Warren Buffet's Sidekick is No Dummy
In an amazing interview given during the Committee of 100 U.S.-China relations conference, Charlie Munger of Berkshire Hathaway (BRK.A), (BRK.B) fame gives his views on America's quest to be energy independent. In a word, Munger believes energy independence is a "dumb" idea. You can watch the video here. His rant on energy independence starts about 37:30 minutes into the interview.
Munger believes oil and gas supplies will become "incredibly short and very high priced." As a result, he believes:
Foreign oil is your friend.
You want to produce domestic energy assets as slowly as possible.
The oil you leave in the ground is a national treasure.
Every barrel that you use up that comes from somebody else is a barrel of your precious oil, which you're going to need to feed your people and maintain your civilization.
There is no substitute for hydrocarbons: drugs, fertilizers, fungicides, etc. -- all of which China needs to feed its population -- they all come from hydrocarbons.
The U.S. has a problem, but China has a bigger problem.
His views echo those of ExxonMobil (XOM) CEO Rex Tillerson, who also believes energy independence is a bad idea.
How Do You Pay For Foreign Oil?
It's ironic that Munger, who along with Warren Buffet is well known for his keen eye for maintaining a strong balance sheet, takes such a simplistic view of the oil problem. While many would agree it makes sense to save your energy treasure for the future, that sidesteps a crucial issue: how do you pay for the foreign oil reserves you need today?
Most of my readers know that I believe foreign oil imports are at the root of America's financial weakness. Foreign oil imports are the biggest component of the U.S. trade deficit and they have been for decades.
click to enlarge)In 2012, the total U.S. trade deficit was $741.5 trillion dollars, of which net petroleum products contributed $291.3 trillion -- 39% of the total. And these numbers are after a big increase in U.S. oil and gas production as a result of the shale revolution. Trade numbers have been worse in the past. In 2008, the trade deficit was $816.2 trillion. Although the trade deficit is trending lower, primarily due to increased U.S. oil energy production, in May 2013 it was still a whopping -$45 billion.
Issue Long-Term Bonds To Buy Foreign Oil?
So what is Munger's solution? He offers the following anecdote during the interview: in 1930 when oil was about $0.50/barrel, he says the U.S. should have issued $150 billion in long-term bonds and shipped 150 billion barrels of foreign oil to the U.S. and stored it in salt caverns. While hindsight is 20/20, how would such a policy work today?
The U.S. consumed 18,555,000 boe/d in 2012. At $100/barrel for example, that equates to $677.3 trillion. Can you imagine issuing $677 trillion in bonds in addition to what the Treasury is already issuing for its fiscal deficit, combined with the Fed's $85 billion/month of QE? Who is going to buy these bonds? Can you imagine Russia or China buying U.S. bonds to enable the U.S. to buy and store oil for the future? Such a scenario is quite preposterous, in my opinion. However, as my faithful readers know, I feel the U.S. is already printing money out of thin air to "pay" for its imported oil. Last month, "QE" was $85 billion while foreign oil imports for June were $30.5 billion. So the U.S. is already implementing Munger's suggestion to some extent, but I suppose he would prefer the U.S. cut domestic production by 5 million bpd (or so). That would only add another $15 billion a month to the deficit. But hey, when you own the world's reserve currency and you can just print money with paper and ink, why not?
It's ironic and somewhat humorous that Warren Buffett has long dismissed gold as an investment while Munger is recommending the U.S. go into debt to live off of foreign oil until it runs out. Printing money out of thin air to "buy" foreign oil will simply erode the value of the U.S. dollar, leading to higher inflation, higher oil, and yes, higher gold prices.
But I do agree with Munger on several points:
Oil and gas prices are going significantly higher in the coming years.
Climate change is an issue; running out of hydrocarbons is a bigger issue.
The U.S. should be building non-hydrocarbon based energy solutions.
Unfortunately, U.S. energy policy has been all over the map. The ethanol mandates and the billions wasted on unfinished clean-coal plants are just two examples of terrible energy policies. Meanwhile, while politicians talk incessantly of reducing foreign oil and carbon emissions, they have yet to pass significant natural gas transportation policies, which would easily accomplish both those goals. That fact is even harder to believe since the U.S. has the lowest natural gas price on the planet and a 100+ year domestic supply. Note that Munger did not even touch on natural gas transportation. I guess Burlington Northern is making too much money transporting Bakken oil by rail.
Summary And Conclusions
Oil is the most precious and irreplaceable commodity on the planet. I agree with Munger that the price of oil is going significantly higher over time. In spite of the shale revolution, the U.S. remains the world's largest importer of foreign oil and is printing money out of thin air to "pay" for it. The only domestic energy source capable of being scaled up to significantly reduce foreign oil imports is natural gas. However, unlike China, Russia, and the EU, the U.S. government has yet to implement a strategic long-term energy policy that puts a priority on natural gas transportation. As a result, the U.S. will continue to pile on debt (on top of debt...) to import oil. Thus, the price of oil will continue to climb. Geopolitical unrest in the Middle East simply adds a price premium on top of an already bullish outlook for oil.
So what's an investor to do?
If you believe oil is going significantly higher in the future, you should consider buying gold bullion or a gold ETF (GLD) for two reasons:
First, rising oil prices means rising oil import costs for the U.S., which means more money printing (debt), which in turn will lead to higher inflation and (at some point) will lead to a weakening U.S. dollar. Since oil is priced in U.S. dollars (in most trades, but not all), a lower dollar means higher oil prices. The only reasons the U.S. currency hasn't weakened to date is because it is the de-facto world's reserve currency and it is the best house in a bad neighborhood. But can you imagine any other country on Earth getting away with printing money to pay for oil like the U.S. does? No, you can't. In fact, other countries -- China and Russia to name two -- are working hard to create a new world reserve currency to replace the U.S. standard. This currency would not be owned by any one nation, and thus reduces the risk of holding foreign reserves in huge piles of U.S. dollars -- as is the case today. This won't happen overnight, but in the long run, it will be successful because the current status quo is not sustainable. If and when it happens, it will not be good for the U.S. or its currency -- especially if the U.S. has not yet transitioned to natural gas transportation in order to reduce its dependence on foreign oil (gasoline).
Secondly, as I showed in my 2011 article Oil Will Drive Gold Prices Even Higher, gold generally follows oil prices. If you believe in Munger's hypothesis that long-term oil prices are going significantly higher, you need to own some gold because it will rise in tandem with oil (see chart below).
Gold Price in US Dollars data by YCharts
Lastly, and obviously, an investor should protect him or herself from high oil (gasoline) prices by devoting a portion of their portfolio to large international energy companies like Chevron (CVX), ConocoPhillips(COP), and ExxonMobil. These are great companies and good insurance policies if the (slightly apocalyptic) views of Charlie Munger come to pass. As shown in the chart below, these companies have been excellent long-term vehicles to store and grow wealth. The companies are currently cheap -- trading at below market multiples while simultaneously providing a significant income stream:
CVX => $4.00 dividend; Yield=3.2%; P/E=9.6
XOM => $2.52 dividend; Yield=2.7%; P/E=9.6
COP => $2.76 dividend; Yield=4.2%; P/E=10.6
XOM data by YCharts
Whether or not you agree or disagree with Charlie Munger's view on energy independence, gold and large-cap energy stocks will protect you from higher oil and gasoline prices, higher inflation, and a potential weak U.S. currency. All of which, in my opinion, are highly likely scenarios.