Oil – Looking Down the Barrel?

Creative Destruction

I remember the opening line of the book “The Third Wave” by Alvin Tofler, the futurist:
A new civilization is emerging in our lives and blind men everywhere are trying to suppress it.

He wrote the book many years ago, but that sentiment is still true. Blind men cling to the idea that buggy whips will always be needed, that we must continue to mine coal  in order to achieve energy independence. But the handwriting is on the wall – the world is rapidly embracing a new paradigm which will spur a multi-trillion dollar change in direction. If we see it coming before the blind men we can get in early as investors, entrepreneurs and citizens.

In an oft-quoted comment Wayne Gretzky, the superstar hockey player, said, “I skate to where the puck is going to be, not where it is.” That was the rare ability that made him such a dominant player. It is the same in investing and entrepreneurship. Those that are successful don’t just look at the existing landscape, they see future trends and paradigm shifts and creative destruction and new worlds emerging from the destruction. They see the phoenix dives into fire and rebirths. They see Vishnu, the Destroyer of Worlds, and Brahma, the Creator of new Worlds!

Optimum – A 5 -10 Year Investing Horizon

Of course how far you can see into the future has limits. For a comfortable and practical investing horizon lets take 5 – 10 years. This, I believe, is the optimum time for trying to predict the economic puck’s location. Also, as a side note, I think that if you want to invest in the stock market you must have a buy and hold mentality of 5-10 years. In-and-out strategies are guaranteed to lose money because you’re playing in a  rigged game against professional players armed with large data, analytics, special information and nano-second trading. It’s like a game of poker where they can see your hand but you can’t see theirs! The largest professional short-term traders make a very large percent of the Wall Street profit, and the counter-parties to these profits are losers in the zero-sum game, usually small investors, day traders, large pools of managed money and the like. A 5-10 year horizon, however, is not where the sharks are feeding and you have an excellent chance.

[In fact, a purely passive strategy of buying a large cap US index fund with low fees, like the DIA (the Dow Jones Index Fund), will provide you with great returns over a 5-10 year horizon. You will probably beat inflation by 5 – 7% and you will beat 95% of the Mutual Funds! All this without lifting a finger. I keep repeating this in my blogs and for most investors this may be all the advice they need.]

But suppose you have insights about the puck as it is likely to be in 5-10 years. You can make better investment decisions. The trends for this time frame are beginning to become apparent but are not yet fully appreciated or widely acted on, making them an opportunity.

Death Watch

In the 5-10 year time frame the following large sectors should be on a Death Watch list

  • Oil, Coal, Gas – Fossil Fuels
  • Banks, Brokerages, Investment Houses, Financial Institutions.
  • Insurance Industry including Healthcare Insurance providers

These industries (and others) are in the early throes of an extinction spiral – not yet apparent to everyone. In 5 years it will be apparent to a lot of people but we want to act now before everyone bails.

In this blog let’s focus on the Oil, Gas and Fossil Fuels industry. We can hopefully take on the others in future blogs. Stay tuned.

Grim Reaper

To the blind men it looks like the oil and coal industries are essential to the world’s energy needs and will remain a part of a balanced investment portfolio. The US Energy Information Administration (EIA), which  makes official forecasts several decades out says in its 2016 report that in the year 2040 petroleum and other fossil fuels will still constitute 78% of the world’s energy use.

Here is their Summary:

“Even though consumption of nonfossil fuels is expected to grow faster than consumption of fossil fuels, fossil fuels still account for 78% of energy use in 2040. Liquid fuels—mostly petroleum-based—remain the largest source of world energy consumption, the liquids share of world marketed energy consumption will go from 33% in 2012 to 30% in 2040.  Coal, the world’s slowest-growing energy source, rises by 0.6%/year.

Solar will be the fastest growing at 9% per year, but still not enough to change the landscape much by 2040.”

This is so bad a prediction that it should qualify for malpractice in forecasting! Talk about the blind men! Solar is already producing more in 2017 than they predicted for 2020. In fact if you look at an internet article on solar predictions that is 6 months old it already feels woefully obsolete. Wikipedia predicted in mid 2016 that India will have 6 GW of solar by year end. The real number on Dec. 31, 2016 was more than 9 GW.

In fact solar will grow more than 25% per year! It will generate twice more energy in 2025 than the EIA predicts for 2040. The contribution from oil and coal will dive precipitously, down to virtually buggy whip levels.

Take this report, much more on the button from the insiders in the field. It says:

Cumulative solar PV capacity will double every 24 months. Since the inception of solar, there has been a total of 320 GWp built. Within the next two years, this total capacity will be doubled. In the next 4 years there will be 4 times as many solar installations.

Therefore, in 2018, there will be ~640 GW of PV installed and the industry will need to employ up to 5 million people. By 2020, there will be ~1,280 GW installed and possibly 10 million people employed.

At the same time, costs of PV panels will continue to drop, so PV electricity will be cost competitively in more and more local markets.

Here’s a visual cue to the future of energy as the deeper predictors see it. Green means significant or growing, Yellow stagnant and Red declining.

Energy Outlook

The oil industry (or the fossil fuel industry more generally) has a lot of champions, including the blind men in our current government. They are building a huge wall. Its  cost is trillions of dollars, not just billions. And you, not Mexico, will pay for it!

The Wall

wall of liesThe big wall that the oil/coal industry has built is one designed to keep facts out, bottled behind the wall. But for how long? Very soon the facts will build up, form an inexorable force and break the wall.

Here the the inconvenient facts that are blocked by this wall:

  • Global Warming is real. It is exacerbated by human fossil fuel burning and is not just part of the natural earth cycle. Moreover it can and will be economically addressed, creating new businesses and meaningful jobs. The whole world is on board with this. In the US there is deliberate disinformation being spread using enormous sums of money from entrenched fossil fuel interests and feckless politicians
  • There is also huge non-carbon pollution from the burning of oil and coal. It’s choking the air with toxic particles, pumping mercury and other pollutants into rivers, causing aquifer degradation and methane etc from fracking. (In New Delhi, India, for example where I was last winter, the air is unbreathable. Lung cancers are growing. Children are developmentally arrested. All from oil-burning cars and coal-burning plants nearby).
  • Oil has gigantic, civilization-destroying geo-political costs. Oil is the lifeblood that feeds the tumor of terrorism and causes us to engage with dreadful countries like Russia, Venezuela, Iraq and Saudi Arabia. If you really want to win the war on terror no need to “bomb the shit” out of the Middle East. Just get off oil.
  • Fossil fuels are no longer the economical solution for the world’s energy needs and a growing, thriving world economy. We don’t need to trade off growth and material well being against poisoning ourselves or being beholden to Russia and Saudi Arabia. This is because we have, for the first time, very viable and less expensive green options.

Of all of the above facts the one that will be most decisive is the last.

Solar is on Moore’s Law Journey

Already alternative green tech like solar is at parity with oil at $50/barrel in much of the world. This is true even when we do not recognize the true cost of fossil fuels by subsidizing them, not attributing CO2 costs to them, or terrorism-fighting losses to them. But solar power, in particular, is seeing an exponential reduction in cost. In ten years (or sooner) it will beat oil even at $10/barrel. And a big enabler of this green, plentiful and inexhaustible energy source is batteries. Great strides are being taken in solving the battery road block and soon solar will ride the Moore’s Law exponential curve. It is in the early stages of this exponential ride which could go on for decades. See my article on why Tesla, at the vanguard of the battery business,  will be a trillion-dollar company in 10 years.

The consensus among the energy industry Gretzkys, those who see the puck 5-10 years from now, is that we will leave up to 80% of all our oil and coal in the ground. This makes a lot of sense in bending the carbon curve while building a new economy with good jobsThink about it: we should value much of the oil reserves of oil companies at zero! I’m sure this sounds extreme but this is emergent reality.

I’m not including any Black Swan events in this prognostication which can further speed us into an alternative energy future. Black Swan events are by nature unpredictable so I don’t know what they’ll be. It’s still fun to speculate. Could it be a new revolutionary battery? Artificial photosynthesis? Genetically modified bacteria? Graphene-based semi-conductors?

We know with much forecasting certainty that the fossil fuel industry is headed to the gallows.

The oil stocks are already beginning to reflect a persistent malaise. For sure our current administration is going to fight this trend. They will deny all mention of CO2 harm, they will eliminate environmental protections, they will cut funding for green energy research and  subsidies. Even more, I predict they will try to sell off federal lands to oil interests in fire-sales, with subsidized mineral rights to big oil and coal interests. None of this will work for long. Reality is a formidable opponent.

A couple of weeks ago (on March 19th, 2017)  Dr. Ernest Moniz, the Energy Secretary under Obama was on Fareed Zakaria’s excellent CNN program, The Global Public Square, or GPS. He said that the Paris Accords were not just an agreement among countries to limit their emissions to specified levels. The main outcome of the Accords was a commitment to building shared new technologies and products toward a renewable energy future. Technologies such as new kinds of batteries, new integration of solar panels into building materials, new standards to allow uniformity and compatibility of products, improvements in Balance of Systems for solar. Also, offshore coastal grids for transmitting wind and solar power from ocean sites, and a host of other engineering innovations.

This will spawn a spate of new, well-paying and meaningful jobs. In manufacturing, construction, management, accounting, scientific research and even new art and literary expression. If the US signs out of this we cease to be a prominent player in this multi-trillion dollar emerging sector. The leadership will go to China, Germany, India and other committed countries. And our jobs will migrate out no matter how much global trade we ban.

From this perspective it makes little sense to invest in the fossil fuel industry. Losers will include large oil conglomerates, oil services companies, pipelines, coal interests and even the fracking and natural gas companies. It is interesting that pipeline partnerships such as Energy Transfer Partners have fallen in price despite support from the Trump administration and even when oil had a (dead cat) bounce. Dear TransCanada – sorry, the Keystone pipeline is not going to be killed by environmental concerns alone, you will be dead because we don’t need another 800,000 barrels of oil per day.

How to Invest

What is the best way to invest with a 5-10 year horizon? The passive purchase of the Dow Index Fund (DIA) or equivalent S&P 500 ETF remains the best approach for most. I know that the Dow 30 stocks have Oil/Gas, Financials, Brokerages as components. Still the 30 stocks are selected and monitored by very smart people  and they will most likely get out of dying sectors before the inevitable.

If one has a stomach to be somewhat more proactive, I would create my own large cap “Modified Dow”. It  would consist of all Dow stocks except  ExxonMobil, Chevron, Goldman Sachs, JP Morgan Chase, Travelers and American Express. I  would add in Tesla, some other tech stocks,   like Amazon, Google (Alphabet), even  Salesforce,  and some tobacco including a couple of international  giants, like British Tobacco. Throw in a progressive utility or two like Duke (active in green energy).  Also Tencent (SEHK) – a Chinese company that just bought a 5% stake in Tesla. The Chinese see the value of clean energy that is why they are requiring that companies that want to sell electric cars in China hand over their battery technologies! I hope we don’t give away our tech edge – now that would really be a bad trade deal.

I would buy equal number of shares of all on my list and not touch this for many years. Reinvest dividends.

This is not really an investment advice column. I’m stating a macro level view and guessing where the puck will be in about a decade. It’s purely a sharing of a personal perspective.

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5 Responses to Oil – Looking Down the Barrel?

  1. akhil kumar says:

    Glad to see you’re back. Terrific post! Very insightful and helpful. I am reading Tom Friedman’s latest book and it has some interesting insights. He is optimistic though he finished the book before Trump. A Moore’s Law path for solar may be a stretch! The next 4 years will be rough.

    • The next four years will be rougher than if we had a clean fuels policy. But the world is committed and the economic, not political, imperatives of solar will win out. I don’t find it unreasonable for solar to grow 4-fold.

  2. Jay Sethuram says:

    Good analysis on fossil fuels. I also think that there is a tremendous future of hydrogen economy. Hydrogen is a highly renewable energy and in many ways better than solar and wind. Only issue that needs to be solved is the safety and storage of hydrogen. On the global warming equation, it is true that burning fossil fuels is a contributor to it but if you look at the graph of CO2 emissions, there is a good correlation with world population growth. I wonder how much of the CO2 from humans and animals in general contributes to the total CO2 emissions.

  3. Jay, thanks for the comment. I see hydrogen as a means to deliver the energy, a carrier – not as a primary source of energy because it does not occur naturally. It would require energy to isolate the hydrogen which can then be burnt to power things. So you could use solar generated electricity to produce hydrogen via electrolysis say, which could be burnt to run cars. Or you would use heat to isolate hydrogen from hydrocarbons in a process called reforming.

    Population growth is a factor. But reducing industrial pollution will go a fairly long way.

  4. addiprimus says:

    All things must come to an end. That is a true-ism. The age of petroleum will eventually come to an end, as will the current Mlikanovitch Cycle, man, the sun, the stars, the Universe. But how does that help anyone invest any differently? If I can ride out an oil and gas producer for less than the present value of its future discounted dividends, why should I do anything differently? I get the margin of safety concept in buying a capital compounder, but capital compounding is moreso idiosyncratic to the management itself, not an entire industry!

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