By
Dr. Stephen Leeb
:
Today as I pen these notes natural gas is trading at $3.89 per
million BTU, down about 4 percent from Friday's close.
The news driving the commodity lower is not a sudden increase in
production but forecasts of a warmer December than previously
expected. Still, despite the drop natural gas is trading today at a
higher price than its average over the past four years, or to be
more precise, since the beginning of 2009.
Why pick 2009? Because it was the beginning of the surge in
unconventional gas production: fracking started to take off right
at the beginning of 2009. Now, readers know that we are not
believers in fracking, or at least believers that fracking will
change our energy calculus. If truth be told, I would side with
Jeremy Grantham, CEO at GMO Capital and one of the financial
world's sharpest thinkers, who recently wrote an opinion piece in
Nature
magazine in which he strongly implied that much of U.S. energy
policy stems from the control Big Oil has over major policy
decisions.
Moreover, given the abysmal record the International Energy
Agency (which recently asserted that the U.S. would soon be energy
independent) and the Department of Energy have had in
overestimating U.S. and world production of energy, you would be
hard pressed to say how so many intelligent people can be so wrong
for so long - unless there was a very powerful force pushing them
in a particular direction.
To set the record straight: My view is categorically not related
to climate change or environmental issues. Indeed, I think the
climatologists do themselves as well as everyone else an injustice
when they argue that environmental degradation (which includes the
release of methane, a greenhouse gas) is the reason we should halt
fracking.
After much thought and research into this issue, I have
concluded that we really have no way of measuring what we are doing
to the climate. Indeed, it would not be surprising to find that the
warming and rising sea levels could easily be part of a natural
short-term (in a geological sense) cycle. Actually, it's arrogant
to think that we can understand it, and primitive - like making a
sacrifice to Thor - to think we can mitigate it.
A friend of mine who is a top mathematician at Yale argues that
when models get as complex as the climate models we have today,
they are likely to spit out nothing more than random numbers. That
these models include very little role for the sun makes them much
more (if that is even possible) suspect. Another friend, also at
Yale, who is a world leader in his mathematical specialty, cites an
e-mail, (that became available during Climategate) which evidenced
that one of the key researchers of climate change did not
understand a very basic statistical concept - that of regression,
which underlies all the models on climate change.
Yet the climate
is
changing, I won't dispute that. But extrapolation is probably a
better way of understanding what is going on, and politically it is
probably a much more compelling argument. In other words, what we
are witnessing is part of a cycle that could run for another five,
10, or 1,000 years: sea levels are rising and may continue to rise,
precipitation patterns are changing and may continue to change,
etc. I could accept that kind of thinking.
The difference between accepting the climate models and the
extrapolation perspective is that the former argues that the only
thing we can do is try to change the climate, while the latter
acknowledges that we probably can't do that, but instead can at
least try to control the
costs
of these possibly inexorable changes.
I found the Al Gore movie,
"Inconvenient Truth
," galling because it called for remediation without comparing the
costs of remediation with those of providing infrastructure that
would protect us against the various changes continued climate
trends would bring. And, of course, there were no discussions of
the positive benefits of climate change. I believe Freeman Dyson
(one of the leading physicists of his time) has written quite a bit
about positives from the ongoing climate trends. A couple of years
ago an article appeared in
Nature
, penned by a number of Chinese scientists, which argued that there
was a good case the ongoing changes in precipitation patterns might
benefit Chinese agriculture. In other words, we can't even be sure
that the net outcome of the current trends are going to be
negative.
But some trends definitely
are
going to be negative, as the physical and human toll recently
exacted by Hurricane Sandy illustrates. In 2009, the Army Corps of
Engineers said that rising sea levels posed a serious threat to New
York, and New Jersey. Clearly, it would likely have cost less money
to protect against Sandy than repair the damage the storm caused.
Moreover, had we been smart perhaps we could have found some other
use for the dikes, etc. that would have been built. Instead, no
money was spent on protection, and we simply throw up our hands and
say that we are at the mercy of carbon-induced climate change.
Indeed, taking it a step further, the fact that in their
zealotry and faulty science many climatologists are actually much
more accurately characterized as religious ideologues than
scientists makes it easy to ignore them - and not take into account
what I think is the real question: resource scarcity.
And this makes all the difference in the world when it comes to
understanding and developing policies to deal with fracking. That
is to say, instead of trying to find real solutions in the form of
new energies to deal with resource scarcity and ways of controlling
the costs of rising temperatures, the debate becomes a
quasi-religious battle between the acolytes of eternal oil (read
Big Oil) and the crusaders against climate change. In this context,
the idea that money spent on developing new energies is actually
money very well spent simply gets lost in the shuffle.
Lately the arguments that fracking will create energy
independence are pretty common, but tend to ignore a lot that is
happening right in front of our eyes. For example, the depletion
rate from either oil or gas fracking is far greater than in the
case of traditional wells. In oil fracking it is especially severe,
with 60 percent depletion in the first year not uncommon. The only
way to keep production up is to continually add more rigs. This is
the reason that dedicated frackers such as
Chesapeake Energy
(in gas) and
Continental Resources
(in oil) have seen capital expenditures rise considerably faster
than fracking profits. In other words, while these companies are
profitable, once you subtract capital expenditures from the
earnings you come up with a negative number. In the case of
Chesapeake the number is an extraordinary negative 70 percent of
total equity. Not surprisingly, the company has been forced to
restructure.
Add to these arguments that the low hanging fruit is always
picked first, and that in many cases such seemingly low hanging
fruit is much harder to pick than appears at first glance. For
example,
BHP Billiton (
BHP
)
, the world's leading commodity company, paid a king's ransom for a
tract of land that was close to another tract that was producing a
lot of gas. As
Chevron (
CVX
)
and many others have said, "close" in distance is not a guarantee
of "close" in geological properties. Now BHP has put on indefinite
hold plans for developing that property.
As a separate issue there is also the question of water - not
simply involving issues of contamination, which are undecided - but
the fact that fracking requires much more water than conventional
drilling. Water, save for desalination efforts, is a commodity that
has likely peaked in the wake of rising demand - as reflected in
the fact that the past two years have been catastrophic for food
harvests. I have no idea what future precipitation will be, but as
I said before, climate trends, for whatever reason, do tend to
persist. And that means that if our energy policy is based on
fracking we will be facing a horrific choice between food (the
largest consumer of water) and energy (the second-largest consumer
of water.)
There is also the issue of methane, the major component of
natural gas. Methane is a much lighter and less dense hydrocarbon
than oil, which is one of the reasons it trades on a BTU basis at a
huge discount to oil. To convert methane into heavier molecules,
and thus into forms usable for transportation, as well as other
applications such as chemical feedstocks, requires a lot of energy
and water. Until we figure out how to convert the light molecules
of methane into heavier ones in a way that is less costly, not just
in dollar terms but in energy terms, natural gas will be basically
used as a substitute for coal and not as a broad-based answer to
our energy problems.
The Chinese seem to get the entire problem in spades. Yes, they
have positioned themselves as adamant about pollution control. But
the reason is much more related to resource scarcity than the
impact on climate. (And as I said above, the Chinese may in fact be
benefiting from climate change.)
Looking at what you might call the "supply side" of hydrocarbon
fuel, China appears to take seriously not only the impact of "peak
oil," but peak coal, as well, within the next decade. Thus, by 2020
the Chinese are aiming to have 15 percent of their entire energy
produced by renewables, which include nuclear, hydro, wind and
solar. Moreover, given that their goals for some of these energies
continue to rise 15 percent may turn out to be conservative.
Indeed, projections for photovoltaics have risen from 20 gigs in
2020 to what appears to be nearly 40 gigs by 2015. One hundred gigs
by 2020 is hardly a far out guess.
One major advantage to photovoltaics is that it is one of the
very few energy sources that does not need any water. A
disadvantage is that it uses quite a bit of silver, and indeed by
2020 is likely to be the largest consumer of silver by far.
We don't want to leave you with just a lot of philosophising but
rather conclude by urging to stay away from dedicated frackers and
make sure you have a core holding of silver in your portfolio. This
would include silver ETF
iShares Silver Trust (
SLV
)
as well as established and growing silver stocks such as
First Majestic Silver (
AG
)
,
Endeavour Silver Corp (
EXK
)
, and though we still have some qualms about it,
Silver Wheaton (SLW)
as well. To be honest, Silver Wheaton held up much better than we
expected when silver dropped, and based on an expectation of rising
silver prices, the stock is not expensive in terms of familiar
metrics such as P/E.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
Resolution Of The Fiscal Cliff: Be Careful Of What
You Wish For
on seekingalpha.com