The Coming Oil Crisis

What really concerns me at present is not the sub prime induced credit crunch but actually the next oil crisis. There is an interesting debate going on about the future for oil supply between official oil industry sources such as the US Government backed International Energy Agency (IEA) and an independent band of mostly ex-industry professionals, the so called "peak oilers". As their name suggests, peak oilers believe that global crude production has reached it's limit and that supply is about to decline (or indeed that it already has).
This argument is very well presented in a report by the Energy Watch Group (EWG) published in October 2007 which analyses production data in detail by geographic region. The other side to the debate is led by the IEA which largely forecasts demand, where increases will come from China and India and assumes (backed by reserve data) that OPEC countries will increase supply to fill the gap. But the difference in methodology produces vastly different results: EWG predict that by 2030 global oil supply will be down to 39mbpd whilst the IEA forecast 116mbpd (against about 85mbpd for 2007). If the IEA is wrong and EWG is right we are, globally, are in for a serious shock.
The whole issue is far too lengthy for me to repeat in my blog but I will, from time to time, discuss some of the respective arguments. Suffice it to say that a key part of the differential arises in respect of the Middle East, particularly Saudi Arabia.

Royal Bank of Scotland

I had been eagerly awaiting the RBS trading update today and have listened with great interest to the press and analysts conferences (the media conference was much more interesting). The statement was very solid and Sir Fred impressed me as being very clear and straightforward in his presentation. Pragmatic and, as he put it, just delivering what they said they would. RBS (excluding ABN) is expected to produce operating profit and EPS well ahead of consensus whilst ABN is in line with guidance. Integration is going well and the acquisition is expected to produce a better return than originally envisaged. Credit market write downs were significant at £950m but were much less than the had market feared and contained within the overall earnings expectations. Sir Fred refused to be drawn on 2008 but expressed great satisfaction with the greater diversity by business and geography that RBS now had. Overall there was less business to be done but underlying business growth and ABN opportunities remained. Asia was a particular high spot. In the UK as yet there were no tangible signs of increased stress amongst corporates nor consumers and indeed they were seeing very high levels of credit card spending compared to last year which seemed positive for Christmas. An interesting point that leveraged finance is less than 2% of income so the slow down here wouldn't have a great impact. http://www.rbs.com/

Video Tour of Berkshire Hathaway

"Warren Buffett Watch" with Part II of a video tour around the Berskshire Hathaway HQ with Warren Buffett:

http://www.cnbc.com/id/22045978/site/14081545/

On the page this link takes you to is a further link to Part I of the tour.

A Few Thoughts on Buffettology

I have followed Warren Buffett for a number of years now. Whilst I don't think his investment strategy is totally suitable for my own situation I have learnt a lot from him. The following notes summarise the key components of Buffet philosophy which I like to keep by my side. I will add to and edit this from time to time.

1. Buy Businesses not Stocks. When buying highly liquid stocks it is easy to get lazy and think that "if I don't like it I'll just sell". But if you owned the whole company a "greater fool" might be hard to come by. Buffett buys on the basis that he would be happy holding for 10 years even if the market was closed. This is a great way to focus your attention on the underlying business fundamentals rather than the daily share price.


2. Focus on companies with Wide Economic Moats. When I was at ICG we used to talk in terms of "credit" rather than "a moat" but actually we were talking about the same thing. Simply, how well protected is the company against outside influences? Buffett calls it a sustainable commercial advantage and encourages his portfolio companies to invest to widen their moat further.


3. Use Intrinsic Value. This is probably the hardest concept to fully gasp and put into practice. Unlike most analysts I am not at all interested in the relative P/E and try and find some absolute measure based on discounted cashflow which I think is what Buffett bases his valuations on.


4. Always Require a Margin of Safety. In my view the only certainty about any forecast is that in some way it will be wrong. A margin of safety shortens the odds considerably.


5. Think Independently and be Patient. Easily said but a blind contrarian is soon trampled underfoot when the market rushes for the exit. The market is not always wrong (but sometimes can be slow)! Clearly the best performance follows from buying low and selling high but for this to work you have to be sure of the reasons why the market is being irrational. Like Mohnish Pabrai I generally find stocks continue to fall after I have bought and continue to rise after I sell which is one of the joys of not following the herd. Patience: Using a baseball analogy, Buffett also points out that you increase your batting average by only swinging at the best pitches.

Sold out of China

I'm now out of China. Actually that was a couple of weeks ago but since it seems to have been a reasonable move I'm now prepared to write about it! It's been a great couple of years and although I still believe the long term story, valuations seem to have got way out of hand. I've decided a good indicator of market top is when I hear of a really crazy IPO story. In the case of the Dot com boom it was Lastminute.com whilst Blackstone signalled the top of the private equity market. So when I read of an IPO called Alibaba (maybe a clue there in the name) which multiplied 3 times on the first day of dealings to a PE of 306 I couldn't wait to get out. Now a couple of weeks on with the market about 20% off it's peak, the IPO of Sinotruk (which had been 300 times oversubscribed) fell 15% on the first day of dealings.

Contagion

The word we have all just learned is contagion, defined in my dictionary as "the transmission of a disease by contact". When this is all over I hope the bankers will remain humbled by being the origin of this ghastly infection. But how far will it spread? I detect ever increasing gloom in the City where it has rapidly become apparent that the impact on the debt markets is going to be more severe and lasting than first thought. Almost everyone is now saying "there is worse to come" whereas a couple of months ago it seemed only I was saying that .....

I don't believe China is uncoupled and think the country will soon start to export inflation. Consumer confidence has been shaken both here and in the US and the housing market has stalled. Add in a near record oil price and sky high commodities and the economic outlook is decidedly cloudy.

Meanwhile on the Stock market for many companies, particularly financials, there has already been a big pricing correction and despite the uncertainty, I don't forsee another crash (the particularly overstretched structured finance markets have already been decimated). Overall the market has further to fall but for the long term equity investor there are a few value opportunities emerging so for me cautious and very, very selective buying.

Intermediate but not Boring

Today Intermediate Capital Group reported their half year figures. Given the current investment climate results were outstanding with continuing strong capital gains, 24% increase in core income and 33% growth in PBT assisted by a significant write back of provisions. It should be pointed out that the trading period covered mostly relates to the period before the contraction in the debt markets which happened in September and the outlook is less robust, but unsurprisingly the market reaction was very positive. ICG has for some time been wary of the credit bubble and avoided expanding too aggressively other than by geography. Now with plenty of funding, ICG is well placed to take advantage of the current conditions leading to more creditor friendly structures, prices and terms. However long term growth is very dependent upon the overall growth in the private equity market and that is currently constrained by availability of debt. Sources tell me LBOs are being put together but there is no bank underwriting and banks will only sign up to their final take appetite, if necessary as part of a "club". Apart from a nominal holding I sold out of ICG earlier this year near the all time high. This is a good business with a very thorough long term investment process and deeply embedded credit culture but there are risks and I see less upside. http://www.icgplc.com/