Peak Oil smackdown, Part 1
The piece by Justice Litle of Outstanding Investments in Wednesday’s DR laying out the reasons ExxonMobil could well go broke in 20 years’ time prompted a fascinating email exchange between Justice and Dan Ferris of Extreme Value. I reproduce it below, with some minor edits. Dan's initial reply (posted in Thursday's DR) expresses skepticism (to put it mildly) about Justice's dire prediction for ExxonMobil in particular — and Peak Oil in general:
After all, if peak oil is true, isn't it a good thing to own 70+ billion barrels of oil?
Good luck making money betting against the largest, lowest cost producer ofa product the world grinds to a halt without. At around 6 times pretax earnings, Exxon is like a AAA bond yielding 16%, with a coupon that grows whether oil is $70 or $7. It made 12.1% on equity in 1999, the year oil dropped down around $10 a barrel. It has paid a dividend every year forover 100 years. It has raised its dividend every year since 1983. It has returned more than 14% a year to investors for more than 50 years. It has $32 billion in unrestricted cash on its balance sheet, and it generated $29 billion of free cash flow the last four quarters. At that rate, it could easily finance enough debt to buy Microsoft–and still pay out more than $10 billion a year to shareholders. It is one of 8 AAA-rated public companies in existence. (BRKA, TM, ADP, JNJ, UPS, PFE and GE are the other seven.) Earnings cover fixed charges more than 50 times over, and that's with an effective tax rate exceeding 40%.
ExxonMobil is not going broke. It'll have no trouble hitting $100/share in the next year or two. It's a no-brainer. If peak oil were right, whichit's not, the stock would be a no-brainer to go to $200 at some point in the near future, as the world runs out of the product it owns more of than just about anybody else.
P.S. Peak oil repeals the laws of economics, and endows prognosticators with knowledge of the future that no one has.
And now, as Paul Harvey would say, the rest of the story, beginning with Justice’s reply:
Not sure we're actually in disagreement Dan… or at least not in the way you might think.
I certainly wouldn't short Exxon in the next few years, and I agree w/ you it could do very well for the balance of the decade. $100? Sure, why not. After all, their recent quarterly profits weren't too shabby. (Humorous understatement there.)
That's why my piece gave a multi-decade timeframe, i.e., the long long view. If Exxon peaks in the next 5 years as Maxwell predicts, even as global consumption of energy continues to rise, and if the NOCs say no mas, then how will the picture look 15 years after that?
Hence your short-term forecast and my longer-term forecast could both be correct at the same time.
As to whether or not peak oil is true, I'll stick with guys like Byron King (35 years in the field) and Charley Maxwell (50 years in the field)… but we can certainly agree to disagree.
p.s. Here's an idea…. Maybe you, Matt Badiali, and Porter could team up against, say, Dan Amoss, Byron King and myself. A point-counterpoint steel cage match of sorts. That would be fun, no?
Dan’s rejoinder comes in the form of this essay posted yesterday:
Peak Oil: A Pass/Fail Intelligence Test
by Dan Ferris
You know about peak oil.
That's the idea that the world is running out of oil, that the price is
going sky high as the global supply of oil shrinks to nothing.
It's going to happen so fast, say true believers, that we won't have
time to develop new alternatives. We'll be caught with our pants down,
and the world will plunge into chaos.
C. J. Campbell, geologist and author of The Coming Oil Crisis, says, "We
have come to the end of the first half of the Oil Age."
As if the Stone Age ended because we ran out of stones.
Peak oil theory is wrong because it demands a repeal of the laws of
economics, the simple dynamics of supply and demand. It also endows
prognosticators with the ability to see the future, an ability,
unfortunately, which no one actually possesses. Finally, like all
Malthusian theories, it ignores the fact that every human mouth comes
with one human brain attached (and at no extra charge, I might add).
I recently gained a new respect for the folks at Morningstar, who wrote
recently (and correctly), "The laws of economics have not been
repealed… Canada alone has almost 300 billion barrels in its tar
sands, economical to process at prices above $30 per barrel and
astonishingly profitable at $70. Ratchet prices up to $40 per barrel
and coal-to-liquids (gasoline, diesel, etc.) becomes realistic,
providing more than 50 years supply alone. At $70, oil shale – which
could supply the world at current consumption levels for 100 years –
becomes realistic. Finally, above $80, biomass-to-liquids, an
essentially limitless source, becomes economical."
Peak oil, like every apocalyptic depletion argument, is one of life's
little intelligence tests. If you believe it, you're stupid and you
fail. If you know it's crap, you're smart enough to pass. It's like
Y2K. If you moved your family to the hinterlands of Arkansas and
predicted violence in the streets, you failed that little test. If you
ignored it, you passed.
As for your money, you can take the peak-oil test with your portfolio on
the line. Accepting peak-oil nonsense requires ignoring the highly
cyclical nature of oil (it was near $80 a couple months ago; now it's
under $60). That, in turn, could lead you to downplay the role of savvy
management, like that of, oh… say… ExxonMobil (XOM).
ExxonMobil's management knows that the company has to make investments
work across cycles and in many different pricing environments. That's
why its deepwater Gulf leases only go out to 2008. Management knows the
company will get a chance to buy in cheaper at some point. Charley
Maxwell's recent piece in Barron's is wrong about this. He says they'll
miss out… but Maxwell believes in peak oil, so he fails the test.
ExxonMobil's management buys to make money, to earn a return on
investment, not to indulge fears about paranoid theories. And
ExxonMobil has done a better job of earning shareholder returns than
most of the companies that now exist or have ever existed.
Since 1950, when it was known as Standard Oil of New Jersey, ExxonMobil
has generated average annual shareholder returns of more than 14% a
year. More than 5% of that was from dividends. ExxonMobil has raised
its dividend every year since 1983. Think about how oil prices hovered
in the teens from 1983 to 1998, and you'll appreciate that dividend
record even more. In 1999, when hardly anyone made money in the oil
business and a barrel cost about $10, ExxonMobil earned 12.1% on
capital. That's its worst perfor
mance: 12.1%. These days, it exceeds
30%. If ExxonMobil can make money at $10 oil, it's going to be raising
its dividend forever.
ExxonMobil's managers have made it clear that the company doesn't buy
into the peak-oil nonsense. They pass the test.
Never got an answer on my proposal for a friendly peak-oil duel. I can see that you answered in your own way though, as surely as if your white glove had slapped my face. Or should I say, our faces — those of us who believe peak oil is real.
From your missive: Peak oil, like every apocalyptic depletion argument, is one of life's little intelligence tests. If you believe it, you're stupid and you fail. If you know it's crap, you're smart enough to pass.
John Kerry fan by any chance?
At any rate, you shall have a gentlemanly, if ruthless, response. Peak oilers unite!
Ouch! Says Dan…
Justice, Justice, Justice…
If peak oil is real, it means markets don't work, or even crazier, that they work for everything but oil.
You want me to believe only you, Hubbert, Maxwell, Colin Campbell and the rest of the Peak Oil Society are smart enough to get it and that the rest of us are the poor, benighted masses. I imagine one of you will run for Supreme Chancellor one day to lead us through the crisis.
But this is not a geology question. It's an economics question. And the answer is: markets work. Read Julian Simon and Hayek. It's been fun, but I'm done. Good luck.
While we await Justice’s “gentlemanly if ruthless response,” he leaves us with these thoughts:
Dan, Dan, Dan,
Once again there is a confusion of timeframes. It's wholly possible for peak oil to be correct in the short to intermediate term… and the Simonists to be right in the ultimate long run.
The idea that the cheap oil is all gone… and that at some point all the oil will be gone… does not preclude the possibility of long-term technological alternatives saving the day. It just means a lot of turmoil and upheaval between here and there.
Peak oil and Simonism are not like matter and anti-matter. They do not have to explode when they come in contact with each other. To speak in simple soundbites is to deny the complexities of reality. Re the energy question specifically, Peter Tertzakian has some good thoughts.
Whenever someone starts telling me what I think, I'm inclined to believe they don't actually understand my position. But at any rate, I hope you aren't taking all this too seriously. I doubt you really believe we are stupid, and suspect you just got caught up in the moment. (That won't spare you from a well-considered rebuttal though. You might be done, but we're just getting started here.)