Global Market Comments – SPECIAL ENERGY ISSUE

Friday, April 8, 2010

As a follow up to my trade alert for Macro Millionaires to buy the double leveraged oil major ETF (DIG), I thought you’d like to know what my second choice was. There are a lot of belles at the ball, but you can’t dance with all of them.

While a student at UCLA in the early seventies, I took a World Politics course which required me to pick a country, analyze its economy, and make recommendations for its economic development. I chose Algeria, a country where I had spent the summer of 1968 caravanning among the Bedouins, crawling out of the desert half starved, lice ridden, and half dead.  I concluded that the North African country should immediately nationalize the oil industry, and raise prices from $3/barrel to $10.  I knew that Los Angeles based Occidental Petroleum (OXY) was interested in exploring for oil there, so I sent my paper to the company for review. They called the next day and invited me to their imposing downtown headquarters, then the tallest building in Los Angeles.

I was ushered into the office of Dr. Armand Hammer, one of the great independent oil moguls of the day, a larger than life figure who owned a spectacular impressionist art collection, and who confidently displayed a priceless Fabergé egg on his desk. He said he was impressed with my paper, and then spent two hours grilling me. Why should oil prices go up? Who did I know there? What did I see? What was the state of their infrastructure? Roads? Bridges? Rail lines? Did I see any oil derricks? Did I see any Russians? I told him everything I knew, including the two weeks in an Algiers jail for taking pictures in the wrong places. His parting advice was to never take my eye off the oil industry, as it is the driver of everything else. I have followed that advice ever since.

When I went back to UCLA I told a CIA friend of mine that I had just spent the afternoon with the eminent doctor (Marsha, call me!). She told me that he had been a close advisor of Vladimir Lenin after the Russian Revolution, had been a double agent for the Soviets ever since, that the F.B.I had known this all along, and was currently funneling illegal campaign donations to President Richard Nixon. Shocked, I kicked myself for going into an interview so ill prepared, and had missed a golden opportunity to ask some great questions. I never made that mistake again.

Some 40 years later, while trolling the markets for great buying opportunities set up by the BP oil spill, I stumbled across (OXY) once more (click here for their site). (OXY) has a minimal offshore presence, nothing in deep water, and huge operations in the Middle East and South America. It was the first US oil company to go back into Libya when the sanctions were lifted in 2005. (OXY’s) substantial California production is expected to leap to 45% to 200,000 barrels a day over the next four years. Its horizontal multistage fracturing technology will enable it to dominate California shale. The company has raised its dividend for the eighth year in a row, by 15% to 1.60%. Need I say more?

The clear message that has come out of the BP oil spill is that onshore energy resources are now more valuable than offshore ones. I decided to add it to my model portfolio. Energy is one of a tiny handful of industries I am willing to put my money in these days (technology and commodities are the others), and BP has handed me a rare opportunity to get in as the tightwad that I truly am.

Oh, and I got an A+ on the paper, and the following year Algeria raised the price of oil to $12.

A Faberge Egg

I received some questions last week on my recent solar pieces as to whether I minded paying more money for “green” power. My answer is “hell no,” and I’ll tell you why. My annual electric bill comes to $1,500 a year. Since the California power authorities have set a goal of 33% alternative energy sources by 2020, PG&E (PGE) has the most aggressive green energy program in the country (click here for “The Solar Boom in California”). More expensive solar, wind, geothermal, and biodiesel power sources mean that my electric bill may rise by $150-$300 a year.

Now let’s combine my electricity and gasoline bills. Driving 15,000 miles a year, my current gasoline engine powered car uses 750 gallons a year, which at $4/gallon for gas costs me $3,000/year. So my annual power/gasoline bill is $4,500. My new all electric Nissan Leaf (NSANY) will cost me $112/year to cover the same distance (click here for “Getting Something for Nothing”). Even if my power bill goes up 20%, as it eventually will, thanks to the Leaf, my power/gasoline bill plunges to $1,912, down 57%.

There is an additional sweetener which I’m not even counting. I also spend $1,000/year on maintenance on my old car, including tune ups and oil changes. The Nissan Leaf will cost me next to nothing, as there are no oil changes or tune ups, and my engine drops from using 400 overcooked, severely stressed parts to just five. We’re basically talking tires and brake pads only for the first $100,000.

And battery life? The intrepid magazine, Consumer Reports, just put a ten year old Toyota Prius through its paces and found the battery performance was identical to the new model.

There is a further enormous pay off down the road. We are currently spending $100 billion a year in cash up front fighting our wars in the Middle East, or $273 million a day! Add to that another $200 billion in back end costs, including wear and tear on capital equipment, and lifetime medical care for 3 million veterans, some of whom are severely torn up.

We import 9.1 million barrels of oil each day, or 3.3 billion barrels a year, worth $346 billion at $105/barrel. Some 2 million b/d, or 730 million barrels/year worth $77 billion comes from the Middle East. That means we are paying a de facto tax which amounts to $137/barrel, taking the true price for Saudi crude up to a staggering $242/barrel!

We are literally spending $100 billion extra to buy $77 billion worth of oil, and that’s not counting the lives lost. Even worse, all of the new growth in Middle Eastern oil exports is to China, so we are now spending this money to assure their supplies more than ours. Only a government could come up with such an idiotic plan.

There is another factor to count in. Anyone in the oil industry will tell you that, of the current $105 price for crude, $40 is a risk premium driven by fears of instability in the Middle East. The Strategic Petroleum Reserve, every available tanker, and thousands of rail cars are all chocked full with unwanted oil. This is why prices remain high.

The International Energy Agency says the world is now using 87 million b/d, or 32 billion barrels a year worth $2.6 trillion. This means that the risk premium is costing global consumers $950 billion/year. If we abandon that oil source, the risk premium should fall substantially, or disappear completely. What instability there is becomes China’s headache, not ours.

If enough of the country converts to alternatives and adopts major conservation measures, then we can quit importing oil from that violent part of the world.  No more sending our president to bow and shake hands with King Abdullah. Oil prices would fall, our military budget would drop, the federal budget deficit would shrink, and our taxes would likely get cut.

One Leaf shrinks demand for 750 gallons of gasoline, or 1,500 gallons of oil per year. That means that we need 20.4 million Leafs on the road to eliminate the need for the 2 million barrels/day we are importing from the Middle East. The Department of Energy has provided a $1.6 billion loan to build a Nissan plant in Smyrna, Tennessee that will pump out 150,000 Leafs a year by end 2012. Add that to the million Volts, Tesla S-1’s, is Mitsubishi iMiEV’s hitting the market in the next few years. Also taking a bite out of our oil consumption are the 1 million hybrids now on the road to be joined by a second million in the next two years. That goal is not so far off.

Yes, these are simplistic, back of the envelop calculations that don’t take into account other national security considerations, or our presence on the global stage. But these numbers show that even a modest conversion to alternatives can have an outsized impact on the bigger picture.

By the way, please don’t tell ExxonMobile (XOM) or BP (BP) I told you this. They get 80% of their earnings from importing oil to the US. I don’t want to get a knock on the door in the middle of the night.

Is This Worth It?

“We have been pretending that we’re too big to fail. We’re not too big to fail, You can jump off of a 90 story building and feel fine for the first 89 stories. It’s the sudden stop at the end that tells you you’re not.” said Tom Friedman, New York Times columnist and author of Hot, Flat and Crowded.