The Energy Paradox: More Is Less

Includes: CBI, CHN, GLD, SLV, USO
by: Dr. Stephen Leeb


Whether for unconventional oil or to protect the conventional sources, energy has placed a major albeit largely invisible break on worldwide economic growth.

Global annual growth in energy demand this century has run at roughly 2.4 percent, at the high end of prevailing ranges since 1973.

From 2000 through 2013, the world directly invested roughly $16 trillion in real dollars in global energy supplies; annual direct investments more than doubled in that period.

Lately investors can rightly wonder why oil prices have not spiked in the wake of all the geopolitical troubles-especially in Iraq. However horrific the human cost and suffering, as long as the oil fields do not come in the direct line of fire, while the oil market may get a little nervous, no one will panic. The current fighting in Iraq may not immediately affect energy prices, but longer term there will be a price to pay. The price may not be easy to quantify-events may not even reduce oil production-but it will be a price all the same.

Indeed, we already pay these sorts of prices. Whether for unconventional oil or to protect the conventional sources, energy has placed a major albeit largely invisible break on worldwide economic growth. Moreover, this break on growth stands only to increase in coming years. Thus investors must construct their long-term portfolios to benefit.

Most investors have grown up thinking it smart, indeed essential, to broadly diversify their portfolios. But times, and investing imperatives, change. Today, broad-based diversification no longer functions as the main or only key to safe and sure returns. Portfolios additionally must focus on capturing gains from two inevitable trends: rising energy costs and the inescapable need to buy energy in hard currencies that cannot be created from thin air-in other words, gold and gold correlated assets.

Plainly, a host of statistics show, obtaining energy grows ever more costly, especially given the indirect costs that accompany the direct ones.

For example, according to remarkable recent data compiled by British Petroleum (NYSE:BP), global annual growth in energy demand this century has run at roughly 2.4 percent, at the high end of prevailing ranges since 1973. Even in 2008-09, when world gross economic product was shrinking, energy demand grew by nearly 2 percent a year. By contrast, for the last 13 years of the previous century, annual energy consumption grew at only 1.4 percent.

Couple this with the tech plunge that inaugurated this century, plus the most devastating global recession since the 1930s, which began in late 2007. According to the World Bank, during this period, global GDP growth climbed at only 2.5 percent annually, its lowest level for any 13-year stretch since at least the end of World War II. I cannot but conclude: it takes more energy to generate growth than at any other time in modern history and the entire world pays to generate all this extra energy. The situation looks likely only to worsen.

Another striking statistic: according to the International Energy Agency (IEA), from 2000 through 2013, the world directly invested roughly $16 trillion in real dollars in global energy supplies. Moreover, the yearly direct investments more than doubled in that period, from about $700 billion in 2000 to $1.6 trillion in 2013. The world needed to increase its energy investment simply to permit the global economy to march in place, as clearly this spending did not increase economic growth. Indeed, if energy investment had instead remained relatively constant, average annualized growth in gross world economic product would have been some 0.15 percent higher per year and equal to that of other recessionary periods. All the extra spending on energy, however, has accompanied the lowest global growth since World War II.

These expenditures include everything from fuel tankers to pipelines to transmission grids to barges-all to produce raw materials and deliver them in needed forms. Moreover, these extraordinarily high costs very likely understate the true costs. For example, to supply energy requires a great deal of water. Even if the direct water costs are included, the costs of selective water shortages are probably not, as these in turn cause higher prices for everything from food to extinguishing forest fires. Also true: ever-growing need for expenditures to protect existing sources of energy, such as oil-producing assets in Saudi Arabia.

Moreover, China's emergence hardly explains things, considering the idea of "energy intensity." This means how much energy is associated with each dollar of GDP; and since 1990, the number has been declining and is now more than 15 percent lower than peak intensity reached in 1990. In other words, the world as a whole, including China, uses less energy per unit of GDP today than it did one, two, and three decades ago.

It might seem counterintuitive that energy intensity is declining even as the amount of energy growth associated with GDP growth is increasing. That is, how can we spend more on energy despite the increase in global energy supplies, but use less energy to generate GDP? The explanation: it takes increasing amounts of energy to get energy.

For example, when a car gets 30 miles per gallon of gasoline, rather than 20 miles, that represents a decline in energy intensity. Meanwhile, however, it takes more and more energy to produce each gallon of gasoline than in the past. The net effect: the greater fuel efficiency is overwhelmed by the extra energy required to produce the gasoline.

And this is happening on a large scale. It is taking ever more energy to produce the energy needed to generate our GDP. The gain in energy growth goes along with the sharp increase in energy expenditures and relates to the ever growing difficulty of finding sufficient energy-much less the ever greater amounts of energy to produce energy. As economists would put it, energy return on investment (EROI) has declined sharply.

The data and abundant anecdotes and headlines-increased fracking, deeper drilling, etc.-all suggest that EROI is likely to continue to decline. That makes it plain that the world needs to develop all the energy sources it can, including wind, solar, hydro, nuclear, and geothermal. You name it, we need it.

The good news is that in fits and starts, alternative energies, led by wind and hydro, have been increasing as a portion of the energy pie. The bad news: while many alternative energies such as wind and solar are ultimately self-sustaining, the costs of installing them are front-loaded to an extreme. For example, it costs roughly $1mm per megawatt of wind. That is, we must spend a million dollars on a one megawatt turbine before it generates even one watt of energy. In other words, it takes a tremendous amount of energy to build out an alternative energy infrastructure, one that would include hydrocarbons as well as the many alternatives.

Where will we get all this energy? For the most part it must come from existing energy sources-those hydrocarbons that take ever more energy to produce. I see a clear potential for a vicious circle: the world does not have enough currently usable energy to create the infrastructure needed for the 21st century.

Clearly China understands these basic laws of supply and demand and I hope the U.S. is beginning to get it too. But America has a long way to go. Indeed the U.S. must eventually realize that it cannot go it alone and will need to make resource alliances with many countries even to gain a chance to succeed. That would include the other big three global powers at present, including Germany. We need to bury to the cyber-hatchet with Germany and stabilize relations with Russia and China, and take care not to give India short shrift. While such policies seem very unlikely today, but remain hopeful.

For investors, all this means that I recommend overweight positions in energy related and gold correlated stocks.

Why gold? More scarce energy means generally scarcer materials-and that a printing press and paper currency will no longer suffice to exchange for commodities in short supply. We will need a form of commodity rationing, which means that gold and related commodities must play a big role. Buy gold now for the long term and buy as much as you are comfortable with.

Buy silver now, too. This special metal not only provides a means of exchange but will play a vital role in the transition to new energies. Silver, the best thermal and electric conductor, plays a vital role in solar energy. China recently tripled its solar capacity target to 70 gigawatts by 2017. I don't think the market yet prices in that new target, and if the past is prolog, China will easily exceed its goal.

Indeed, China may exceed its target (to generate 15 percent of all its energy needs from renewables by 2020) and that target could easily rise to 20 percent. Many China bears fail to realize that building out a renewable infrastructure creates a massive number of jobs-likely numbered in the millions-and requires trillions in spending. In other words, investing in China itself could help investors to play the coming demand for energy. Though many Chinese stocks have been disappointing for many years, I expect that to change. Moreover, many Chinese stocks not available to U.S. investors are gainers, as evidenced by the performance of the closed end fund, China Fund (NYSE:CHN). Its top holding, conglomerate Beijing Enterprise Holding, is very hard for U.S. investors to buy directly, but is involved in many energy related activities. That's just one reason this fund has returned over 20 percent in the past 12 months.

Another company front and center in energy, Chicago Bridge and Iron (NYSE:CBI), was recently pummeled by a report arguing that the company overvalued its purchase of Shaw Group, another energy outfit, and could need to mark down its book value and take a large one-time charge. I think the accounting issues are vastly overstated and that the value of Shaw to CBI will be much more rapid growth than it otherwise would have garnered-partly the result of increased scale and partly of new markets (like nuclear) now open to the company. I expect growth in at least the mid-teens for this diversified energy company. With a PEG (P/E divided by projected growth) of less than 0.9, this is a compelling value in a world desperately needing new energy sources.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.