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Feb 06, 2006 NEWSwire
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After Peak Oil: Apocalypse or Opportunity?

West Coast Asset Management Inc.'s co-founders discuss the investment implications of peak oil.

Published: 06-Feb-2006

In 1942, 17-year-old Pvt. Harold Zatkowsky sat down for his first breakfast in the U.S. Army. "That was the first time in my life when I got enough to eat."

America hasn't always been rich, but most of our generation always had enough to eat. Too many of us younger than 60 see films like "Seabiscuit" and view the Depression as some sort of literary device. But not so long ago, Americans lived very differently than we do now. With our accelerated rate of change, how differently will we live 20 or 40 years from now? Will the end of cheap oil destroy our standard of living or create new opportunities to improve our lives? Or both?

Last month's article prompted some readers to look up "Peak Oil" on the Internet, where they found predictions of continuous Middle East resource wars and all-out nuclear conflict with China, Russia, India, etc. They found charges that the entire Peak Oil discussion is prompted by oil interests (and investors like ourselves) to increase prices and profits, and they saw life-after-the-peak scenarios that make the "Mad Max" movies look like a romp through Disneyland. The pessimists' vision evokes Treasure Island's Long John Silver, who declared, "Them that dies will be the lucky ones."

Like most Internet-based debates, arguments on both sides are light on verifiable primary sources, and void of practical solutions. To its credit, a Web site at http://www.oilscenarios.info at least presents a range of five oil-depletion timeline possibilities, from "Pollyanna" to "Optimistic" to "Plateau" to "Pessimistic" to "Head for the Hills."

We cannot predict which — if any — of these scenarios may play out, but we believe big changes to our oil-based way of life are coming, and we need to adapt the way we live and invest. The more we look around us, the more we believe the changes could be improvements, particularly if we choose to make them so.

Spend a full hour people-watching at any shopping mall in America, and you may experience a sobering revelation. Be honest with yourself and admit that you see vast numbers of overweight people, shopping for things they don't need and demanding continuous entertainment. Blessed with liberty hard-won by our nation's founders and veterans, and enriched by 150 years of cheap oil, we've somehow reduced our highest aspirations to a new sweat suit and a corn dog on a stick. But what if oil cost $300 a barrel? How might our priorities change?

Consider the bottle of water you drank while conducting your mall observations. That water probably cost more per quart than the gasoline you burned driving to the mall. Doesn't that seem wrong? As the world's oil production struggles to keep up with demand, America must learn what the rest of the world has known for decades: Oil is extremely valuable. How will life in America change? Is there any way to prosper in the age of expensive oil?

Death and rebirth of suburbia

James Howard Kunstler approaches the topic of Post-Peak America with more journalistic integrity than most, and his book, "The Long Emergency," is probably the best overview of issues we must face in the coming years. According to Kunstler, America made poor choices after World War II: "Perhaps the worst was to let our towns and cities rot away and to replace them with suburbia, which had the additional side effect of trashing a lot of the best farmland in America. Suburbia will come to be regarded as the greatest misallocation of resources in the history of the world."

Well, maybe, but humans have a funny way of surprising pessimists. We may yet invent or discover new energy sources to maintain our current way of life. Still, there are powerful advantages to developing more compact, walkable communities supported by nearby farms. Such arrangements are far more energy-efficient and people-friendly, especially with our increasing ability to work from home.

Kunstler sees the suburbs as the future slums and ghost towns, but there are other possibilities. They might evolve from their failed vision of "country living for everyman" into a province of the rich. Or, with houses large enough for extended families and yards big enough for French intensive farming, the suburbs could evolve into reasonably self-sufficient towns.

The community of the future, based on the small towns of the past, is already attractive to Americans. Research shows that home buyers are willing to pay a premium to live in pedestrian-friendly communities with convenient mixes of residential, retail and office space.

Energy alternatives

No known combination of alternative energy resources can replace the efficiency of oil, which possesses magical properties of energy compaction. A mere gallon of gasoline carries your whole family from 20 to 40 miles from home for a day at the beach or the lake. Your great-great-grandparents rarely traveled that far and only with considerable effort. Cheap oil allows us to travel far and wide without a second thought.

Wind, biodiesel, nuclear, ethanol, solar and other alternatives all have serious limitations, including the amount of oil they require, but some have achieved unexpected improvements in cost effectiveness, and perhaps more importantly acceptance by corporations and the public.

Companies devoting resources to research and development of such innovation should be studied as prospective investments.

No combination of these resources can replace oil, but all of them will be essential for the survival of mankind. That's not hyperbole; remember that a lot of things more important than gasoline and electricity come from petrochemicals. Food, for example.

Agriculture

At the dawn of the oil age, the world population was about 1.5 billion. Early in the 20th century, Fritz Haber figured out how to make fertilizer from petrochemicals, dramatically boosting food production worldwide. As a result, today there are well over 6 billion people, a three-fold increase in 150 years.

While the Peak Oil doomsday fanatics might recommend an investment in crematoriums for the massive die-off they predict in 2070, we will instead look for promising alternatives to petrochemical agriculture. When rising oil prices encourage agribusiness to seek alternatives to oil-based fertilizers and pesticides, entrepreneurs race to provide them.

Transportation and the rail

Alternative fuels and electricity may suffice for personal transportation, but electricity and pedal power do not stand a chance moving mass quantities of goods.

America's distribution system relies on diesel-guzzling trucks and an incredibly expensive highway system. Railroads are the most fuel-efficient transportation, and the rail system is more economical to maintain than the interstate highway system. Unfortunately, our railway system is in ruin. We don't expect this very soon, but the railroads will be back. We see few alternatives.

Even so, food will have to be grown closer to home. Other forms of manufacturing will also become smaller and more local, tying into the walkable communities described above.

Energy security

The term "Energy Security" is discussed in nearly every periodical these days. Despite the tens of thousands of nuclear warheads in the world, a fuel spigot now represents the weapon of choice for resource-rich nations. When Russia's President Putin turned off the natural gas pipeline to Ukraine (and by extension to parts of Eastern Europe), the reaction was immediate and dramatic.

Putin compromised on the price increase for Ukraine, but made his point clearly. As supplies dwindle, resource-rich nations will become enormously powerful, or targets, or both. Energy disruptions make powerful weapons; hence Osama bin Laden's expressed desire to drive the price of oil to $200. He believes that a sudden increase would destroy our economy and our society. If we do not think through the scenarios and prepare for the post-oil world, he will be right. Because most oil is traded in dollars, the effect on the value of the dollar could be disastrous by itself. Many investors hold foreign bonds as a hedge.

At the end of the 1975 film "Three Days of The Condor," Joseph Turner uncovers a CIA plot to secure oil by invading the Middle East. When Turner tells the deputy director that he should ask the American people before making such ruthless decisions, the deputy replies, "Don't ask 'em now. Ask 'em then. Ask 'em when they're running out. Ask 'em when there's no heat in their homes and they're cold. Ask 'em when their engines stop. Ask 'em when people who have never known hunger start going hungry. You wanna know something? They won't want us to ask 'em. They'll just want us to get it for 'em."

That's one choice; go take what we need. Some believe it's happening right now. This might delay oil shortages for a decade or two, but at what cost? Fear can empower politicians and drive the economy but destroy everything we value at the same time. Rather than fear the coming changes, investors must think and ask questions.

How credible is the Peak Oil argument? Should we invest in defense companies like Northrop Grumman? What about electricity providers like Edison International? Will tight supplies of natural gas make nuclear and/or coal a better investment? How long will oil and gas companies profit from excess demand? Should you be investing in urban real estate, or betting on the redevelopment of the suburbs? Is there a play in agriculture?

On the other hand, what happens if Peak Oil is a myth and the price of oil drops? We try to maintain a portfolio that can benefit from a range of different scenarios. For example, we believe companies like Wrigley and Johnson & Johnson are less vulnerable to fluctuating energy prices. Dramatic changes face the entire world economy as oil prices become more volatile. As the world continues to change, where will you find opportunity?

Lance Helfert and Kinko's Inc. founder Paul Orfalea are the co-founders of West Coast Asset Management Inc., a private independent money manager in Ventura. Orfalea sold his interest in Kinko's two years ago. Vice President Atticus Lowe and Dean Zatkowsky contributed to this column. Please e-mail questions to info@wcam.com. The principals of the firm or their clients may own shares in the companies they write about.

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