An Oil-Driven Paradigm Shift?

Includes: DBO, DIA, OIL, QQQ, SPY, USO
by: Roger Nusbaum

A couple of heavy comments came in over the weekend expressing concern about what might be coming around the bend, not so much in the stock market but bigger pictured items that could impact the stock market--well all capital markets really.

One reader questions whether the the current state of the energy market represents a paradigm shift in that "we are an oil-based economy and the supply of oil is finite."

That oil is finite (aka peak oil) is a complex issue. We know about ANWR, the Bakken Shale, the Marcellus Shale and one or two other spots where there is likely oil. The oil supposedly under water at Tupi and Carioca would make Brazil a big source of oil. I saw a report that the Athabasca oil sands will be able to double production over the next ten years.

That all sounds good, so what's the problem?

There is declining production in Mexico, the North Sea/Norway and probably a couple of other places that escape me at the moment.

At some point the US is going to drill in the places that are controversial which combined with new drilling in the places that are not controversial will buy time versus the gloomiest of forecasts.

It is also quite likely that the pace and subsequent adoption of replacement fuels will occur at an accelerating rate as technological advancement in all fields comes faster and faster (the last 100 years as an example).

None of that is to say uncomfortably high prices won't be something we have to deal with, because we might (depending on your thoughts you might think high prices will be permanent and maybe they will).

The fact is we know what sorts of technologies will contribute to the solution, they already exist. For now, most of them (maybe all of them?) are not economically viable, but they will become more so. Prices will come down, for example solar panels will never be the thing, it will be the cheaper solar film because it is much cheaper.

Knowing what the solution is makes things easier. People need to change their orientation, which will not be easy, but it will happen at some point.

What if my cock-eyed optimistic theory above turns out to be wrong? This leads to another comment about whether somehow oil or oil derivatives could be come the new currency.

My initial reaction to that comment was to question whether the threat of delivery nips this in the bud. What could anyone do with a barrel of oil? Who but George Costanza could lift a barrel of oil? Now factor in that one contract delivers 1000 barrels.

That society could devolve into some sort of Mad Max movie with gasoline being the most prized thing seems very difficult to imagine because as mentioned above the solution already exists. Further when we do start drilling in more places that will relieve some of the problem.

Even if it takes ten years from day one, ANWR is capable of 2.1 million BPD which is in the ballpark of 10% of daily US consumption which I think is significant. At some point it will make sense for some of us, depending on where we live, to cover our roofs with film. More and more of us will have one hybrid in the garage.

I think these things will just happen very undramatically even if gas is $6 a gallon.

My little scenario would not be hiccup free. I would expect distortions with inflation, interest rates and economic stats which would make things ugly but not depression ugly--I don't think.

If you maintain a globally diversified portfolio, you will own the things that do well. I would expect some of the same themes working over the last couple of years to keep on working. China and other countries will continue to ascend, and so anything selling into that need should do well.

Companies providing fossil fuels and alternative energy solutions will do well. That may seem like a contradiction to other comments I have made about solar stocks but it isn't. The technology will matter but we are at least a few years away from anything resembling widespread use and so I think there will be companies that come and go as capitalism does its thing in the next few years.

Or I'll be totally wrong.

Bottom line for me is the same thing I have been saying for a while, which is that historically normal returns will continue to exist but they may not be in all the same places as before. We must be willing to look for them in places that are not as familiar or comfortable for us.