Monday, June 23, 2008

Has the U.S. Become Less Relevant on the World Stage?

As I was channel flipping today, I caught CNBC's Jim Cramer making a good point. He was asked whether or not coal was a good investment given the uncertainty about the development of "clean coal" technology in the U.S. His response was that coal is a great investment and what the U.S. does or doesn't do is irrelevant. He pointed out that China is no longer exporting coal and will fuel demand with or without the U.S. market.

It was later pointed out that India is currently constructing the world's largest gas refinery, which will come online before the end of the year. The U.S. may be unwilling to build more, so India is taking full advantage of the void. While we enter our third decade of discouraging domestic oil production, Brazil and Canada are developing huge new finds and using technology to exploit known reserves.

The U.S. once set the pace of progress around the globe. Now we are so paralyzed by the smorgasborg of fears fed to us by politicians and the media that we are like a very large corporation. We're able to institutionalize and tweak existing ideas at the margins, but we're losing our ability to make dramatic leaps forward. We are so afraid of making a mistake that we wont take anything but baby-steps in any direction, right or wrong. There are lots of great automobile designs being pursued by individuals and small companies across this country, but by the time they pass muster for mass production, they will likely be obsolete. Someone in some other country will have leap-frogged the U.S. market.

The only industry that the U.S. has not regulated into stagnation is information technology. At least when we officially pass the mantel of entrepreneurship to another country, we'll be among the first to know.

This is not a doomsday scenerio, just an observation. Large, non-agile entities have an important role in any economy. They preserve and extend the life of existing ideas until they are no longer viable. They ensure that we exploit things to their fullest before we dispose of them. They must be complimented however, by smaller, more agile risk takers for a robust economy of ideas to thrive. How many bad songs are produced for every great one? On the other hand, how many great songs would be produced if every piece of music had to be pre-approved by a panel of experts?

Conservatism creates demand for innovation. Innovation leads to ideas that warrant conservation. For both to exist, each must recognize the value of the other and not set out to dispense with one or the other. If the U.S. is going to be Yahoo, somebody has to be Google. If the U.S. is going to be Microsoft, somebody has to be Apple.

We will become what we become. While we do so, we should let India be India, China be China, Singapore be Singapore, Saudi be Saudi and not try to impose some kind of international economic order on the controlled chaos. That's not to say we shouldn't champion individual rights and freedoms. Free association of individuals in the absence of force is another critical component to a thriving world economy. But if we are going to progress, we have to allow risk takers to be risk takers.

Restricting the development of ideas is like restricting the gene pool. Nothing good will come from it.

Saturday, June 14, 2008

Windfall Profits Tax

In what seems like the latest episode of "Back to the Future" or "That Seventies Show" Barak Obama and friends are proposing a new "windfall profits" tax on oil companies. Never mind that nobody can actually define what a "windfall profit" is. The idea is to imply that there is a certain level of profit that is simply unacceptable and must be stopped.

The idea has come about due to record oil prices and record profits being posted by the likes of Exxon. They never mention the fact that Exxon's return on investment is almost half of what the government takes, with zero investment being made on their part. Yet a 9% return on investment is touted as obscene, while the government's 15% take still isn't enough.

What would be the impact of a windfall profits tax? We don't have to wonder. It's been done before. Essentially you're telling the oil companies that while there downside risk is unlimited, their upside potential will be capped at a level deemed appropriate by the government. Why in the world would one put big money at risk for exploration and development under those conditions? Of course, once you reach the level of “windfall profit” there is zero reason to do anything to become more efficient or increase productivity. Once you’ve made your quota, you might as well send everyone home, shut everything down and take the rest of the year off. At a time when we are ever increasingly dependent on foreign oil from countries who don't like us very much, we're going to bend over backward to make sure we don't produce any more at home.

Believe it or not, oil company execs and shareholders are not genetically compelled to produce oil. If there's easier money to be made elsewhere, they'll take their talents and resources elsewhere. That's exactly what happened the last time we tried windfall profits taxes and price controls, and it's exactly what will happen this time.

Politicians don't want you to be energy independent. They want you to be government dependent. They are once again taking an opportunity to demonize the producers in a bid to gain more control over resources. They want to be the gatekeepers, the power-brokers. Now, I'm sure some are well intentioned, just ignorant, but the result will be the same.

I don't know that the big shift to the left can be avoided in the short term. I do believe it will be reversed in the long term, because it can't and wont work. It never has. It never will. The folks who run the post office, Amtrak and the DMV cannot outperform the free market. I guess we just have to learn by demonstration once again. The good news is that ten years from now, some upstart will push through a package of massive tax cuts, privatization and deregulation.

The more things change, the more they stay the same.

Monday, June 9, 2008

The Chevy Volt - Where Will it Take the Market?

Chevy is going full tilt into the electric car market with mass production of the Chevy Volt scheduled for 2010.

Actually, it's a hybrid, but it can be recharged by plugging in to a regular wall socket. It's a good start, and it can kick-start the rest of the market into high gear if demand is strong.

It could also impact the energy market in a big way. Consider that the federal government taxes gas to the tune of about 18 cents per gallon. State governments tack on even more. California's gas tax is a whopping 69 cents/gallon. In total about 15% of the price of gas goes to the government (by comparison the greedy oil companies net is about 4%). The big conflict between the government and the advent of electric vehicles is: How do you keep that revenue flowing?

What if electric vehicle technology goes fully electric? You can already buy home wind generators at Sam's Club and other retail outlets. What if you could power your car without even going on the grid?

The folks who stand the most to lose by a change in the status quo are not the oil executives, it's government; here and abroad. Producers will find something else to produce. Government produces nothing. It must find a new way to take.

There are a few ways things could go. First, we could see a resurgence in privately owned and operated roads. Toll roads could become much more common as revenues from pumping gas decline. This option makes too much sense, so is the least likely. Too much of the money flow would come out of the hands of Congress. Since controlling cash flow is where all of their power and influence comes from, they'll never go for it.

The government could dramatically hike taxes on electricity, but that would only encourage more private generation. They could tax generators, but I don't think the public would go for it, and it's too easy to get around.

The most likely scenerio is a dramatic drop in the price of crude well before the mass production roll out. Once politicians realize the threat, they'll suddenly come around to drilling in Anwar, off the coast and elsewhere to deal with our "energy emergency", yes, even the left will find some pragmatic justification for their 180 degree swing. This will just be cover. There really is no short-term supply crunch. We just let too much of the supply fall under the control of OPEC and friends. There is still plenty of untapped oil in the ground. Just as the falling dollar and demand in China and India have been used to explain the run up (as if the dollar fell 80% and/or demand in China quintupled in 18 months) the perception of increased supply will be used to explain the precipitous fall in the price of crude.

I don't know if it will work. There are a number of promising technologies that may well be able to compete with $28/barrel oil. Timing is key. If oil falls fast and far enough, a lot of investment dollars could come out of alternatives. If the players wait too long, they wont be able to get the genie back in the bottle.

Monday, June 2, 2008

The May Surge in Oil Prices

Oil has been on the rise for some time now, but in May it accelerated a bit, up about 15% for the month. What happened? Did demand suddenly spike? Did supply drop? Was there manipulation?

Actually, I believe I put my finger on it this morning as I watched a commercial for $2.99 gas, guaranteed for three years when you buy certain new cars. If I were a CFO for a car company considering making such an offer, what would I do? Well, you may be on the hook for some big losses if gas continues to go sky high. But, you can offset that potential expense by buying oil and gas futures. I suspect that the car makers went to the market before and during this promotion and purchased as many oil and gas contracts as they felt they needed, to hedge against losses due to the offer. Smarter speculators than me would have realized this much earlier on and taken advantage by increasing their own positions, so you get a short term spike in demand and prices.

The good news is that given the behavior of oil prices in recent days, it looks like they're close to meeting their reserve requirements.