Smart money in alternative energy?Part 1: current energy quandary

April 9th, 2007

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If you have followed us for a while, you will know that we are generally cautious about investing in stocks right now. As we said in Another sign of the business cycle top:

In a business cycle peak, company profits as a whole are as good as it can get. If you expect the profit trend to continue and pay a premium price for stocks in anticipation for higher earnings next year, chances are, you will be disappointed.

Therefore, if you intend to invest in stocks, you have to be very selective in your choices of businesses to invest in. To do that, you cannot merely extrapolate the status quo into the indefinite future and base your decision on that. Instead, you will have to look beyond the current state of affairs and understand the underlying forces that are driving today?s current macro trends. Only then will you be able to anticipate the coming changes for tomorrow and invest accordingly.

Today, we will talk about one of the macro trends?energy.

The most important ingredient that drives the efficiencies, comforts, automation and wonders of today?s modern way of life is energy. The trains, cars, ships and aeroplanes that transport massive quantities of people and goods over vast distances quickly require energy in the form of fuel. The heavy machines that do heavy physical work far beyond the scope of human labour require energy too. The powerful computers that process and store vast amount of data and information as well as automate mental labour requires energy in the form of electricity. The heating in winter and cooling in summer of our abode requires energy too. Take energy away and our modern way of life will very much grind to a halt and bring us back to the hard life of our ancestors. In fact, contemporary life rests on the premise of abundant and cheap energy. Therefore, whoever controls the supply and provision of energy controls power and wealth.

Currently, most of the world?s energy exists in the form of oil, coal and natural gas reserves, of which oil is the most notable. There are two significant issues with regards to these forms of energy: (1) availability and security, which are applicable to oil and (2) global warming, which is most applicable to coal. We will tackle each one of them in this article.

There are growing worries that given the growing competitive demand for oil from emerging nations (e.g. China and India), there would not be enough supply of it to satisfy everyone (see Analysing recent falls in oil prices?real vs investment demand). To compound this problem, according to some respected scientists and geologists, today?s global oil productions are at or near permanent decline (i.e. Peak Oil). Thus, whether you believe in the theory of Peak Oil or not, there is growing consensus that given everything else being equal, oil is going to be more expensive in the long run (see Is oil going to be more expensive?). Since oil is a major manifestation of energy, which in turn is the most important ingredient for our modern way of life, it implies that if nothing is being done with regards to this issue, then the quality of life that we currently know and enjoy will be significantly eroded in the future. Worse still, a significant portion of the world?s oil resides in the most politically and militarily volatile regions (i.e. Middle East), which puts a serious doubt to the security of oil supplies.

The cheapest alternative to oil will be to use coal in which the world has plentiful supply of and are not located in regions that can result in its supply being held hostage to military and political situations. Unfortunately, the world is facing another serious challenge that makes it highly unwise to burn coal for its growing energy needs?global warming. Scientists are still cracking their heads to think of ways to extract energy from coal without damaging the environment seriously.

Hence, the world is now facing a mounting energy problem, which if not solved, will sooner or later lead to a crisis. The good news is, opportunities are found where crisis are. As investors, we have to train our mind to see such opportunities.