Tuesday, October 26, 2010

ETF Spotlight: Norway and Scandinavia - GXF

This week's ETF spotlight focuses on the Global X FTSE Nordic 30 ETF (GXF).  Scandinavia is one of the world's most energy secure regions, with large Norwegian oil reserves, wide renewable energy adoption, and broad social and government efforts to reduce energy consumption.  The Nordic countries are are also some of the world's most economically and politically stable economies and stand to benefit greatly from peak oil.

The village of Reine in Lofoten, Norway
(Credit: Petr Šmerkl)

Norway is the world's 5th largest oil exporter and 3rd largest gas exporter - ahead of Kuwait and behind Iran, the UAE, Russia and Saudi Arabia.  Western Europe gets much of their oil from Norway's offshore fields in the North Sea and this resource has provided an incredible source of wealth for Norway - accounting for approximately 50% of all exports.

Starting in 1996, the Norwegian government started funneling the excess proceeds from its oil exports into The Government Pension Fund of Norway.  In 2010, the fund topped half a trillion dollars, and currently holds 1 percent of the global equity markets.  The incredible size of Norway's sovereign wealth fund has greatly increased the country's resilience to the possible harmful effects of peak oil.

Norway's North Sea oil production peaked in 2001 at 3.4 million b/d and has been declining at a rapid 13% rate since.  The decline rate is a cautionary tale for anyone who thinks that enhanced oil recovery technology will save the world from peak oil; Norway is a world leader in such technology and rather than postponing the country's production peak, it has merely allowed it to continue to produce oil for a longer period time at production rates that are still declining from their peak.

While Norway's oil production peak might, on the surface, make it in an unattractive peak-oil investment play, there are a number of reasons why Norway could benefit greatly from peak oil - including the country's large existing oil reserves, energy independence, potential arctic oil reserves, position as an oil technology leader, societal push for energy efficiency, large existing renewable energy infrastructure and political and economic stability relative to other oil exporters.

Despite Norway's oil field depletion rate, the large size of the existing oil reserves and the government and societal push for energy efficiency make it unlikely that the country will become a net oil importer in the near future.  This leaves it in the enviable position of being one of the few energy independent nations on earth.  This should allow Norway to not only ride out any oil shocks, but also to profit from them.  Additionally there's some research which shows that energy independence allows economies to continue to grow during worldwide recessions.

Norway is also actively pursuing the exploitation of new sources of oil in the Arctic Ocean.  Oil companies are extremely optimistic about the potential for vast quantities of oil in the Arctic, with some experts saying that reserves could total 25-50% of the world's undiscovered oil.  Norway, along with the United States, Russia, Denmark and Canada, stand to benefit greatly from this "final frontier" of oil exploration.

Norway is a worldwide leader in offshore oil rig technology, due largely to the fact that the North Sea is one of the harshest drilling environments on earth.  Winter temperatures are frequently below freezing and waves can regularly exceed heights of 10 meters - with one instance of a 25 meter wave hitting an oil platform in 1995.  In overcoming these unprecedented technological hurdles, Norway has developed some of the world's most advanced offshore oil drilling technology, and stands to benefit from exporting it to companies which wish to drill in even harsher environments, such as in the Arctic.

Additionally, Norway is a technology leader in advanced oil recovery from carbon sequestration.  Statoil currently operates the world's largest carbon sequestration facility and should be able to easily export its technology and expertise to other oil companies wishing to increase oil production and reduce carbon emissions - both major economic issues for oil companies in the future.  Additionally, this carbon sequestration technology could potentially be combined with underground coal gasification technology to carbon-neutrally harness the 3 trillion tons of coal which lie off Norway's coastline (a reserve 3 times larger than the entire world's onshore coal reserves).

Norway has also long been a leader in offshore oil rig safety standards, with its Det Norske Veritas classification being one of the world's toughest regulation standards for offshore vessels.  As a result, Norway stands to benefit from the current push to retrofit existing offshore oil rigs to higher safety standards, due to new government regulations resulting from the Deepwater Horizon oil spill in the Gulf of Mexico.

Scandinavia has significant existing renewable energy infrastructure.  Norway, due to its vast network of hydroelectric dams, generates 99% of its electricity from renewable energy.  It is also the first country to commercialize tidal power.  Finland generates about a quarter of its electricity from renewable sources.  Denmark, long known for its windmills, generates about 20% of its electricity from wind power and manufactures a significant portion of the world's wind turbines.  Scandinavia's large renewable energy infrastructure, combined with a current push for electric car adoption, will greatly reduce the region's exposure to the negative effects of peak oil in the future.

In addition to its renewable energy sources, Scandinavia is leading the world in an effort to reduce its oil consumption.  Major Scandinavian cities like Stockholm, Copenhagen and Oslo are extremely walkable, have readily available public transportation and lead the western world in bicycle use.  In Copenhagen, 36% of all citizens commute by bicycle and the city has set a target for 50% of citizens to do so by 2015.  In Sweden, 43% of the country's electricity comes from renewable sources and the government has drawn up plans to make the country oil-free by 2020.

The Scandinavian countries have robust economies with stable currencies.  The Norwegian Krone has even been called "the world's safest currency" - a distinction which is particularly salient during the current currency wars, with the world's largest economies in a race to the bottom to devalue their currencies.  The Scandinavian countries are some of the wealthiest on earth; all rank in the top 20 for gross domestic product at purchasing power parity per capita, with Norway holding the 3rd spot, behind only Qatar and Luxembourg.  They are also some of the most productive, with GDP-PPP per hour worked ranking Norway as the most productive country on earth.  Sweden, Finland and Denmark also all rank within the top ten of the world's most competitive economies.

On its own fundamental merits for currency stability, government stability, economic stability and potential for economic growth, the Scandinavian countries make an ideal investment target.  When combined with their focus on energy independence and the vast resource wealth of Norway, investing in the Global X FTSE Nordic 30 ETF (GXF) is a great way to protect your portfolio from peak oil.

GXF Top 10 Holdings:
  1. Novo Nordisk - Danish Pharmaceutical Company
  2. Nordea Bank - Nordic Banking Conglomerate
  3. Ericsson - Swedish Telecommunications Company
  4. Nokia - Finnish Mobile Phone Company
  5. Statoil - Norwegian Oil Company
    • Operates in 34 countries worldwide
    • Technology leader in harsh-environment offshore drilling
    • Offshore safety leader
    • Technology leader in carbon sequestration
  6. H&M - Swedish Clothing Company
  7. Svenska Handelsbanken - Swedish Bank
  8. Volvo - Swedish commecial truck Manufactuer
    • Produces some of the world's most fuel-efficient commercial trucks
    • Volvo Cars is owned by the Chinese Geely car company
  9. Sandvik - Swedish Materials, Mining & Construction Company
    • Large upside potential from increase in commodities prices
  10. Danske Bank - Danish Bank

Saturday, October 16, 2010

Book Report - The Impending World Energy Mess

Robert Hirsch is perhaps most well known for writing the famous "Hirsch Report" in 2005, which was the first official US Government report, written for the US Department of Energy, which publicly acknowledged the threat of peak oil and the potential catastrophic effects it could have on the US economy.  Along with the two co-authors of the Hirsch Report, Dr. Hirsch recently published a book aimed at the general public entitled "The Impending World Energy Mess".

Generally the book does a very good job synthesizing all of the various complexities associated with peak oil, from the overestimation of OPEC reserves (pg. 33), to the summary of current peak date forecasts (ch. 7), the challenges to mitigation strategies (pg. 130), the Energy Return on Energy Invested of alternatives (ch. 13), and the obstacles to scaling up alternatives (ch. 14).  It is very comprehensive in the way it takes each alternative, one by one, and analyzes their market potential and the challenges and risks of their adoption.

One criticism of the book is that the authors chose to treat climate change with a good deal of skepticism.  Obviously the "climategate" scandal shed a lot of negative light on the way scientists build their climate models.  Correlation of temperature changes to greenhouse gas emissions does not necessarily imply causation and anyone who's familiar with modeling - for example, financial modeling - knows that the modeler can adjust the countless assumptions to make their model come to pretty much whatever conclusion they desire.  So while there may be a great deal of skepticism (much of it funded by the largest greenhouse gas emitters) about the anthropogenic roots of global climate change, there is little doubt about the basic scientific measurements confirming global warming since the beginning of the industrial revolution.  So the problem comes down to the simple question: "are you confident enough with your skepticism of the anthropogenic roots of global climate change to risk doing nothing and potentially endanger all future generations of life on earth?".  Which brings us to the "precautionary principle".  For a group of authors who so competently apply the precautionary principle to the problem of peak oil, it's disheartening to see them completely ignore it for climate change.  Certainly, the militaries of the world (including the United States, Canada, Germany, China, & Russia) understand the issue and have been actively building contingency plans for wars resulting from global warming and peak oil.  If our militaries are taking the two problems seriously, perhaps we should as well.  After all, the solutions to our energy security problem, our peak oil problem and our climate change problem are the same: become more efficient in our use of energy, transition our transportation infrastructure to be less dependent on fossil fuels, and build massive new sources of renewable energy.

In chapter 16, the authors name specific countries as peak oil winners and losers, and their conclusions largely mirror the Peak Oil Proof Portfolio:
  • Winners: Oil Exporting Countries
    • Russia
      • I recommend RSX in the Peak Oil Proof Portfolio
    • Canada
      • I recommend EWC in the Peak Oil Proof Portfolio
    • Saudi Arabia
    • Mexico
      •  Hirsch fails to recognize Mexico's 2006 peak and massive 13% decline rate since
    • Norway
      • I recommend GXF in the Peak Oil Proof Portfolio
  • Losers: Oil Importing Countries
    • United States
      • Major economic downside potential as China spends US dollar reserves on oil
    • China
      • Massive recent oil investments (in US Dollars) may help mitigate problem
    • Japan
    • India
    • South Korea
    • Most of Europe - specifically Germany, France and Spain

    On a side note, I had the opportunity to sit in on a discussion panel two nights ago with Michael Nash, the director of the new movie "Climate Refugees".  He told a story of a night he had in China a few years ago where he had a few drinks with some Chinese officials after randomly sharing a cab with them.  He asked them what they really thought of the way the United States was handling its energy security and climate change policy.  The officials responded that they would love nothing more than for the US to have another 10 years of political impasse over energy policy - that while the US has been squabbling over building an energy bill, China has gone from being a developing country to the world's largest consumer of energy and the world's largest producer of wind turbines and solar panels.  The Chinese officials rightly deduced that if the United States waits any longer to get serious about its energy problem, that not only will the US be in severe economic trouble, but that it will be buying the solutions to its problems from the Chinese rather than building them domestically.  As Dr. Hirsch accurately surmises in the book, "the risk of widespread economic disaster is so great that immediate action is mandatory."  If the US politicians don't get serious about creating a comprehensive energy plan to transition the US economy towards energy alternatives, the United States could end up as the "biggest loser" of the above list.

    Additional investment advice is given in chapter 18, including:
    • Avoid holding long-term bonds
    • Consider investing in inflation-protected TIPS bonds
    • Invest in commodities as a hedge against energy-induced inflation
      • I recommend GLD and SLV in the Peak Oil Proof Portfolio
    • Avoid investment in consumer goods companies
    • Consider short sales of stocks
    • Invest in countries which are energy secure
    In chapter 11, the authors also recommend their preferred technologies which countries could adopt in an Apollo-style "crash program" to mitigate the effects of a worldwide oil production decline.  Since each technology carries with it significant technical and political risk, I believe it's best to invest broadly in oil (VDE) and alternatives (PBD) and avoid trying to pick technology winners and losers.

    As for the Peak Oil Proof Portfolio, it's up 4.16% since its inception, vs. 3.07% for S&P 500.

    Saturday, October 9, 2010

    ETF Spotlight: Brazil - EWZ

    I've created a mock portfolio to track the progress of the Peak Oil Proof Portfolio.  For the past week, the portfolio has gained 2.95%, while the S&P500 gained 2.10% - mostly due to poor US unemployment figures raising expectations that the Fed will issue a second round of quantitative easing.  In the event of "QE2", we could expect that US energy demand will increase, buoyed by more readily-available money.  Loose US monetary policy should generally benefit the entire portfolio.

    Sunday, October 3, 2010

    Peak Oil Proof Your Portfolio

    I decided to start this blog to help people adjust their portfolio and their financial lives to make them more resilient to the potential effects of global peak oil.

    For the purposes herein, I'll define peak oil as the point at which global conventional oil reaches a daily production peak (in millions of barrels per day) and begins to decline thereafter.  An easier way to think about this definition is - the point at which all of the "easy oil" is in a state of terminal decline.

    I'm not here to convince you that peak oil will eventually happen - dozens of people have written books and reports detailing the geological reasons for global peak oil, with empirical regional depletion data extrapolated up to the global level. Nor am I here to try to convince you that the global peak is imminent or has already happened - nobody knows the exact timing of peak oil, and it could be a number of years before it arrives.

    Rather, the purpose of this blog is to help you bolster your portfolio, following the precautionary principle - you're better off being safe than sorry, and frankly it'd be financially reckless to not diversify your portfolio holdings against a financial threat with such far-reaching implications.

    I believe an "ideal portfolio" would be invested in the following areas:
    1. Broad market ETFs in countries with good energy security, good existing industry and good growth potential
    2. Commodity ETFs - as a store of value, hedge against stocks and hedge against oil-price-induced inflation
    3. Energy ETFs - both conventional oil and alternative energy - to directly profit from price increases
    ETFs are the ideal way to diversify a portfolio - they provide the ability to own diversified stocks and commodities at a very low cost and they are extremely liquid. It makes much more sense for an individual investor to buy an ETF than to buy a number of individual company stocks. With ETFs, you can easily reduce your risk to poor performance in individual companies; your risk is far lower if you own a broad energy ETF (like VDE) than if you own individual company stocks - just imagine if you had owned BP or Enron as your sole "energy play".

    Countries with good energy security are those which are currently net oil exporters and those which have the potential to increase their oil production. Canada, Russia and Brazil all fit into this category. Norway is a net exporter, and although oil production from the North Sea peaked in 1999, I think Norway and the Scandinavian countries are well ahead of the rest of the world in terms of energy security due to their access to large existing reserves of oil, their access to potential new sources of Arctic oil, their successful efforts to reduce energy consumption, and their heavy investment in alternative energy.

    Pre-Peak Oil Exporters

    Canada and Norway both have large, stable, industrial economies. Australia is a major exporter of industrial commodities. Brazil and Russia make up the B and R of the BRIC countries, and have huge economic growth potential. The other two BRIC countries, India and China, are net importers of oil and both have terrible energy security.

    The United States, while currently the 3rd largest producer of oil, is also the world's largest consumer of oil and a net importer. Oil production in the United States peaked in 1970 and the US has been jockeying for oil security ever since. Obviously the United States is a huge industrial economy, but I believe its economic growth potential could become limited by global peak oil, and therefore, there are better investments to be made in other countries.

    Commodities will benefit in a number of ways from peak global oil. Firstly, commodities themselves are a store of value. Uncertainty over the future value of the US Dollar has been driving many investors into precious metals recently and in the event of a peak-oil-induced global economic collapse, commodities will hold their value much better than stocks or currency. Commodities also provide a hedge against inflation. Energy prices are one of the key factors in inflation - as prices of energy go up, so do prices for agricultural commodities, metals and all industrial inputs. During periods of high inflation, someone holding $100 in gold is going to be much better off from a purchasing-power standpoint, than someone holding $100 in US Dollars or $100 in US company stock.

    Lastly, investing directly into energy is the best way to benefit from higher energy prices. There are two ways to invest in energy - by purchasing oil directly as a commodity (through futures contracts or via an oil-futures ETF) - or by purchasing stock in companies that produce oil or provide equipment and service to the oil producers. I believe the latter method is better for a number of reasons. Holding futures contracts is risky and buying ETFs which hold oil futures is costly, since most are rebalanced on a daily basis. Oil company ETFs, on the other hand, are far less risky, less costly and provide steady dividends. You can think of the choice as: "would you rather own a loaf of bread or own the bakery?"

    Investing in alternative energy is also a good hedge against the political risk of owning oil companies. The political environment during an oil price spike (especially a sustained price spike) is extremely unpredictable. In an effort to punish a scapegoat, politicians could impose irrational (and economically damaging) windfall taxes on oil companies. Oil rationing and oil company nationalizations certainly aren't off the table either. The elimination of subsidies and tax-breaks for oil producers and the implementation of massive subsidies for alternatives energy could also certainly happen, and it would pay to own alternative energy stocks in such an environment. Additionally, as we start sliding down the far side of the peak oil curve, we will need to transition our world from a hydrocarbon-based society to a renewable-energy based society. Renewable energy companies stand to benefit handsomely from this transition.

    So to put all of these recommendations together, I believe an ideal "peak oil proof portfolio" would look something like this:

    • Country ETFs - 50%
      • Australia - 10% - EWA
      • Brazil - 10% - EWZ
      • Canada - 10% - EWC
      • Norway and Scandinavia - 10% - GXF
      • Russia - 10% - RSX
    • Commodity ETFs - 20%
      • Agriculture - 5% - DBA
      • Metals
        • Gold - 5% - GLD
        • Silver - 5% - SLV
        • Industrial Metals - 5% - RJZ
    • Energy ETFs - 30%
      • Oil - 20% - VDE
      • Coal - 5% - KOL
      • Renewable Energy - 5% - PBD