Buffett buys more ConocoPhillips

Figures just released by the SEC show that between March and September 2008 Warren Buffett bought around 66m shares in ConocoPhillips. At 30th September 2008 he therefore owns almost 84m shares representing approximately 6% of the company. The mystery I covered in my posting of 29th September is therefore solved. I was right.

The ConocoPhillips Mystery

I have two investments in common with Berkshire Hathaway; Glaxo and ConocoPhillips. As noted in my blog on 29th January 2008 ConocoPhillips was my first US investment and since then has performed well. But I was a little concerned when I read that Berkshire might have sold out of Conoco in the second quarter of this year since no holdings were disclosed in the 13F return to the SEC as at 30th June 2008. But on further examination the following statement appears in that 13F for Berkshire Hathaway which was filed 14th August 2008:

"Confidential information has been omitted from the Form 13F and filed separately with the Commission. Included in the confidential filing is information regarding Berkshire Hathaway's position in ConocoPhillips. At March 31, 2008, shares held in ConocoPhillips were included in Berkshire Hathaway's public Form 13F".

So it wasn't that there were no holdings in Conoco, rather than the holding hasn't been disclosed. Why might that be? From time to time Buffett gets a special dispensation to avoid public disclosures where this might be price sensitive leading to "copy cat" investing. But it wouldn't make sense to avoid disclosure where the stock had already been sold (unless the holding was in process of being sold down) so the more likely reason is that Buffett is actually buying quite heavily and intends to buy more.

Banks Need Long Memories

Warren Buffett has just revealed a $5bn investment in Goldman Sachs, a very significant vote of confidence in a very fragile market.

Meanwhile I found myself reading some early Letters to Berkshire Shareholders for the period 1969-1976 and a couple of particular comments jumped right off the page at me. These were written in March 1973 about the banking subsidiary of Berkshire, The Illinois Bank and Trust Co and in relation to the year 1972:

"During 1972, interest paid to depositors was double the amount paid in 1969. We have aggressively sought customer time deposits, but have not pushed for large "money market" certificates of deposit although, during the past several years, they have generally been a less costly source of time funds".

In conclusion he writes: "Our subsidiaries in banking and insurance have major fiduciary responsibilities to our customers. In these operations we maintain capital strength far above industry norms, but still achieve a good level of profitability on such capital. We will continue to adhere to the former objective and make every effort to continue to maintain the latter".

These comments were made 36 years ago and yet it is the fundamentals underlying these concepts (a conservative capital position and less reliance on wholesale funding) which have been neglected by many financial institutions and which have subsequently led to their demise in this current crisis. If Buffett understood this in 1973, and has had a further 36 years to refine his thinking, no wonder he is the world's greatest investor.

Looking Back

I find it hard to believe it is now 4 months since my last post. Probably any readers (if there were any) have given up!
My original idea was to write down some investment ideas so that I could use the record to look back and so how those ideas turned out. Now seems to be a good time to do that.

In Between a Northern Rock and a Hard Place (19th November 2007) I suggested that Northern Rock shareholders would end up with very little. Following the subsequent nationalisation that seems very likely.

Renold Renewed (20th November 2007) was when I bought into Renold most heavily at around 86p. The price is currently still around that level or a bit below although the company continues to trade well and I'm happy with my position.

I've done well out of a few IT companies bought since the dot com crash and nCipher is one of them. See The Need for Data Security (22nd November 2007). I wasn't very happy about subsequent management changes but the company is currently in process of being bought at 300p a share giving me a nice profit.

Sold out of China (29th November 2007). This was an outstanding call. This was close to the top of the market and subsequently Chinese stock markets have fallen by almost two thirds and the particular funds I had invested in are down almost half from their peak. Note the funds I had money in were probably invested via Hong Kong and this market for Chinese shares didn't bubble up to the same extent as the local Chinese Stock Markets and hence hasn't fallen so far.

Royal Bank of Scotland (6th December 2007) didn't work out for me. RBS will survive, unlike the US investment banks, but I was shocked at just how hard the impact of the current crisis has been on financial institutions. But at least I recognised the weakness of Alliance & Leicester Business Model Broken (21st February 2008), which subsequently had to be rescued by Santander and the relative strength of Lloyds in Dull like a Bank is Supposed to be (22nd February 2008)

The Coming Oil Crisis (11th December 2007) however was spot on. Oil hit a peak of around $147 a barrel in 2008 causing a massive shock to the oil dependent economies and businesses. I wrote more about oil in 2008 and despite the recent pull back to below $90 a barrel I expect oil prices will rise again in the near future.

In The End of Disintermediation (29th January 2008) I had started to think about the impact on the banking model and investment banks in particular. I can't claim to have predicted their demise but made very clear my aversion and the fact that the investment banking model would need to be revised. A return to old fashioned relationship banking now seems ever more likely.

More to follow.

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No regret over Oil & Gas

BP and Shell both reported on Q1 this week and stunned the market with strong results. For example Shell Current Cost profit for Q1 was 12% up on the prior year, for BP the increase was 48%. The BP result was pretty exceptional but otherwise I'm not sure why there was so much surprise given that the current record oil prices are well known about. Under typical Production Sharing Contracts (PSCs) high oil prices have the effect of reducing volumes so it is wrong to look at production volumes in isolation without adjusting for this. The FT was grudging in it's appreciation commenting that without high oil prices it would be a very different story. But then, for me, the high oil price is the story.

As some of my friends know I have been predicting high oil prices for some time now. Over the past 12 months oil has more or less doubled to around $120. The head of OPEC Chakib Khelil has just warned that oil could hit $200. I think so too (just don't know when) and continue to invest accordingly.

Fuel Cells - Nearly here

Yesterday I attended the "Low Carbon and Fuel Cell Knowledge Transfer Network" (bit of a mouthful that) seminar on Fuel Cells. Four listed companies presented with others exhibiting. Interesting technology but despite low share prices (CMR Fuel Cells is valued at half it's cash holdings) I came away a little disappointed from an investment standpoint.

The fuel cell concept is not new having originally been invented in 1843 and, whilst used in the Apollo moon project, it is only now that commercial products are on the verge of being made available. There was a lot of talk at the show about how difficult they are to engineer for volume manufacture and to reduce the size of the devices to match modern requirements.

Ceres Power and Ceramic Fuel Cells both produce Combined Heat and Power (CHP) systems but on examination these are really just more efficient boilers, still running on natural gas, and producing a bit of electricity as well as heat. In the case of Ceres Power volume manufacturing is 3 years away, it is likely to be an expensive "top end" item which saves about 25% of fuel bills. OK in time that will make a significant dent in domestic fuel consumption but to my mind these need a Government subsidy (or much higher fuel prices) to make them really fly.

CMR make fuel cells for portable devices, laptops being the prime market targeted, but again a commercial product is still 3 years away.

I will continue to follow this sector but mostly through curiosity since I clearly have no way of being able to evaluate these companies technically nor come to any view on their ultimate profitability and hence current value. The OEMs themselves seem only to be cautiously investing in some of the companies, no doubt reflecting their uncertainty as to which technology will eventually succeed.

Feelings of Regret over RBS?

I have to say I was wrong over Royal Bank of Scotland. I own some stock and supported them through the ABN.Amro acquisition. More recently I could see capital was very tight but I thought they would fight and manage to squeak through, making disposals where necessary, rather than do a u-turn on previous commitments and raise more capital, a huge embarrassment for CEO Sir Fred Goodwin. But with £5.9bn more write-offs the company probably had no choice and so launched a massive £12bn deeply discounted Rights Issue. As it turned out the capital raise was so well anticipated that the effect on the share price when it was announced was actually slightly positive. The company has now come clean and with a stronger capital base plus the option of disposals, will be better placed to move forward rather than the alternative of trying to fight with its back to the wall. Other banks may yet need to come to the market and RBS has the advantage of being first in the queue.

So I whilst was wrong about the capital situation, I was right in that the shares had recently fallen so low that almost every possible piece of bad news was already in the price. Ultimately I think the ABN acquisition will be good for RBS and create a stronger business. Whether or not it will create any shareholder value remains questionable.

Saudi Arabian Oil Capacity Reaches Limit

News today is that Saudi Arabia state they do not expect to increase oil production capacity as far and as fast as previously hoped. The Saudi Arabian Oil Minister said current production is around 9mbpd against a capacity of 12.5mbpd but he had no real intention to increase that capacity any further at least in the period upto 2020. Obviously this raises the possibility that Saudi Arabia is unable to increase production, even if it wanted to, because of the high decline rates of existing fields.

Something else: Late last week T Boone Pickens the respected Texan oilman also said he thought global oil supply has peaked and so prices are likely to go up rather than down: “There are only 85 million barrels of oil in the market every day,” Mr. Pickens added. “I don’t think you can get it above 85 million – lock that number in, and we’ll see if I’m right.”

Pabrai - A day at Work

For about a year now I've been following a sucessful US investor called Mohnish Pabrai whom has been operating since 1999 very much in the mould of Warren Buffett. I'm not going a write much about him here - you will need to read his book The Dhandho Investor or look at his website (only you will need a login from him). Pabrai recently published a transcript of his annual investor meeting which was held in September last year. There was obviously a lot of discussion at this meeting about his performance, past investments and philosophy but to me the most interesting point he made was to say a bit about how he works. You see it is easy to read up on the many investment principles but very difficult, without sharing an office with other investors, to find out how they actually work and find opportunities.

In the case of Pabrai he says he goes to work each day very much as a man of leisure and simply reads generally until he comes across something of interest. Then after only an hour or two on such specific idea he quickly decides whether or not to take it further. Somewhere else I read that he often only spends a couple of days of further research before investing.

That might not seem much to know about but is actually very useful information to me. As I sit down at my desk each day I don't really need to be there at all and unless a company I follow is reporting results there isn't anything I really need to do. Yet the possibilities are limitless - look at share prices, set up data base filters, read company accounts and brokers notes, try sector and company specific reasearch, read magazine and internet articles and so on. Once you start to look there is a huge amount of investment comment and "advice" available but the best opportunities come from digging much deeper. How to do that without being influenced by the market and journalistic chatter is key.

Incidentally the Pabrai Fund PIF3 (open to non US investors) returned -12.4% in the first quarter of 2008 after a loss of 7.8% in 2007. Naturally Pabrai focusses very much on his longer term record for this fund of an average of 15% pa since 2002. Not much different to me so I think I'll stick to managing my own money!

Quote from Pabrai I've taken from SmartMoney on how he can beat the market: "Lots of other investment managers have large teams; they have a lot more brainpower, they've got a lot more resources. The only advantage Pabrai funds have, which is why we have done better than the market, is attitude — my ability to be patient and not be swayed psychologically".

Oil Update

A couple of interesting pieces of news this week providing further evidence for a fragile global oil supply outlook. On Tuesday the FT reported the vice-president of Lukoil as saying that he believed that last year's Russian oil production of 10m barrels a day was effectively the most that would ever be produced and that Russia had therefore "peaked". Even the Russian Government admits that oil production has reached a plateau. As other oil producing regions reach maturity we can expect more stories like that from Russia, although this is highly significant because Russia had been seen as an important source of oil to supply the ever increasing demands from China.

Then today an internal report prepared for the Nigerian government highlights the risk that by 2015 Nigeria could lose a third of it's oil output unless it can find ways to further boost investment in the sector. The Nigerian situation is interesting because it shows how countries which try to take more control over their oil resources tend to under invest themselves and also have difficulty in attracting the foreign capital they need to reach full potential. Nigeria has in any case lost a lot of production because of the security situation in the Delta Region forcing Shell for example to shut down some facilities.

The importance of this factor is often not fully appreciated by those sceptical of "Peak Oil" theories such that, even if there is enough oil in the ground, the cost and difficulty of extracting it is increasing fast and whilst the high oil price should theoretically provide the rewards and incentives, in certain countries and indeed globally, there might not be enough investment and skilled resources available to make it happen.

Panic over?

I see it is now a month since my last post and a lot has been going on in the markets but I've found it hard to think clearly about where we are at. It seems the banks have now stopped panicing as if one bank had to fail on each side of the Atlantic before the bottom of the market was revealed, but now that is done (Northern Rock and Bear Stearns) the worst of the bad news from the financial sector is out.

Generally I'm going through a good spell with a recent MBO bid for Civica, bid interest in nCipher and a tug of war over British Energy which has been a long term favourite of mine. But I don't understand why confidence should start to return when bad news from the housing market and high street is still gathering momentum.

On Tuesday the headlines read "Largest house price drop in 15 years" but more significantly I read in the FT that a number of mainstream lenders have just stopped offering 100% mortgages. This surprised me for two reasons:
1. I didn't realise it had been so easy to get 100% loans! Probably on new build where developers offer incentives this means loans could easily have been 105% LTV or more.
2. It is only now some 9 months after the credit crisis hit that such lenders are withdrawing this product: still so keen to maintain market share at the expense of credit quality.
I expect there is a lot more to unwind: I am monitoring the house builders but a long way off looking to buy.

A Long Standard Life

I soon found a good example to illustrate my short term vs long term forecasting point. Standard Life reported their 2007 results this week and left many analysts gasping by the strong out performance - EEV operating profit up 43%, new business contribution up 68%, diluted IFRS underlying EPS up 53% were the best indicators with all financial targets being exceeded. Mind you it is a wonder anyone tries to forecast the results for life companies given the complexity and reporting under two separate bases; European Embedded Value (EEV) and traditional accounting (IFRS). In addition results are greatly impacted by assumptions about future investment returns, discount rates, mortality rates, policy lapse rates and so on.

However despite these strong results analysts were then left very perplexed by the meagre 6.5% increase in the cash dividend announced. Yet you didn't have to dig very deep through the presentation slides to find the answer. Management noted that "normalised" IFRS profits (excluding all movements on reserves and provisions) increased by 7%. So whilst management did indeed pull a rabbit out of the hat for 2007 they have clearly shown a desire to set a precedent for dividend increases they regard as sustainable over the longer term. And of course life companies are used to thinking in that way.

It was also encouraging to see how management are focused on improving capital and cash generation (EEV capital and cash generation after tax up 129%) and exceeded all their efficiency targets. All good for Shareholder Value.

Another Piece of Buffettology

This is a summary of the Buffett like thinking which led to my enthusiasm over Drax. For clarity I've written this as a separate post although it underpins my approach to Drax.

In short, my view is that most investors place too much reliance on their ability to forecast and by increasing the perceived, and misplaced future certainty this leads them to place a higher value on the business concerned. But in times of great uncertainty the rug is firmly pulled from under the feet of such investors and pricing becomes very difficult inevitably leading to undervaluation. The trick therefore is to accept the short term uncertainty which is always there, just not recognised and focus instead on the longer term looking for reliability of outcome through sustainable competitive advantage plus value to shareholders via return on capital. Probably no one will fully understand what I am trying to say here since it turns traditional short term thinking on its head.

Postscript: Just came across these words of John Maynard Keynes; "An investor who proposes to ignore near-term market fluctuations needs greater resources for safety". For that reason I never use leverage nor trade on margin.

Simple But Powerful

Increasingly I try and benchmark my new investment ideas against what I would call Buffett Investment Principles. Usually I subsequently find out that each certainly wasn't a Buffett like investment but this process does at least help shape my overall thinking about what makes a good investment.

The inspiration I had today followed the Drax presentation to report on 2007 results. Drax is a very simple business with a single coal fired power station, by far the largest in the UK and which produces 7% of our electricity. These shares have been pushed down by investors spooked by the increased cost of coal (blame bulk shipping rates) and uncertainty about the future cost of carbon under the EU Emissions Trading Scheme. Simple it might be but Drax is affected by the cost of coal, electricity and carbon with oil and gas prices a part of the equation. These are very volatile factors and so there are just too many variables to make an accurate forecast of earnings over the next year, although Drax do hedge many exposures and this reduces the volatility. My interest is driven by some much simpler and more strategic factors:

• Coal has a strong future - management put global proven reserves at 900bnt which, assuming 6.5bnt pa production, suggests a reserve life of 140 years.
  


• In coal fired generation Drax is the low cost producer with the cleanest and most efficient UK plant.



• By being able to burn biomass Drax helps meet our Renewable power objectives



• Long term the UK energy supply market is tightening due to increased demand coupled with plant closures.



• Management put the cost of coal fired new build at £1,000 to £1,100 per kW. Thus the 4,000 mW of Drax would cost over £4bn to replace. This compares to a current EV of around £2.3bn.



• This is a focused business and management are committed to enhancing shareholder value through return of excess cash.

The message therefore is don't try and forecast all the variables but focus on the overall profitability driven by Drax as a highly important and strategic asset with capacity in a market increasingly becoming supply constrained. In the meantime the P/E is under 6.

Supporting Green IT

The past week has been very busy as seven companies I follow very closely reported plus there was the BP Strategy Review and Chairman's Letter from Berkshire Hathaway to digest. I'll come back to all that later.



But exciting news today was that iBase Systems, a small private software business I invested in a couple of years ago, was shortlisted for an award in the European Green IT Awards 2008. Being unquoted I wasn't going to write about iBase in this blog but since I have a close involvement if there is a chance to promote it in some way I should do that. The award category is "Use of IT to support Green process or people change": Our iTRACE product is now used throughout London to promote Green modes of transport use and so I think a well deserved finalist! Update: The other finalists are BP, Lexmark and London Borough of Hillingdon. It's great to be part of such a strong line up.

A World That Seems a Lot Smaller

Over the past week or so I 've been ploughing my way through the Barclay's Equity Gilt Study 2008. This Study is produced annually and presents a detailed discussion of the long-term returns available on financial assets. I was only really interested in the first two chapters on the economic background.

The key message relates to natural resources which, due to an increasing population and improving living standards, are being depleted at an accelerating pace. Looking ahead it is simply not possible for developing nations to grow to the point where their per capita use of resources mirrors that of the developed world. For example if China and India were to match US oil per capita usage this would triple global oil consumption to some 24ombpd. Since it seems unlikely that we will ever be able to produce much more than the current rate of 85mbpd something very big has to give. Take copper: For Chinese and Indian copper consumption to rise to the average of the Asian developed countries then global copper output would also need to go up threefold.
Under any growth scenario therefore huge additional investment into resource and energy supply will be needed; all the "easy" stuff has gone. Resources are finite, and increasingly harder to extract and so this has inevitably lead to the resource price inflation now being experienced.

The rather worrying conclusion that the current low inflationary environment we have enjoyed in recent years is about to change. And there isn't anything we can do about it....

Dull like a Bank is Supposed to be

Sorry for all the reports on banks but since the financial market got into such a mess last year keeping a watch on the banks seems the best way to see if we are over the worst. Lloyds TSB reported today and almost surprised by the lack of bad news to talk about. Indeed from what I have seen so far the analysts haven't much to say about them either. Treasury writedowns from market "dislocation" were immaterial at only £280m. On the face of it that might seem a lot but would normally hardly be worth writing about compared to profits of £4bn. There were many positives including profits up, EPS +17% and 5% on the dividend.
Lloyds is mostly UK centric, having disposed of it's International Operations a few years ago, and seen as a somewhat low growth and dull business. But that is exactly how a bank is supposed to be. Lloyds has stuck to the traditional domestic banking market with a conservative business model e.g no direct exposure to US sub-prime, strong capital position and efficient funding. Now the number one provider of current accounts, cards and personal loans, management didn't have grand things to say about strategy other than serving customers better, maintaining relationships through the cycle, cross selling, controlling costs and maintaining quality of business. And good for them.
Interestingly Lloyds, with all their sophisticated analysis of customer spending patterns and systems to detect borrower stress, do not note any adverse trends. UK Retail loan impairments were down and there was a reduction in customer insolvencies. Recession? What Recession?
The dividend yield is now 7.8%. On that basis why put money in the bank when you can get a much better return from owning it!

BATM and VoIP

A couple of years ago I made a very unsual investment in a technology company called BATM. Unusual for me in that at the time they were loss making and I didn't really understand their product other that it was hardware to support VoIP (Voice over Internet Protocol) and I had an idea making free calls over the internet would prove very attractive. The interesting part was the company was full of cash so could easily support the R&D and sales effort needed. Today they reported exceptionally strong results for 2007, well ahead of estimates. Sales +32%, PBT +190%. The best bit is they are only just getting started with big contracts so there is lots more to come. My investment has now doubled and needless to say I've learned a lot more about VoIP! Bloomberg interview with CEO Zvi Maron

Alliance & Leicester - Business Model Broken

Yesterday Alliance & Leicester reported their 2007 results. I didn't watch all the presentations so these views are formed mostly from reading the announcement and the FT. Underlying everything profits were up slightly on 2006 but one third of this (some £185m) was then wiped out by losses and impairments on Treasury Investments. I was surprised to read that only 27% of group revenues come from mortgages and savings. Just what kind of (ex) Building Society is this? They clearly didn't stick to their knitting. A little over half of funding comes from retail deposits and management want to increase this proportion but not compete against rivals offering loss leaders. Having had to replace wholesale funding with much more expensive facilities A&L will scale back on new lending and profits will fall. So if they are not going to chase savings and lending business just what are they going to do? (other than wait to be bought).

Incidentally probably one of the best saving deals for a long time is still available from Northern Rock; 6.35% fixed interest for a year with no notice. And being owned by the government this is now the safest place to invest - as good as gilt edged. While stocks last.

The Resilience of Barclays

Barclays reported on their 2007 results today and I watched the webcast of the presentation and related interviews. After all the press speculation and turbulence through the latter half of the year management seemed reasonably happy to report profits which were flat on 2006 and, despite some hysterical prior speculation about shortage of capital, a Tier 1 ratio which was above target. As if to push back further against critics the dividend was increased by 10%.

It must be very hard for top management in a bank like Barclays being questioned by analysts from competing banks and whom, were they employed by your own bank, would be relatively junior executives many rungs down the ladder. Indeed from the questioning it seemed some do not really understand bank balance sheets very well, although Barclays are to be commended for improving their disclosure of the "unusual" assets currently giving rise to angst. Mind you they needed to. No longer do bank assets comprise simple loans to be analysed by industry and geography but the now infamous and eclectic collection of exposurers to ABS CDO, Sub-prime, Alt-A, Monoline Insurers, SIV, SIV-Lite and Structured investment vehicles.

OK the outlook is more uncertain (or at least this time we know we don't know whereas usually we don't know we don't know) but for a strong, diversified and multinational business (mainstream UK Banking is only 1/3rd of profits) the current P/E of 7.3 and yield of 6.9% seem likely to prove ridiculously low.

A Day for Share Buy Backs

From a quick piece of analysis I note that today 15 FTSE 100 companies announced they had bought back of some of their own shares: BT, Glaxo, Unilever, Diageo, Compass, Shell, BP, M&S, Reuters, Schroders, Whitbread, Legal & General, National Grid, Anglo American and Old Mutual. I own 4 of these. I have no historical analysis at all and have not looked deeper to analyse how many shares were bought in each case, but this looks to me like a fairly exceptional event for one day and a clear demonstration (across 15% of the largest UK listed companies) of strong corporate balance sheets coupled with low share prices. In the case of BT for example the yield is so high that there is a clear near term cashflow benefit from increasing borrowings to retire equity thereby saving on the dividend!

Searching for the Standard Life Expectancy

After my comments back in November (How To live Longer) increasing longevity has finally hit the front page. Many pension funds will suffer a further hit from changes to mortality assumptions now being proposed by regulators and this must surely finally mark the end of the defined benefit system.
Meanwhile Standard Life has done a great deal to offload over half of their £12bn pension annuity liability exposure to Canada Life International Re thereby significantly cutting the risks from increased longevity. Apparently this transaction also increases embedded value profits by some £100m a year, releases some cash and frees up capital. It sounds too good to be true. With that kind of deal to do so what if they lost out to buy Resolution - anyway as of today Pearl still haven't closed that deal. The paper profits I was showing on Standard Life post IPO have since evaporated but it is now trading well below embedded value. The institutions are still very underweight this stock so it should come back strongly once confidence returns.

Visibility and Certainty

Every so often I get a flash of inspiration as to what make a good "Buffett Style" investment. Today my idea can be encapsulated as "Visibility and Certainty". Take the example of National Grid which yesterday pretty much (as far as an company would be able) announced its dividends for the next 4 years through to 2012. This comprises a 15% increase for the current year and 8% thereafter. Also yesterday Shell did a similar thing by declaring it's dividend for Q1 2008 at 40c or 11% up on Q4 2007.
In the case of Shell analysts fuss about near term production declines and high capex, seemingly ignoring record profits, buy backs over the past 3 years totalling $17bn, over 8% of market cap and a strong longer term portfolio leading, in time, to production growth. I listened in to the Shell media and analyst conferences and noted a couple of interesting points:
Shell CEO Jeroen van der Veer has now made public his thoughts on medium term energy supply and stated again that he sees "easy" oil production (i.e. excluding oil sands and very deep water) peaking around 2015. To compete with the NOC's the best strategy is therefore to position the company with assets that perform better at high oil prices and build expertise in complex operating techniques. Oil will become more expensive but this will create an unbrella for alternatives to become more economic. On 2008 JvdV noted that the US comprises about 20% of global oil demand and even if there is some reduction as a result of the economic stuation, growth in the Middle East and Far East make it very likely that global demand for oil products for 2008 will, in any event, exceed that of 2007.

The end of disintermediation?

Extraordinary times. In case I ever forget, remind me never to invest in investment banks! Having had direct experience of the "old" Barings back office many years ago I could write loads about rogue traders. Unfortunately Kerviel will not be the last. And who indeed would be central banker in these conditions? But I have just bought Alan Greenspan's autobiography which might provide some useful insights.

My biggest economic fear at present is actually imported inflation (oil and commodities) and falling tax revenues leaving the Government powerless to apply stimulus. I am still optimistic that the recession will be short lived, and not as bad as some share prices suggest, but I haven't yet worked out the implications for the capital markets which, besides everything else, are only now starting to react to the downgrade and possible demise of the monoline insurers.

A few years ago the story was all about "disintermediation"; rather than investors depositing in banks whom in turn lent money out, debt has increasingly being securitised and distributed direct to those investors. Traditional banking credit skills became less relevant since business was based on clever packaging, the co-operation of rating agencies, credit enhancement and aggressive sales. Thus the "old fashioned" banking model was replaced by fancy investment banks whom took fees rather than put their own capital at risk (apart from big underwriting). It appears that is all shot to pieces.

What will the world be like without all that debt capacity and credit enhancement? Certainly a lot of business models need to be rethought.

Yesterday I made my first ever direct investment into a US company. This was ConocoPhillips being part of my oil & gas theme. Fair enough I was originally drawn to COP by Warren Buffett but ultimately what appealed was a low valuation compared to proved reserves, good reserve replacement, strong cashflows and importantly a management team clearly committed to shareholder value: For 2008 they expect to buy back $10bn of shares which represents around 8% of the market capitalisation.

Twilight in the Desert

Back after an extended Christmas "blog break" during which time I read "Twilight in the Desert" by Matthew Simmons. Simmons is an M&A advisor specialising in the Oil and Gas Industry whom also writes and speaks as a very high profile "peak oiler". His book is very well written and impressed me by deep and thorough research based on a review of over 200 technical papers by engineers and scientists involved in the key Saudi oil fields and presented to the Society of Petroleum Engineers.
In short this shows that production from these very large fields is no longer "easy" and Saudi Aramco are having to use state of the art technologies to keep production up. Given the technical difficulties faced it is simply impossible to be confident about being able to sustain high levels of production from these fields for decades to come and this leads to grave doubts about the level of the reserves Saudi Arabia claims still exist. Much of the argument can be followed by looking at Ghawar, the greatest oil-bearing structure ever known and which first began production in 1951. Ghawar has now produced over 55bn barrels of oil and still supplies around 5m bpd which equates to around 55% of Saudi output and 6% of global supply. It is believed that water comprises about 33% of the liquids produced, which increases complexity and expense and clearly shows that this is a mature field. Someday soon production at Ghawar will peak, if it hasn't already. When Ghawar peaks so does Saudi Arabia and so does the world.