy Forsyth’s article in Barron’s Friday September 21, we should be prepared for problematic markets. I have lived through the October “crashes” in 1978, 1979, 1987, and 1989 but not the big one of 1929. What I had not compiled were the other autumn events that were dangerous to one’s capital base. As today’s global stock markets are reacting to government manipulated fixed income markets, recognition of the following Autumn occurrences is important:

1.    September 24^th 1869: the US government sold gold  to break the “corner” that was attempted by Jay Gould and Jim Fisk.

2.    September 20, 1873: the New York Stock Exchange closed due to a panic.

3.    September 21, 1931: Great Britain’s suspension of the pound’s link to gold.

4.    September 21, 1985: the so-called Plaza Accord broke the ascent of the US dollar. (Too bad to bring that wonderful grand hotel into another round of government manipulation.)

5.    September 16, 1992: The withdrawal of Sterling from the European Exchange Rate Mechanism and reportedly a huge winning bet by George Soros.

6.    September 23, 1998: the culmination of the Asian currency crisis which began in July 1997.

7.    September 11^th, 2001: the attack on the World Trade Center in NYC.

8.    September 15^th 2008: the collapse of Lehman Brothers followed the next day by the near collapse of AIG.(These were much more significant in the global fixed-income markets than in the stock markets.)

Long-term fears and where you hold your investments

Ray Dalio, the founder and co-CIO of Bridgewater Associates in an interview with CNBC  had some dark thoughts. His fear is that after a ten to fifteen year managed depression (austerity without growth), that the social tensions between various economic and ethnic classes in southern Europe may produce an appeal to some strongman/woman to take over and solve the problem; e.g. the appeal that brought Hitler to power. Much closer to home, a savvy investor shared her concerns with me. She is worried that in the US (and by some extent in other Western countries and Japan) that the medical and related costs of keeping the elderly will be too much for the younger tax paying generations to tolerate. A financial class war is what she is predicting.

I asked this smart, experienced lady how she was preparing for this with her portfolio today. In general she had foreign investments for 30-40% of her portfolio. But the bulk of the rest was in multinational companies. She uses Coca Cola as an example, which gets most of its earnings from outside the US. I am not sure that her strategy will deliver against her fears or those of Mr. Dalio.

For many years I have complained to various fund managers that displayed their portfolios on the basis of the statements they receive from their custodians. The custodians list securities on the basis as to where the entity is legally domiciled. From an analytical standpoint, I am interested where the company is making most of its operating profit. That is the country or region which will have, in general, the biggest impact on sales and operating earnings. For regulatory reasons I will probably won’t win this argument with published reports but with careful analysis I can probably guess the key sites of operating earnings power which should help in determining the strategic value of the investment. However, the concerns expressed by the lady and Mr. Dalio raise another issue.

If our current fears turn us into a refugee mentality, it is not where an entity makes its money that is important, but where are the assets and where can they be traded in a period of distress. If these fears become somewhat more widespread, we may see wealthy US investors move to vehicles that are beyond the problem areas.

Which comes first: weak currency or weak military will?

A study of history suggests that a weak military will eventually invite others to seize our assets and possibly our lives. Often the decline in military willingness to aggressively defend its homeland comes from a policy of weak currency management as it attempts to take market share away from trade counterparties by having lower prices than they do. For a generation we have seen that many Europeans will not support a strong military; e.g. in the Balkans, and we also see that the value of their currencies decline. While much has been written about Quantitative Easing Infinity,  in terms of US stimulation, on a longer-term basis the decline in the value of our currency is in effect a weak dollar policy. Combining our planned Asian withdrawals and defense expenditure cutbacks, a weak dollar policy is going to invite more trouble. As much as we don’t like to be negative, maybe we need to pay more attention to our worriers.

The bottom line: be careful and stage your money into equity vehicles with some concern as to where your assets are being housed.

What Do You Think?

In London

I will be conducting interviews and investment manager meetings in London during the week of October 8 - 12.  If you would like to meet to discuss investments, client strategies or one of my blog topics, please email me at aml@lipperadvising.com .

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Email deliveries of my blog last week contained only the post’s title with a hyperlink to the complete blog, requiring readers to make an additional click. Unfortunately, Google changed its procedures without notifying us.

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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 28^th.  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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1776 Can Make Us Independent Again

Historical Introduction

Most Americans believe the single most significant act of 1776 was the signing of the Declaration of Independence. I suggest that when facing today’s economic problems we consider a still more important event that occurred  in 1776, the publication of Adam Smith’s The Wealth of Nations.  (Not to be confused with the very insightful contemporary author and television personality who uses Adam Smith as a pseudonym.)

The two events are very much related. Our Declaration of Independence was driven by the colonists’ abhorrence to the Navigation Acts and other laws of Great Britain that raised the costs of imports into America and restricted the transportation of our exports. Remember the famous Boston Tea Party was caused by the tax on imported tea.

These laws were an outgrowth of the mercantilist philosophy of European governments to promote their own exports and restrict imports into their lands. This governing philosophy reigned between about 1500 and 1800, and was based on the need to get trading partners to ship gold to those countries where they had an unfavorable balance of trade. The importance of gold was not primarily economic, but rather to pay for their constant wars. In the minds of the European leaders, particularly the British and French, this was a matter of survival.

What Adam Smith advocated was that nations should specialize in their production of items to be exported and import those items where they did not have a cost advantage. Over the succeeding generations his ideas were finally accepted.

Today and for some time American Presidents have announced policies that would make the US independent of foreign oil. In response to questions and comments from a number of regular blog readers, I will attempt, in a small way, to play an Adam Smith role.

My biases

I have never seen a totally unbiased report. Most of the authors are not fully conscious of their own biases, particularly those that were inculcated into them at their universities. As we are all captives of our experience, biases cannot be completely avoided. The best we should do is to identify either the biases or the sources of our biases. Mine starts with a college course in Middle-Eastern history, geology and geo-politics. I learned that in Saudi Arabia, the direct lifting cost of a barrel of oil was approximately four dollars and did not change much over the years. From time to time I have invested directly into domestic gas producers to make money or energy-focused mutual funds as an inflation defensive move. When I was lucky enough to become a trustee of Caltech I was exposed to numerous professors who were focusing advanced scientific approaches to find energy and use it more efficiently. These inputs allow me to think about a problem from different viewpoints, and therefore biases. 

Parsing the search for energy solutions

The three main fuel sources of energy are oil, gas, and coal. (For the purposes of this search I am ignoring nuclear, solar, wind, hydro, and geothermal with the belief they will play an expanding role, but won’t provide sufficient power in the short to intermediate future.) I believe that each of the age-old big three should be addressed individually.

Oil

This is where I put my hat on as a modern Adam Smith. The popular view of Americans from the White House to Main Street is that it is dangerous for us to rely on the importation of oil from those nations that  “don’t like us.”  The fear is that in time of military conflict those that supply us with oil will cut off flow, or at least hold it up for ransom. There are many counter arguments to this fear. First, our military has developed lots of means to defeat an enemy without the need for the quantities of petroleum products required in World War II and subsequent engagements. Second, we have built a strategic oil reserve which is intended for military emergencies. (Not to be used as a politically-inspired price mechanism.) Third, if needed, government agencies believe that there is more oil underlying US government-owned land than has been discovered in the rest of the world.

There is another set of economic arguments which update Smith, the canny Scotsman. If oil is a scarce resource and cannot be easily replaced, we should deplete other countries’ reserves and political power by buying all that they will sell to us. Further, a rise in the international price of oil, while somewhat painful to the US in the short-term, dramatically changes our competitive position in the world. The US is less dependent on foreign oil than Western Europe, Japan and China. If petroleum manufacturing costs for the rest of the globe goes up and we have competitive products at a lower price, the US share of market will go up which can aid our job growth. Based on what we have already seen, the threat of higher priced oil will trigger greater conservation efforts and the development of more efficient uses of energy.

Gas

There are reasons to believe that the US and certainly Canada can be net exporters of natural gas. Other countries are also developing their gas properties. From a strategic viewpoint, I might be reluctant to become too reliant on imported gas except from Canada. Over time I would expect the bulk of our heating requirements will be filled by natural gas. We are likely to see both the military and large trucking fleets switching to hybrid or fully dependent upon “nat. gas.” The environmentalists will need to prove that fracking is dangerous to the neighborhoods of gas extraction and then our technologists will probably find solutions.

Coal

Some politicians have proclaimed that there is no such thing as clean coal. Considering the US has a reported 250 year supply of coal, I hope they are wrong.

If the price of energy goes up, I believe that there will be enough room in the final price of coal for both steel-making and heating to cover the costs of technological fixes that are underway.

Conclusions

Just as 1776 brought forth thoughts and actions that changed the world, I think we are at the point of achieving meaningful economic energy independence in the near-term future as we modernize our thinking.

As is my wont turning to investments, I would suggest investments in stocks of companies that are devoting some of their efforts to new ways to make our search and use of energy more efficient. These areas could be mining and extracting efforts, transportation efficiencies, and battery producers among many other beneficiaries of the application of new and improved technologies. These could include some, but not all, of the major oil, gas and coal companies.

Are you ready to be independent in the new world?  Let me know.

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Exploring for $1/Gallon Gasoline

This is the season that the great religions of the world celebrate the past and look forward to a rewarding future. Analysts should also study the past and look to the future by thinking the “unthinkable thoughts.” Today’s blog seeks to do exactly that. I am exploring the possibility of $1 per gallon gasoline. Like most prospectors and researchers, our work is a series of explorations, not of successful predictions. Whether we will ever see $1 gas is dependent on many of the variables to be discussed. As with successful prognosticators to the public, I should not predict both a direction and timing; but I suggest that if you choose to save these thoughts, it should be for your children or probably your grandchildren.

An incomplete list of the variables:

Taxes

No government that I am aware of will let a major stream of energy move from its source to its consumption without layering on taxes. (The main differences between our close to $4 price and Europe’s about $9 price for the same amount of auto fuel are the taxes imposed. There are some governments that subsidize the retail price, but find other ways to collect tax revenues.) Thus, the final price that we pay is dependent on tax distribution policies of host countries.

Technology

Due to my biases as a US Marine Corps communication officer, a securities analyst of tech companies, and most of all as a trustee in close contact with Caltech, I admit to being in awe of technology. Fundamentally, most forms of physical energy are found in nature and converted to power through various mechanical steps. Just as wars have spurred on the development of much of what is considered to be modern medicine and organizational management practices, I suspect that our exploration of space will lead to material changes in finding sources of energy, the extraction of energy as well as the processing, distribution and safe use of energy. Already, major oil deposits have been found through the use of manned and unmanned satellites. In order to accomplish our mission of exploring the planets, various remote techniques have been developed that deal with dangerous gasses and techniques for probing and “mining” from land surfaces. Some of the technological developments from space such as efficient payload management and global positioning systems (GPS) found use here on earth.

Technology is at work uncovering more efficient and safer ways of developing our natural resources; bringing into economic production energy sources that today look to be too expensive and too dangerous. Clearly we will utilize more fuel efficient vehicles on land, sea, and air in the future. Homes, offices, and manufacturing/processing plants will manage their usage of energy better. There are many other ways in which technology will both help give us more bang for our energy buck, and will also make us even more dependent on the increasingly efficient use of energy. Thus technology will affect both sides of the supply/demand equation.

Oil, natural gas, coal and nuclear

Ever since I first started looking at the economics and politics of energy in the 1950s, I have heard about reaching “peak oil production,” as we are not finding oil as fast as we are using it. I recall that some believed that we would have found all the oil the Earth had to give us by the 1960s. In each decade since, the peaking date has been reestablished, and in each decade more “juice” has been found. For both commercial and regulatory reasons, the size of these discoveries has been downplayed. Further, I suspect secondary drilling through the use of advanced technology will be more productive than is currently believed. In this season of heightened religious belief, I believe that there is more productive oil out there than most others believe, and a good bit of it in or near the US.

Natural gas was a waste product in the days of early oil production; it was just burned away at the wellhead. Through the use of technology and higher prices for oil, the governments and the people of the world have begun to appreciate the economic advantages of natural gas. We are addressing the concerns about fracking in terms of environmental dangers. Actually, at the moment we have too much natural gas, and this week we hit the lowest recorded price for this commodity in ten years. To me, it is only a matter of time and some technology until we have a significant expansion in the use of “NG” (No longer standing for Not Good, but for Natural Gas.) Thus, I see that the available supply of energy will rise and at some point impact the price of oil.

Coal

We are all aware of how dirty coal is. We are conscious of the dangers of manned mining and the effects of coal burning on our once pristine environment. Because of these issues and to some extent unwise government regulation, coal in all its forms has lost share of market. However, as a firm believer both in technology and the eventual power of economics, I do not think we have experienced the last of the beneficial use of coal on a global basis. In South Africa, I have seen the conversion of coal to oil to meet a politically-driven need, which demonstrates the creativity of some of the coal business leaders.

Nuclear

If you don’t want coal burning in your backyard do you want to have an atomic reactor quietly producing energy? The tragedies both in Japan and Russia were caused by faulty locations and poorly constructed facilities. Little publicity is seen on the safe use of atomic power in Europe, US, and elsewhere. After a period of twenty years, the US government has authorized the first new non-military use of a reactor. (The US Navy and others have been successful users of atomic power for a couple of generations.) Will procedures be developed to reduce the odds of fatal accidents? Yes.

Thus, I believe that with technology’s help, we have sufficient potential supply of energy.

The demand side

The Saudi Arabian government and others are vitally aware that the price of energy is, in the end, driven by demand. One of the best ways to measure the level of economic development in a country is to track its use of energy. (Some of the political leaders in China are more sensitive to the level of electricity use than they are to the softer calculation of GDP.) While the price for oil will have an impact as to the costs of a society to produce a particular standard of living, Saudi Arabia’s fear is that too high a price will drive substitution efforts even faster. On a long-term basis they should be worried. (As mentioned above, there are energy alternatives and technology is making them safer and cheaper.)

Habit changes

Slowly we are becoming more efficient consumers of energy. However, this is being offset by our growing demand to use more energy by our various appliances, including computer and entertainment devices. Some governments recognize that gradualism won’t work to bring energy demand into better balance. As an Easterner I hate to admit it, but the government of California has a useful idea. A recent Wall Street Journal article, entitled “California Declares War on Suburbia” suggests that a more efficient use of resources would be to gently move people into the cities, which is what is happening in China. Not only could this improve our use of energy, but could significantly improve the overall level of education and safety available within the cities. If it were to happen, then the number of energy consuming cars is likely to drop.

Two other considerations

Our current world is, as always, a balance of power. The current fulcrum of power is in the amount of energy that is produced both for internal and external use. If we had a world with a more balanced use of energy, various forces would likely cause changes of political leadership, and perhaps even the composition and identity of various countries. Many political leaders are not blind to these possibilities.

The second consideration is the monetary value of energy. At the wholesale level, energy today (particularly oil) is priced in dollars. This is a historic accident of past wars, economic development and relative stability of the value of the US dollar. At the moment, I believe the US society is committed to inflation, therefore at some point the rest of the world will wish to price things in dual, if not multiple currencies to protect from politically-inspired deficit spending by the US government. Thus, perhaps I should amend my search for $1/gallon gasoline to a level commensurate with about a $1700 per ounce price of gold.

Investment afterthoughts

Consider the following on how to put these thoughts into practice:

1. You should not bet that the price of oil will always be a good inflation protection.
   
   
2. Inflation is a product of global excessive spending relative to saving, and is likely to continue
   
   
3. View some of the large international oil companies as akin to investment banks. If they choose investment wisely within their circle of competence, they can have good results. (Interestingly, both international oil stocks and those of investment banks are low price/earnings ratio groups. The difference is that the oil companies have higher dividends and yields.)
   
   
4. Find technology producers that have a pattern of producing labor and energy saving devices, particularly those that can be applied to finding, extracting, transporting, processing, and using energy.
   
   
5. Watch for useful lessons from space activities in terms of uses of energy on earth.
   
   
6. Bet on increased urbanization, some of which will be cajoled by the government, which will lead to better primary and secondary education and safer streets.
   
   
7. While $1/ gallon gasoline is not an “odds on favorite,” it could happen and that may not be a good thing
   

Does any of this make sense to either discuss with your children/grandchildren or to pass it on to them at some future point?


Did you miss Mike Lipper’s Blog last week? Click here to read.

I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.

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