The day fast approaches when Greece will ditch the euro, default on its debt, and leave Europe to deal with Italy and Spain. And the fall of the European centrists is nigh. But before we get to that, we want to begin another week of reckoning with a practical investment observation about energy.
A lot of readers have sent a link to this article by the Telegraph’s Ambrose Evans Pritchard. His article talks about the resurgence of America as a global power in the 21st century. He paints a picture in which manufacturing moves back “on shore” in America. And most importantly, he paints a picture of real energy independence (from Middle East oil) thanks to shale gas.
Some of the facts were new to us. For example, did you know the United States was the largest single contributor to global oil supply growth last year? US oil output grew by 395,000 barrels per day last year, mostly thanks to the Bakken oil fields in North Dakota. The same technology used in shale production is leading to enhanced oil recovery from unconventional sources.
But the main argument of the piece is not that different than the one we made earlier this year in Revolution in the Desert. Our argument there was that shale gas would change the world’s balance of energy power. It would allow some countries to become less dependent on oil imports from the Middle East. Other countries could exploit abundant unconventional natural gas supplies to retire their coal-fired power plants, build petrochemical industries, and power industry.
A New York Times story in late October called New Technologies Redraw the World’s Energy Picture elaborates (emphasis added is ours):
From the high Arctic waters north of Norway to a shale field in Argentine Patagonia, from the oil sands of western Canada to deepwater prospects off the shores of Angola, giant new oil and gas fields are being mined, steamed, and drilled with new technologies. Some of the reserves have been known to exist for decades but were inaccessible either economically or technologically.
Put together, these fuels should bring hundreds of billions of barrels of recoverable reserves to market in coming decades and shift geopolitical and economic calculations around the world. The new drilling boom is expected to diversify global resources away from the Middle East, just as the growth in consumption of fuel shifts from the United States and Europe to China and India and the rest of the developing world.
The biggest wild card for the future of oil and gas may be shale and other tight rocks. Finding and producing hydrocarbons from these rocks has taken off in the United States with such velocity that is already significantly altered government and corporate energy expectations….Shale gas production in the United States is more than five times as great now as in 2006, and the country surpassed Russia as the world’s largest gas producer in 2009.
Big “wild cards” can also be big investment winners. The three shale-related shares we’ve recommended to readers of Australian Wealth Gameplan are up 41%, 41%, and 42% respectively. Two of those were recommended in late June and during that same time, the All Ordinaries is down 5.61%, as of Friday’s close. The other we recommended back in early February. Over the same time the All Ords are down 12.62%.
Those aren’t exactly “big” gains. Not yet anyway. But as we wrote to our readers on Friday, your best strategy in a range-bound market that’s subject to volatility from random intervention is to find, if you can, investments that aren’t correlated to “the market”.
In this case, these recommendations are speculations. The companies are trying to determine how large the shale gas resources are on the permits they’ve been granted. And they’re trying to determine if that gas can be produced economically (given East Coast gas prices) and converted into a reserve. Like all exploration and development projects, a lot can go wrong.
And none of that includes a discussion of whether these potential energy resources are politically accessible, much less economically or technologically. Australia is becoming increasingly hostile to minerals and energy development. This is not unrelated to the government running a budget deficit that is getting harder and harder to turn back into a surplus.
But that’s why it’s called risk! It would be nice if uncertainty about the political environment didn’t weigh on shares. But you can’t wait for perfect conditions. Alex Milton from NovaPort Capital put it this way in an October 31st interview in the Australian Financial Review:
If you can find a small company with good management, a good balance sheet, favourable industry conditions, some sort of competitive advantage, then the chances are over time it will be a meaningfully larger company regardless of what the stock market is doing over that period.
Having vast energy resources is a competitive advantage, even in a world that’s going to spend several years (decades) paying down debt and reducing consumption. That’s why Milton and his partner Sinclair Currie took a punt on one of the shale shares we recommended earlier this year. Currie says:
What management have done there, which has been very impressive, is they’ve thought outside the box in terms of investing into the potential for non-conventional gas in the Cooper Basin…You’ve seen in the US non-conventional oil and gas has become a huge growth industry. Beach Energy saw that technology had made a difference and was one of the first to bring that over to Australia and have a go.
What could be more Australian than having a go? Australia would enjoy a big strategic and economic boost if it can figure out how to develop its vast energy resources. In a world laid low by the Credit Depression, having abundant and cheap energy is a great foundation for the next stage of global growth.
In fact, Europe’s financial crisis is a case study in how resource wealth will be more important in the next 50 years than financial wealth. Europe is losing economic power and control of its own political destiny because of its large government debt problem and its unsound money. Europe also imports its gas from Russia and its oil from the North Sea and Africa. This makes it vulnerable to countries that have accumulated savings and vast energy resources.
The question in Australia is whether the development of unconventional energy resources is going to be completely derailed by the political hysteria over coal-seam gas (CSG) and hydraulic fracturing. There’s certainly a debate to be had over how the industry should expand in balance with food security, water safety, and energy security. But we’re certainly not having a debate yet. Keep in mind that CSG has been safely producing electric power in Queensland since 1996.
While Australia wrestles with its energy future, Europe is one step closer to facing the reality that top-down central planning is a failure. The G-20 summit of political leaders in Cannes last week failed to produce an agreement that would help Europe out of its mess. Greece is set to have a new government. But is anything resolved?
The G-20 summit revealed the absurdity of Europe’s situation. The October 26th plan that led to a huge rally in markets had three components: the resolution of the Greek problem, the recapitalisation of Europe’s banks, and a mechanism to fund the European Financial Stability Facility (EFSF). Since the 26th, all three components have fallen into general disarray.
Take the EFSF. It’s an unfunded bailout fund. The institutions that CAN fund it – China and the IMF – don’t want to. And the institutions that can’t fund it – the bankrupt governments of Europe – don’t want to either. Any bailout fund that must borrow money in order to lend money is bound to fail when no one has any money to lend to begin with.
Then there’s Greece. Under the October 26th plan, Greece’s creditors would accept a 50% write-down in their bonds. The Greek people – who were denied the right to consent to their own servitude – would endure painful years of austerity, lower pensions, a higher retirement age, and less government spending (all of which are probably a good idea anyway). In exchange, Greece would stay in the Euro.
But why should Greece stay in the Euro if the cost is years of lower living standards? There are 27 nations in the European Union yet only 17 of them are in the currency union that uses the Euro. Can’t Greece remain in Europe but ditch the Euro?
Of course it can! It can withdraw from the currency union, revert to the Drachma, default on its debt in an orderly way, and pay back creditors after devaluation. A devaluation of its currency is exactly what Greece needs to pay down its debts and become more competitive.
But Greece cannot devalue the Euro as a member of the currency union. This is the drawback of currency union finally exposed – lack of flexibility when managing a national economy, not to mention loss of sovereignty. The answer is simple: Greece should leave the Euro, devalue and then default.
Would the world end? Probably not. It would free Europe to focus on the banking systems and countries that really are too big to fail: Spain and Italy. And just think…if Greece leaves the Euro and defaults…it would provide the financial markets with enough certainty to rally by ten or twenty percentage points by the end of the year. And we could postpone Italy’s reckoning until next year.
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