Freedom, Corrosion and Investment Opportunities

On July 5, I traveled to Las Vegas to give a talk at Mark Skousen’s FreedomFest 2007 convention. Mark is one of the great thinkers and public intellectuals of our age, whose brilliant, brief and ineffable class and style far exceed what you see or read with the usual schlock emanating from the drive-by media and the puff-piece celebrity commentators. So Mark’s gathering was far more than an investment conference full of stock picks, although there were stock picks galore, and there is nothing wrong with good stock picks. The economic and investment themes were there, of course. But the conference also offered a set of sessions concerning history, philosophy, current events and other themes, delving into modern culture and its trends and direction.

Speaking in the argot of our highly refined modern culture, my Agora “homeys” Dan Denning and Jim Amrhein were there in Las Vegas, as well. (And don’t worry, guys. What happens in Vegas stays in Vegas. Right?) Dan came up from Australia to discuss investment opportunities Down Under, and Jim discussed issues of personal freedoms, as he does so well in his essays in Whiskey & Gunpowder. There was far more to the conference than I could assimilate, what with its multiple sessions occurring simultaneously. It was a true intellectual smorgasbord, so I did the best I could during the time I was there.

I listened to my good friend Rick Rule discuss natural resource issues, which is kind of like having Babe Ruth as your batting coach. Both Rick and I are keen on the future of geothermal power, which has been the subject of discussion in Outstanding Investments in the past couple of weeks.  I also attended sessions that discussed such things as immigration policy, the conduct of the war in Iraq, the direction of international terrorism, the interest rate trends of the Federal Reserve, as well as the life of Abraham Lincoln and the guiding ideas of Winston Churchill. You never really know when or where you will find a good idea, let alone a good investment idea. So be on the lookout for FreedomFest in future years. It is quite a good ticket to a great ride.

Mountains of Our Fears

The talk that I presented to one group of FreedomFest conference attendees (including many of our very own Outstanding Investments and Whiskey & Gunpowder subscribers… thanks for listening) was entitled “Mountains of Our Fears: Personal Freedoms in a Post-Peak Oil World.” Why the title? My thinking was that FreedomFest 2007 was focused on, well…on “freedom.” So I decided to discuss how much of what we consider to be “freedom” in our culture is really just the liberal application of abundant and cheap energy.

Think about it. Could you really enjoy the so-called “freedom of speech” that the Internet offers without an abundant supply of high-quality electricity or a well-wired and powered-up telecommunications system? Could you really enjoy the so-called “freedom of travel” without relatively cheap and accessible motor or jet fuel? Could you live in the climate-controlled comfort you enjoy without a long network of power lines and pipelines bringing energy supply directly to your thermostat or keyboard, if not your fingertips? Could you live the lifestyle that you live without a highly evolved system of global trade, relying on massive cargo ships and airfreighters hauling goods rapidly across intercontinental distances? Like it or not, our lives are part of vast energy and material systems, and we are all products of the grid. There is the power grid, the transportation grid, the trade grid and more.

Now add the Peak Oil factor, and in the foreseeable future, bring on physical scarcity and high prices for basic elements of the world’s energy supply. Let’s think about how this will degrade the world’s energy and material systems and grids, with physical scarcity of product and very expensive energy supply. How much “freedom” (or stated another way, how much less “freedom”) will you have in that environment? Good question, huh? That is where the “fear” part of “Mountains of Our Fears” comes from. One of the great benefits of giving a talk like that is that I could ask the questions in true Socratic fashion, but did not have to come up with the answers. Why not? Well, we are talking about the future. And we are not there yet.

The future will be the product of many options and choices. As the great futurist of the 1960s and 1970s, Herman Kahn (1922-1983), once noted, “We invent our own future.” If we invent the wrong future, our society is going to have some very rough times. So we had better invent the right future, huh? As a society, we had better invest in things that will work in the future whose profound energy and material trends are already looming.

Inventing the Future

On that note, I should add that I left FreedomFest a day early to fly down to Southern California to attend the funeral of a close relative. Genealogically, the deceased was a second cousin, but in terms of family ties, he may as well have been an older brother. He and my late father were quite close, having grown up together in Pittsburgh many years ago, in the 1920s and 1930s. Among other forms of trouble that they got into, my cousin and my father used to build model airplanes and hold flyoffs, sometimes in large but crowded spaces such as church…on Sundays. Eventually, during World War II, my dad flew P-47 Thunderbolts in the Army Air Corps, and my cousin flew the P-38 Lightning. So between the two of them, they were Lightning and Thunderbolt, both literally and figuratively. Now, good and faithful servants both, they have gone on to the great flyoff in the sky.

I am mentioning all of this because since we are discussing airplanes and energy and material systems and grids and inventing the future, I made other good uses of my visit to the California Southland. While I was staying at the Irvine Hyatt, perched above and overlooking the convenient, if not scenic, Interstate 405, I watched the Internet broadcast of the rollout of the Boeing 787 Dreamliner, held at Everett, Wash., on July 8, 2007 (7/8/7 — get it?). I wrote about this in an article published July 9 in Whiskey & Gunpowder, but there is far more to say about Boeing’s remarkable new aircraft. The airplane is a philosophical statement in and of itself.

How Will You Travel Through Life?

“How will you travel through life?” ask the good people of Boeing in their promotional effort for their revolutionary new Dreamliner. It is an interesting question to ask — certainly, to pose to someone who is in a reflective mood, having just attended the funeral of a close relative whose life spanned much of what we consider the modern era. As I said about FreedomFest, you never really know when or where you will find a good idea, let alone a good investment idea.

Obviously, the folks who build and sell Boeing Dreamliners want passengers to travel through at least some moments of life while strapped into the seats of one of their fine B787 airplanes. And if the early returns are any indication, this Boeing airplane is selling like gangbusters (677 sales booked so far, for some $120 billion) to airlines and operators all over the world. (And for more on that point, see below.) The Boeing production line is booked solid through 2014 and well into 2015, and it is all but assured that the Dreamliner will become one of the most commercially successful airplanes ever built and offered into the aviation marketplace.

From nose to tail, wingtip to wingtip, the B787 is filled with technological innovations, to include operating at a fuel-efficiency that is a dramatic 20% improvement over the current standard within the airline industry. One of the things that make this improved fuel-efficiency possible is the extensive use of lightweight composite materials, as opposed to traditional metals, for much of the structure and frame of the aircraft. The B787 is 50% composites by weight, versus 12% composites in the 1990s-vintage B777. This is a very important point.

Composites

To say that the Dreamliner is built of composites is not to say that the B787 is a plastic airplane. Composite materials have been used in aircraft for well over 40 years, but have been incredibly expensive to incorporate recently. As a result, composites were used primarily in military-grade applications such as with the B-2 stealth bomber. But in recent years, developments in computer-assisted design and fabrication, plus fundamental advances in physical and carbon chemistry, have brought costs down dramatically for composite materials.

The term “composite” refers to a material made from two or more different ingredients that, when used in combination, take on the properties of each and offer benefits beyond those of the individual components. The B787 makes extensive use of carbon fiber reinforced polymer (CFRP), which is more than twice as strong as either aircraft-grade steel or titanium, by weight. That is, fine carbon fibers are entwined together into larger bundles, known as yarns. These yarns are then laced into a loose mat or ribbon, called a tape. The tape is wound around a mold (such as a mold for the nose section or fuselage of the aircraft) and saturated with another substance called polymer. You can build up certain sections of your creation by adding more tape, so as to make certain areas (say, around the baggage or cargo compartment) thicker or stronger. Finally, this saturated tape is baked under pressure in an autoclave, resulting in a molded part.

The molded part can then be finished by cutting penetrations for doors and windows. Eventually, the molded sections will be fitted together on the assembly floor of the Boeing hangar at Everett. Yes, the buildup process requires carbon feedstock and uses significant amounts of energy to run the autoclave. But by comparison, fabricating a traditional aircraft fuselage barrel out of aluminum requires hundreds of sheets of aerospace-grade metal (not the stuff from which they make beer cans, but an advanced form of energy-intensive metallurgical substance in its own right), held together with tens of thousands of rivets inserted into holes that have to be drilled at precise locations. So with composites, the part counts and labor costs plummet within the assembly process. And for the purists out there, I will have to look into the complexities of the overall carbon budget and relative energy balances, because these calculations are by no means simple.

Corrosion

Another great advantage of composite material is its resistance to corrosion. Moisture is the enemy of finished metal, to include aerospace-grade aluminum, and corrosion is a critical maintenance issue for airplane operators. Moisture has a cumulative and insidious effect on metal structures, weakening structural strength in vulnerable and usually hard-to-access areas. Classic forms of corrosion include galvanic corrosion, when two dissimilar metals make contact with one another in the presence of an electrolyte. Or there is concentration cell corrosion in which foreign materials can lead to the internal breakdown between metal joints. Another form of corrosion includes fill form corrosion, which attacks metal beneath painted surfaces. There is metal ion corrosion and intergranular corrosion, which begins along the boundaries of chemically different parts of the metal. The low points in any structure, where gravity tends to concentrate drippings of water, oil and other fluids, are the places of primary vulnerability, but any metal surface is prone to corrosive damage.

In short, corrosion is a deadly enemy of any aircraft, particularly when you consider the stresses and strains that the entire flying system undergoes due to takeoffs, flight at extreme altitudes and temperatures and landings. Corrosion, plus the general stresses of flight, tends to enhance and enable metal fatigue, as well. So left to its own devices, corrosion can lead to catastrophic failure, which is why aircraft operators always have (well, they should always have) an aggressive inspection and maintenance program. (This is not at all unlike the situation within the energy extraction business, by the way, where corrosion issues are of paramount concern from well bore to gasoline pump.) And the B787 has addressed this critical maintenance issue by incorporating extensive amounts of corrosion-resistant composites within principal structures.

Live the Dream, or Fly It

So with Boeing’s B787, we are seeing an airplane that is lighter, stronger, safer, more fuel-efficient and less maintenance intensive than its air transport forebears. The B787 is a remarkable achievement and quite an investment in the future of transportation — except that most U.S. air carriers have not signed up to buy any of them. In fact, almost all of the 677 Dreamliner aircraft under contract are going to foreign purchasers, except for a total of 43 planes destined for Continental and Northwest.

This is quite a comment on, if not an indictment of, the blurred vision and myopic investment style of the present-day U.S. business culture, where simply making money is more important than the fundamental concept of making things. But at the same time, the short-term view that permeates U.S. business culture is certainly not confined to the airline industry. (And the long-term corrosion of the U.S. business culture, if not of U.S. politics and policy, is a subject for future articles in Outstanding Investments and Whiskey & Gunpowder. )

In case you are wondering, the list price for the new Boeing product, depending on the specific model and accessories purchased, is in the range of $130-150 million per copy. Can you afford one? Asked another way, if you fly airplanes for a living, can you afford not to have a Dreamliner, especially in a post-Peak Oil world? This sticker price, which will put you literally in the pilot’s seat of the world’s most fuel-efficient large aircraft, compares favorably with the $165 million asking price for the newly listed 29-bedroom Hearst mansion in Beverly Hills, Calif., located on 6.5 acres of prime real estate just north of Sunset Boulevard.

So it is your choice, dear readers. You can buy the Hearst mansion and live the dream, if not admire the view from Sunset Boulevard. Or you can buy the Boeing Dreamliner and fly it into your own sunset. The price is about the same.

As the Boeing people ask, “How will you travel through life?” At the end of the day, it boils down to these questions: What are the guiding principles of your investment style? What are your priorities? Where do you want to be in a few years? If you subscribe to Outstanding Investments, I think you are giving us a clue about these issues.

With that, I bid you all farewell.

Until we meet again…
Byron W. King

July 23, 2007