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Eric D. Wanger is the President and Chief Executive Officer of Wanger Investment Management, Inc. and serves as the Portfolio Manager of the Wanger Long Term Opportunity Strategy. Prior to founding Wanger Investment Management, Mr. Wanger was a senior investment analyst at Barrington Research... More
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  • Oil, Drugs, and Social Networking 0 comments
    Nov 17, 2011 3:07 PM | about stocks: WTI, OIL

    From the Desk of Eric Wanger

    Oil, Drugs, and Social Networking

    Our analyst team recently attended Global Hunter’s “land based drillers” conference, an overview of industry economics that included presentations by four firms that own, lease, staff, and operate land based oil rigs. These are relatively small pub¬lic companies that provide contract drilling services for clients that need gas and oil wells drilled. As one might expect, there was a lot of discussion about the prices of gas and oil. The price of oil was (is) impressively high based on a dramatic increase in middle-east unrest, heavy speculation, and big money flows looking for a place to invest. Likewise, the price of natural gas was (is) impressively low.

    Crude Oil (NYSE:WTI) & Natural Gas Prices: December 2008 – May 2011

    Source: Bloomberg


    Some of the more interesting things we learned:

    • Few in attendance believed that oil could maintain its (then) current $110-120 per barrel price levels for very long, believing that such high prices represented short-term speculative bets and middle-east risk premia, not underlying demand or supply issues.
    • On the flip-side, these same analysts seemed to think that $60-$70 is about as low as oil can legitimately go at this point given actual supply and demand conditions.
    • Relatively conservative balance sheets are in fashion among this crowd. While capital is plentiful and avail­able to these land drillers, they are terrified of taking more money than they can put to work right away. The last crash was so severe that it “put the fear of God” into their CFOs. None of these smaller land drillers are will­ing to get “overbanked” again.
    • Natural gas is once again a fuel of choice for electricity generation, especially in parts of the country (such as the Northeast) that have under-invested in nuclear power and can’t safely and cleanly burn coal.
    • As one might expect, the gas rig count continues to drop while oil seeking projects are exploding in number.

    Admittedly, that’s all pretty mundane stuff. Competent, in­teresting, possibly useful, but certainly dull. Dry as dust.

    Want something a bit more interesting? What did every single senior executive in the room mention as his number one concern after trying to get and retain customers? Every man­agement team in the room agreed:  Finding and keeping com­petent employees is the toughest problem they face. The reason? Rampant drug use!

    Rampant Drug Use

    Working on an oil rig is a tough job. It’s dirty outdoor work. It’s hot. It’s cold. It’s wet. It’s icy. Nobody ever said it was work for wimps. But it pays really, really well. Here is a job that doesn’t require a high school diploma that can start at over $50,000 per year. Furthermore, hard working, experienced rig crew mem­bers can make in excess of $100,000 per year if they are respon­sible and can manage others.

    Obviously, these companies have to maintain a zero toler­ance posture on drug abuse. Their people are operating heavy machinery in tough outdoor conditions. The equipment is heavy and prone to difficulties. Injury is common and safety is a constant concern. Yet, in a world where populist politicians regularly complain that American workers can no longer get a decent job without a fancy education, I am listening to a bunch of senior corporate officials telling me that they can’t find a suf­ficient numbers of workers that will come to work straight and sober for $50,000 per year.

    Admittedly, there’s not much to do for fun on your days off, but that’s hardly a new problem. When did bored, lonely, and recently-paid oil, gold, coal, timber, or cattlemen ever behave like Eagle Scouts on their personal time? The highly paid “suits” at the conference were not complaining about whiskey or vene­real disease among the lowly, poorly paid, or disenfranchised. They were complaining about the rampant, recreational use of cocaine, methamphetamines, heroine, andother hard-core, ad­dictive illegal drugs among unionized workers earning solid middle-class wages.

    One official told us that merely announcing mandatory drug testing dramatically lowered his job application rate. An­other told us that his firm went to hair follicle testing because urinalysis only caught marijuana abuse and was too easy to fool by people using methamphetamine or cocaine on their days off.

    Americans demand drugs — lots of drugs. So it is a basic law of economics that there will be huge efforts put into supplying drugs to Americans — and the current policy regime keeps it so profitable that it is worth killing people for the right to sell drugs. It was no different with oil, booze, or even newspapers back “in the day.” People beat and even killed each other competing for the right to own the channels of distribu­tion.

    Basic economics guarantees that as long as Americans are willing to pay high prices for drugs, illegal or not, nearly infinite effort will be put into meeting that demand. No honest free-marketeer can deny this fact.

    In 1931, Aldous Huxley wrote Brave New World, a science fiction novel rooted in social commentary (“Praise Ford!”). He foresaw our future in his eerie utopia with our entire population continually popping state-sanctioned recreational narcotics. In his world, psychotropic drugs were a tool of political control as much as of psychic self-medication. But as far back as 1931, he saw taking pills as part of the fabric of our society.

    What We Think About Energy and Other Commodities

    In the long-run, the price of oil will keep ramping higher, but the short-term will inevitably see the same zigzaw pattern we have always seen. In the short-term, the price is as likely to head back down to $70 per barrel as it is to jump back up above $110. Many oil and gas stocks have or will become cheap again after coming off huge bull-market run-ups. Stocks like Double Eagle Petroleum (NASDAQ:DBLE) and Venoco (NYSE:VQ), for example, can be pur­chased at or below the value of their proven hydrocarbon re­serves. It might be awhile before these stocks peak again, but it’s hard to argue with tangible asset value.

    America continues to be awash in coal. But Americans, at least right now, universally despise this abundant natural re­source. Why aren’t we investing in the technology necessary to burn coal cheaply and cleanly? I’m sure the answer is political. In any case, high quality coal is expensive and dirty coal is cheap. And coal is expensive to export to the countries clamoring for supplies of it. Unfortunately for us, coal stocks are hard for us to buy, because they are so cyclical and momentum driven.

    Food prices have soared. Droughts in China and other Asian regions have caused significant food shortages. Weather problems havecoupled with market distorting subsidies (such as America’s Ethanol subsidy for corn farmers) to create the wealthiest American farmer we’ve seen in a long time. One result, American farm land is selling for huge prices, maybe even at “bubble” levels. We are hard at work looking to invest in things that wealthy farmers want to buy.

    Corn Prices: January 2009 – May 2011

    Source: Bloomberg


    Lastly, there is another tech-bubble under way. This time it’s the social networking companies likeFacebook, GroupOn, LinkedIn, and others that are acting like the proverbial cow jumping over the moon. Are GroupOn and LinkedIn going to be Googles or Alta Vista? Are they going to be Yahoo’s or NeXTs? Hard to tell. But I doubt any of the investment banks will return any of their hefty fees when we find out.

    Eric Wanger, JD, CFA, President,
    Wanger Investment Management, Inc.

    originally published Q1 2011

    Stocks: WTI, OIL
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