Energy and Capital

In its own way, energy is a form of capital, isn’t it? And it is a major competitive advantage to control a source of low-cost energy. Byron King explains…

I live in Pittsburgh, and grew up here, as well. Both figuratively and literally, Pittsburgh is built on coal. Coal is the remains of ancient plant life, buried within the rock record.

For example, one of the most extensive and valuable mineral resources in the U.S. is called the Pittsburgh Coal Seam. The Pittsburgh Coal Seam shows up in outcrops all over town, if you know where to look and what you are seeing. But there is a lot more to this hunk of rock.

The Pittsburgh Seam extends underground all over western Pennsylvania. The Pittsburgh Seam is high-grade coal and can be as much as 6-8 feet thick. That’s a lot of energy stored up in one place.

A century or more ago, coal from the Pittsburgh Seam was abundant and cheap. People heated their houses with coal, cooked with coal, powered simple engines with coal. And all over western Pennsylvania, people like Henry Frick and Andrew Carnegie pulled a heck of a lot of money out of that Pittsburgh Seam.

They built mines, powered mills and created immense industries based on burning coal. More fundamentally – if not philosophically – they profited from harnessing and releasing the stored-up energy from ancient sunshine.

Let’s think about that for a moment. It was not that capital was cheap back in the last century. Gold was gold. Money was money. When they borrowed funds, Frick and Carnegie paid the same interest rates as anyone else anywhere else. But they succeeded, and did so in great fashion. What was their advantage?

Well, it gets back to that Pittsburgh Coal Seam. In the last century, western Pennsylvania had rich seams of coal located near the surface. Pittsburgh had proximity to some of the best energy reserves in North America. So coal became the foundation of industry. Energy powered industry, and industry created wealth.

The rivers of western Pennsylvania made it easy to transport that coal. That is, using barges to float things down the rivers required relatively less energy per ton-mile to move the coal to Pittsburgh’s mills. And using the rivers meant that it required less energy per ton-mile to move the value-added products out to the interior of the country, and to the world. (For example, the steel locks on the Panama Canal were built at Pittsburgh and floated down the Ohio and Mississippi rivers, across the Gulf of Mexico and to Panama.) Yes, it took capital to gain access to the energy sources. But the energy sources also leveraged the capital.

In its own way, energy is a form of capital, isn’t it? And it is a major competitive advantage to control a source of low-cost energy.

In fact, control over reliable sources of low-cost energy may be even better than access to cheap capital, especially in years to come. There are so many dollars in this world that almost any darn fool can borrow them, or how else to explain what has been happening on Wall Street lately? But ample and low-cost energy can certainly multiply the effectiveness of capital. Ask Frick or Carnegie.

Have you seen the price of coal lately? In 2008, thermal coal prices are set to double, from about $55 to $125 per ton. That’s based on a recent agreement between Japan’s Chubu Electric Power and the giant mining firm Xstrata, and it should become the benchmark for 2000-09 contract prices worldwide.

Spot prices for thermal coal have tripled in the past 12 months. And spot prices for coking coal (used to make steel) have quadrupled in the last 12 months. Just in the last two months, those prices have doubled. Do you notice any patterns?

Let’s boil it down to a few key points. The cost of the world’s "traditional" energy source – coal – is skyrocketing. And about 40% of the world’s electricity is currently generated using coal. Many other industries use even more coal, from steel makers to cement kilns.

So if coal prices are going up, what will that mean for electricity prices, or steel, or cement or whatever? They are headed up, as well. I would say grab your oxygen mask. But that’s a bad joke, because of the carbon dioxide (CO2) issues that people blame on coal.

And look at the current U.S. presidential race. All three potential nominees (Obama, Clinton and McCain) are discussing issues related to CO2 and associated climate change. All three candidates discuss the need for the U.S. to utilize what is called "clean-coal technology." And I live just a few miles from a major U.S. Department of Energy "clean coal" research center. So I know that there is some great "clean coal technology" out there, and more coming down the pipeline.

But at its root, "clean coal" really means taking expensive coal and making it more expensive in order to use it. So face it. In the U.S., the days of burning raw coal and living with belching smokestacks are gone with the wind.

You can believe in the climate change argument or not. But your personal view on climate change does not matter for these purposes. The next president of the U.S. (and much of the next Congress, as well) will not be "friendly" toward old-fashioned coal-fired electricity. That is already baked into the political cake.

So can we predict the future? Well, nobody can. But we can connect the dots and make some intelligent forecasts. The dynamics of electricity are changing.

Whether you like it or not, people all over the world are burning coal. The black rock is getting scarce, and prices are going up. Those contracts are already signed.

Here in the U.S., as well, much of the nation’s electrical capacity is based on burning coal. So electricity costs in the U.S. will rise with the prices for coal. That is just "Public Utility Regulation 101."

And to add to the problem, U.S. national policy is headed toward less energy generated from coal. This is due to CO2 concerns. Read the Web sites of the presidential candidates.

So where can we in North America get significant amounts of "clean" electricity with minimal CO2 emissions? Not from coal. How about windmills? Yes, when the wind blows. How about solar? Yes, when the sun shines. And how about geothermal? Yes, all the time. 24/7/365.

Really, the stars of economics and politics are aligning on this one. The time for geothermal has arrived. Welcome aboard. How can you take advantage?

Until next we meet,

Byron King
for The Daily Reckoning
April 15, 2008

Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments, and editor of Energy & Scarcity Investor.

America’s triple-A credit rating may be in danger, says Standard and Poor’s.

If the country has to bail out Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) through a prolonged recession, it could cost the nation’s treasury as much as 10% of GDP.

We’re beginning to see the whole world financial situation as a U.S. problem. There is a lot going on…but the big story seems to be about America (and Britain, to the extent it shared the Anglo-Saxon economic model)…its money, its wealth and its place in the world.

The plot is simple enough. After an extremely successful run, the United States is struggling to maintain its edge. Its people are deeply in debt. Its currency is being sold off. Its labor…its capital markets…and its technological lead are all being challenged by faster, more youthful competitors.

Like any Greek tragedy, the hero is a victim of his own hubris. He thought he could steal the gods’ fire and get away with it.

Americans thought they could do things that have always been off-limits to mortals. They believed they could operate a financial system based entirely on paper money, for example. They believed they could spend money they hadn’t earned – and live off credit forever. They believed the myths of the Efficient Market Hypothesis and Benign Capitalism…the Black Scholes Option Pricing Model and the Great Moderation…that Deficits Don’t Matter and the War on Terror does.

And now…the whole society is being marked down – by inflation, deflation and a trillion-dollar, unwinnable war.

On the surface, it is merely another chapter in the world’s financial history. George Soros elaborates:

"The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years. However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years."

Those last 60 years were the 60 glorious years in which the United States was on top of the world. It’s the period roughly corresponding to Baby Boomers’ lives. Born after WWII…growing up in the ’60s…taking command in the ’80s…and now looking forward to retirement. Was there any better time to be alive? Was there any better place to be alive in than the United States of America? Its money was the world’s best. Its economy was the most dynamic and productive. And its people were the world’s richest. Full employment. Full stomachs. Free love and open bars…what more could you ask for?

Yesterday, the dollar hit another record low against oil. It now takes $111 to buy a barrel of oil…and, in Atlanta, $3.36 to buy a gallon of gasoline.

"That’s nothing," said our driver in Manchester yesterday. "Here, the price of gas is nearly $10 a gallon. Of course, you don’t see any big American gas guzzlers either."

Our driver showed us the instrument panel of his 2-year-old Skoda. It revealed an average fuel consumption of 56 mpg.

The car was comfortable and reasonably large. It didn’t seem to lack power.

"Here in England, we couldn’t afford to drive your cars," he concluded.

Our guess is that Americans can’t afford to drive American cars either. The latest numbers show consumer spending rising – but only because consumers are forced to spend more on fuel. And experts believe that the summer of ’08 will be the first in which Americans actually drive less – forced off the road by high fuel prices.

Most people think of inflation as affecting prices they pay for bread and magazines. But inflation has a bigger agenda; it adjusts the wealth of whole societies.

The problem for Americans – and many others in the developed world – is that their wages are too high. They are used to earning a lot more money than their counterparts in, say, China or Vietnam. But why? Only because they have more capital and more skills, so they can produce more. But that situation is changing fast. Capital is piling up in China, Russia, Brazil and India – and elsewhere. As a result – wages in those places are soaring. Nestle just agreed to a 16% wage increase for its St. Petersburg, Russia, staff. In China, urban wages rose 18.7% in 2006. Ten percent annual increases in India are said to be the average.

In the United States, the last real, hourly wage increases came in the 1970s. Since then, adjusted for inflation, wages have been flat. But we Baby Boomers scarcely noticed. Because we were entering our peak earning years, our assets (stocks, then houses) were rising in value, and the expanding credit cycle left us with more money to spend.

But now, as Soros points out, that credit cycle has turned against us. The super boom is over. Our houses are going down. And the value of our labor and our stocks – which have held fairly steady – are being marked down by inflation. We are not becoming a Third World country…but we are becoming a poorer one…with a labor force that is less and less overpriced each year. Seems like a good time to retire. But forget the Winnebago – with gasoline at $3.36 a gallon, who can afford to cruise around on the wide-open spaces?

"Inflating is immoral in a sense because it steals," Ron Paul said to us in an interview for I.O.U.S.A. "It steals value if you double the money supply and your prices go up twice as much…it’s an invisible hidden tax. But the real immorality here is that some people pay higher prices then others. So if you’re in the middle class, or especially low middle income, your prices might be going up fifteen percent a year. Somebody on Wall Street working leverage buyouts doesn’t have to worry about the rising cost of living. This to me is a immoral act, that is prohibited by the Constitution, and the outcome is always tragic."

Could it be downhill from here on out – to the end of our lives?


*** Crude oil futures surged to their highest price ever today, hitting a new record of $113.93.

The rise in the price of crude was due to yet another rash of dollar weakness, prompting traders and investors to run to the safety of oil and other commodities, such as our favorite yellow metal.

Supply concerns also pushed the price up, as there were some minor pipeline disruptions.

There is a way we could circumvent these problems, our resident oil expert, Byron King tells us.

"There’s a new technology that can also be used to pump oil from old wells that were thought to be dry for decades. That alone could potentially add several hundred years to America’s oil supply.

"The truly awesome potential lies in this fact: The ‘Oil Vacuum’ could prove to be the only way to economically extract an oil reserve on U.S. soil that amounts to three Saudi Arabias.

"The U.S. Department of Energy says anyone who can pull this off ‘could contribute nearly 3 million barrels per day to reduce oil imports, improve energy security and fuel economic growth.’"

The possibilities available with this breakthrough technology are staggering…as are the gains for investors who get in on the ground floor. Byron will show you how in his latest report in Energy & Scarcity Investor…and until midnight tonight, you can get Energy & Scarcity Investor for the lowest price we’ve ever offered.

*** What’s up with food prices?

Agricultural commodities are notoriously cyclical. Prices rise; farmers plant more. The resulting bumper crop causes a bust in prices. Then, farmers reduce production, causing prices to rise again. Farm prices hit highs in ’74, ’77, ’80, ’86, ’94 and ’98. In the period following ’98, prices sank to what might have been all-time lows – adjusted for inflation. Now, they’re reaching up again. In terms of nominal prices, the CRB index of soft commodities is 150% above its 1993 low. Adjusted for inflation, farm products are up considerably less. And adjusted to the euro or gold…even less still.

What to make of it all?

Well, there are big cycles…and there little cycles. There are farm cycles…and there are monetary cycles. There are economic cycles and there are cycles of history.

Our guess is that right now we are witnessing a scene like on a street corner in Amsterdam – with several cycles coming together at once. There is a natural rebound of the farm cycle, in which farmers are offsetting low production with high production. We can expect prices to fall as a result.

But we also have a monetary cycle, in which the world’s reserve currency is being over-produced. This over-production will probably continue for a while – causing worldwide inflation in all globalized markets – notably foods, resources and gold.

And then, there is also a bigger trend in which billions of people who previously got by on meager, locally-produced diets are joining the international economy. They are moving to the cities (this year, the world’s urban population is said to be bigger than its rural population – for the first time in history), earning money, and buying their food with cash. Not only are they drawing on globalized food markets for their daily bread, they also want more food…and better food, such as meat rather than just grains. Meat requires more farm inputs…thus, putting pressure on the whole food chain. And there are limits on how much land and water is available to produce food. Some experts think we are near the limit now…or even beyond it.

At some point…in some places…the food chain snaps. Even today, billions of people spend 50% to 75% of their incomes on food. Double the price of rice or wheat – as has happened in the last two years – and millions of people are in serious trouble.

*** Last week, we went to visit our first grandson. He looked just like his father when he was a baby.

Born in 2008, he could expect to live to the 22nd century. What marvels…what disasters…what might he see? We can’t imagine.

What will he turn out to be?

The gene pool is remarkably diverse. We have six children – each one is completely different from the others. There are traits we can spot. One has Uncle John’s hair. Another has Aunt Eleanor’s temper. One looks just like a photo of Elizabeth’s grandfather. Another is timid and retiring, like Aunt Lillian.

What will these children become? They are now in their late teens and twenties, but still we don’t know. One is out in L.A., learning the film trade. "An awful business," says he. Another is looking for work as an actress in London…learning to live with rejection and to avoid drinking too much champagne at theatre parties. One has already begun a family of his own…and his career – in the family publishing business. The others are in still in school, not sure what they should study or where they should go.

And now, we mix another generation of genes into the Bonner pool…and wonder what will become of the tadpoles.

*** Poor Henry. He is a good student and a smart kid. Henry is in one of the best schools in France, but the teachers tend to grade more severely than in the United States. He has never studied in an English-speaking school. And when it came to take the SAT tests for American colleges, he found himself at a disadvantage; he didn’t understand some of the terms. Still, he applied to a group of elite colleges – on the advice of his guidance counselor.

So far, most of the news from them has been negative. He got on the waiting list for some…was rejected by others…and accepted only by a few, not necessarily the ones he was hoping for. His was among the largest group of college applications ever recorded, say the papers. At Johns Hopkins, for example, there were some 16,000 applicants for only 2,000 places. The odds were against him.

"Maybe I’ll take a year off," he says, "And give myself time to think about what I really want to do. Maybe I don’t really want to be a doctor, after all."

Until tomorrow,

Bill Bonner
The Daily Reckoning

The Daily Reckoning