Jeremy Grantham on Tesla, Fertilizer Wars; GMO’s famed investor also discusses peak oil and fracking. Plus, investing lessons learned over 47 years


Jeremy Grantham on Tesla, Fertilizer Wars


GMO’s famed investor also discusses peak oil and fracking. Plus, investing lessons learned over 47 years.

Fossil Fuels: Is Tesla a Tease or a Triumph? 
In an earlier report, “The Race of Our Lives,” I finished on the unusually optimistic point (for me) that a combination of declining fertility and eventual declining population combined with unexpectedly strong progress in renewable energy might just save our modern civilization from a slow and, no doubt, irregular descent into dystopia. More recently, while still believing we are in this critical race, I have become increasingly impressed with the potential for a revolution in energy, which will make it extremely unlikely that a lack of energy will be the issue that brings us to our knees. Even in the expected event that there are no important breakthroughs in the cost of nuclear power, the potential for alternative energy sources, mainly solar and wind power, to completely replace coal and gas for utility generation globally is, I think, certain. The question is only whether it takes 30 years or 70 years. That we will replace oil for land transportation with electricity or fuel cells derived indirectly from electricity is also certain, and there, perhaps, the timing question is whether this will take 20 or 40 years. To my eyes, the progress in these areas is accelerating rapidly and will surprise almost everybody, I hope including me.

Because of this optimism concerning the technology of alternative energy, I have felt for some time that new investments today in coal and tar sands are highly likely to become stranded assets, and everything I have seen, in the last year particularly, increases my confidence. China especially is escalating rapidly in its drive to limit future pollution from coal and gasoline and diesel powered vehicles. Increased smog last year in major cities led to an unprecedented level of general complaint. China simply can’t afford to have Chinese and foreign business leaders leaving important industrial areas in order to protect the health of themselves and their families. Nor are they likely to be comfortable with a high level of sustained complaint from the general public. They have responded in what I consider to be Chinese style, with a growing list of new targets for reducing pollution. A typical example recently was an increase of 60% in their target for total installed solar by the end of 2015! Hardly a month goes by without a new step being announced.

Even when considering oil, with enough progress in alternatives and in electric vehicles one begins to wonder whether this year’s $650 billion spent looking for new oil will ever get a decent return. I recently took a drive in a GMO colleague’s Tesla (ticker: TSLA) from New York to Boston. Now, I am about as far from a car freak as you will easily find. I just turned in a 12-year-old Volvo that unfortunately had been sideswiped, for otherwise it was good for years more. But I have to say that my recent Tesla journey was my #1 car experience ever. Three years ago I test drove a Tesla in Boston and it was a tinny, rattly, super-expensive toy. Its battery alone cost $50,000! Last month, its chief engineers suggested its cost today is $22,000. In three years they and other experts are confident that the battery will be less than $15,000 and probably its weight will have fallen also. The Tesla feels like the $75,000 vehicle it is and not simply adjusting for the fact that it is electric, but on its own merit. Many of you will know that this vehicle has a range of 150 to 270 miles depending on battery size and that it received two prestigious car of the year awards along with being given the highest crash ratings of any vehicle ever! Consumer Reports gave it the co-equal highest ratings in the magazine’s 77 years! Even more importantly for me, there was this series of what I can only describe as my first iPad moment: “Wow, that’s cool!” And cool it was as the extreme acceleration pushed me back into the passenger seat for the first time in my life, aided, it must be said, by an exuberant new owner at the wheel. We had enough charge to reach Boston easily, but out of curiosity and in need of a coffee break, we stopped to charge the battery at the one and only charging station halfway home. Twenty-five minutes later, we were back on the road, fully charged up. And for free! (Full disclosure: I regrettably have owned no shares in Tesla.)

Okay, “Enough!” you say. But at $10,000 to $15,000 per battery in three years plus some economies of scale, there will probably be a $40,000 vehicle that even die-hard cheapskates like me will have to buy. (Our stop-gap Jetta diesel, which gets an honest 41 miles to the gallon, was $24,000.) One can easily see that in 10 years there could be a new world order in cars. (And if that weren’t enough, there is a wholly different attack on the traditional gasoline engine from an entirely new technology, the hydrogen fuel cell, to be introduced by Toyota this year.) In short, with slower global economic growth, more fuel-efficient gasoline and diesel vehicles, more hybrids, cheaper electric cars, more natural gas vehicles, and possibly new technologies using fuel cells and, conceivably, methanol, it is certain that oil demand from developed countries will decline, probably faster than expected.

Some emerging countries, notably China, are likely to take more dramatic and faster steps to reduce demand than we have ever thought about. Already they have 200 million electric vehicles – mostly motorbikes – almost as many as the rest of the world squared. Total global oil demand at current prices or higher is likely to peak in 10 years or so. At much lower prices we would fairly quickly lose most of our high-cost production: deep offshore, fracking, and tar sands. Times may be changing faster than we think. My guess is that oil prices will be higher than now in 10 years, but after that, who knows? The idea of “peak oil demand” as opposed to peak oil supply has gone, in my opinion, from being a joke to an idea worth beginning to think about in a single year. Some changes seem to be always around the corner and then at long last they move faster than you expected and you are caught flat-footed.

Fracking in the U.S. has already been a bonanza for economic activity (and Lord knows the economy can use any help it can get) as drilling and its massive support system has ramped up to 20,000 wells or so a year. The importance to the U.S. of increased domestic oil production has, of course, been in reduced import bills and lower dependence on a potentially dangerous market. But oil is a truly global market, with 64 countries producing oil and every country using it, and our new fracking oil moves our dial but barely touches the global market. Our remarkable 20% increase in output is only 2% of world production. The real oil problem is its cost – that it costs $75 to $85 a barrel from search to delivery to find a decent amount of traditional oil when as recently as 15 years ago it cost $25.

And fracking is not cheap. The fact that increased fracking has been great for creating new jobs should give you some idea: it is both labor- and capital-intensive compared to traditional oil. Also, we drill the best sites in the best fields first, so do not expect the costs to fall per barrel (although the costs per well drilled certainly will fall with experience, the output per well will also fall). No, fracking, like extracting tar sands, yields a relatively costly type of oil that you resort to only when the easy, cheap stuff is finished. Fracking wells also run off fast. We still get 10% of global oil from a single traditional field discovered in 1945 that is still chugging along. Fracking wells are basically done for in three years. They are definitely not your grandfather’s oil wells!

Natural gas is a local market, so local that Japan can be paying $12 per MCF while we, with our new fracking supplies, pay only $4.00 or so, vastly to the competitive advantage of our chemical industry and other energy- intensive industries. However, if we tried very hard we could mess up this splendid advantage: we could ship our gas overseas. The costs of liquefying, shipping, and delivery come to around $6 per MCF, well over half the total energy value at global rates of the world’s premium fossil fuel – premium in terms of its ease and cleanness in handling, its huge reduction in air pollution, and, critically, its reduction in CO2 produced per unit of energy.

So from a global environmental and resource view, fully half of the benefit of our premier fossil fuel (or the least bad to an environmentalist) would be totally wasted in shipping costs. Oil is perfectly designed for cheap shipping; natural gas, in contrast, is perfectly designed for painfully expensive shipping. Exporting our natural gas would also take a big bite out of the relative cost advantage of a large slice of U.S. industry. Building incremental chemical and other industrial plants would produce many multiples of the new jobs that exporting gas would create.

Exporting gas would, however, help raise the price of gas in the U.S. and make some more money for gas producers if that is what you value. Rising demand as industry and consumers reorient activities toward this cheaper energy will push the price up steadily anyway. And, very probably, long before the huge investment in shipping and port facilities were amortized, the U.S. gas price will have crossed the $6 gap, which, added to shipping costs, would close out the international markets. Surely it is far better to have the U.S. sit back and enjoy a few years of energy cost advantage. (Similarly, the XL pipeline is designed primarily to arbitrage the gap between higher global oil prices and the lower oil prices in parts of Canada by making more tar sand oil available for global markets. Higher prices are much to the advantage of Canadian tar sand producers. Lower prices are much more to our advantage in the U.S. Multinational oil companies with profits in both countries do not see this issue so straightforwardly .)

Yet More Technical Stuff on Fracking 
“Fracking gas,” like all natural gas, is basically methane. Methane unfortunately is an even more potent greenhouse gas than CO2: at an interval of 100 years it is now estimated to be 32 times as bad, and at 20 years to be 72 times worse! If it leaks from well head to stove by more than 3%, it gives back its critical advantage and becomes no better than coal in its climate effect. Emissions, for whatever reasons, have not been carefully monitored. It would be nice, though, to know how fast we are roasting our planet. A series of tests in the next three years or so, privately funded, will measure leakages. In old cities with Victorian era gas lines, leakage will be terrible – probably 2% or 3% on their own. At some “cowboy” wells, emissions will be much higher than that. This, however, is just a matter of best practices: all production and transmission could be reduced fairly quickly to 0.5% or less. In comparison, retrofitting antique city gas lines will not be easy. It will take real money, but there are some ingenious new methods of renewing pipes being developed as we read. We could really do this with a little exercise in good judgment and sensible regulations. Carefree deregulation à la Greenspan et al. helped make the financial meltdown interesting.

But this issue is much more important: planetary meltdown. You can see that in the Midwest earthquakes measuring over 3.0 on the Richter Scale occurred with the almost remarkable regularity of 17 a day on average. Decade after decade this pattern continued – producing a remarkably straight line – until 2002, when the line climbed steadily above trend, coincident with the drilling of fracking wells in the region. From 2002 until now the average has risen by over three times to 54 a day and peaked in 2011 at 171! There is no prize for pointing out that few, if any, individual incidents can be attributed to a particular well with certainty, but to me at least the connection is clear and statistically certain … far more certain than anything I ever see in the stock market or the economy. But would you know this from the way this data has been presented, or, rather, not presented? Hey, they’re only earthquakes! Fortunately these earthquakes are, as always, overwhelmingly minor quakes. Large earthquakes are, happily, very rare. In this data there were only two events over 5.0 on the Richter Scale, but one of these was deemed by the authors to be very likely the product of fracking.

Update on Metals, Fertilizers, and Food 
A group of important elements – iron, aluminum, and potassium – are generously supplied in the earth’s crust, 2.5% to 4% each, and at some price that is affordable at least to rich and middle income countries they will be available for a century or two at least. Many other important elements, though, are genuinely scarce so that their availability at even fairly desperate prices is not assured, at least not for their current uses. Copper, for example, may become a semi-precious metal but will certainly not be commonly used for piping in a few decades. All of these metals must be replaced eventually by organic substitutes, just as cellulosic plastics from wood have already been substituted in some uses for petrochemical plastics. Substituting for copper and other elements that have special qualities such as conducting capability or use as a catalyst will take decades – a time period far too long to attract many corporate research dollars.

As readers know, I consider phosphorus (phosphate) to be an especially important case. Phosphorus is about .07% of the earth’s crust compared, say, to potash’s 2.5%. This .07% had been washed down rivers for millions of years and, once in a geological while, an ocean dried up. If everything was just right, we were left with 20% or 30% phosphate concentrations, at which concentration extraction is efficient and cheap enough for the farmers of developed and most emerging countries to use in required quantities. As mentioned before, phosphorus (and potassium in potash) is necessary for the growth of all living things and, unlike very nearly everything else, cannot be substituted for or made. Currently both are mined and the mines deplete.

Particularly worrying to me is that phosphorus is not evenly divided: you either sit on a dried up ocean or you don’t. Morocco and the neighbor it controls, Western Sahara, contain within their boundaries some 75% ±10% of all of the high-grade, low-cost phosphate known to exist in the world. Outside of these Moroccan deposits there is still a lot of phosphate – about enough for 50 years at 2% a year growth in demand. Even after allowing for further discoveries to add 40% to this total, it would mean that “peak non-Moroccan phosphate” would occur in some 30 years and all hell would break loose. Take out Morocco from the production side and serious people (most Scandinavians and maybe five in Congress, but which five?) would immediately worry. I’m pretty sure, though, that the U.S. military already pays suitable attention to this issue as it clearly does to problems stemming from climate change. (Who would have guessed that on several vital long-term issues the military here and in the U.K. seems to have the most sensible views of any establishment entity?)

Well, Morocco fortunately seems like a reasonable enough kingdom with an unusually reasonable king and sensible-sounding people running its phosphate operations, who seem to me to be not as short-term greedy as, say, your typical investment banker circa 2007. It seems to be settling into the role of market leader and price setter, and things could be a lot worse.

But think for a minute where Morocco is. Egypt, Syria, Libya, and Mali are not far from being failed states, and Tunisia, Algeria, Chad, etc., are not themselves models of stability. You will remember, perhaps, my thesis on North Africa and Syria. Their populations all increase rapidly, they are largely desert countries abnormally affected by climate deterioration (Syria’s recent troubles were preceded by the driest six years in its long history), and wheat does their heavy calorie lifting. They cannot grow all of their own wheat and must import it on the world market at prices that vary from two to four times what they were only 10 years ago. Libya and Algeria have oil or gas to export but, critically, Egypt, which did until recently, is now an importer. The much- increased prices of wheat and oil and, to some extent, fertilizer, have helped destabilize their societies. They mostly run trade deficits that are hard to imagine being funded for long by international good will. So, what happens if this irregularly deteriorating situation spreads to Morocco, with its most important quasi-monopoly in the history of man, as I like to say? Surely the U.S. military or, say, the Chinese military will not allow Morocco to become a failed state for these reasons? Perhaps if we’re lucky and not too reckless the worst will be avoided, but we should definitely try to avoid the Great Fertilizer War of 2037.

Problems in Forecasting Short-term Prices for Resources 
I underestimated both the skullduggery of “miners” and the great lumpiness of their new production capabilities. New mines are surprisingly few and usually gigantic in scale. Deliberate delay in completing projects, legal or not, when shortages are intense and profits exceptional is understandable and does occur. I missed the point that when you run a copper mine at 1.2% average copper ore you start with the 1.5% stuff and end with the 0.7% dregs. And when the replacement mine comes on with a painfully lower average of, say, 0.7% it nevertheless starts mining its 1.1% ore first on its way in 30 years or so to its dregs of 0.4%. So, even as the quality of ore irretrievably declines in the long term, the quality of ore mined can increase in the short term when a new mine comes on line. And this higher quality for a short time improves the cost structure and puts temporary downward pressure on prices.

The skullduggery factor in mining was revealed recently as the potash “cartel” in Belorussia and Russia fell out in a farce that, put to music, would sell tickets. The Belorussian President invited those bosses of the Russian syndicate who had broken ranks to discuss the issue, and the one who unwisely turned up was promptly arrested on arrival and put in jail, where all cartel breakers clearly belong. The price meanwhile fell 10%, not as much as expected, but enough to make the point that some aspects of mining are scarily far from any efficient and free market hypothesis. Many of those “special” factors were considered in some detail in a report by an independent consultant, Frank Veneroso as he objected to parts of my original April 2011 thesis on commodity scarcity and qualified others, often with good reason.

As for my stock predictions, like a coward I will continue to hide behind my original (April 2011) warnings that: a) if China slowed, metal prices could be hit badly for a while; and b) if there was finally some more reasonable weather, grain prices would dive under the influence of substantially more land than ever having been planted in response to the sustained high prices. And that is how it has worked out. However, with the probable exceptions of the truly widespread iron ore, bauxite, and potash, for which I am an agnostic, I still believe metals, phosphate, and grains will move much higher over future decades as opposed to falling as they did in the past before 2000, and that these price rises will have profound consequences for the poorest 20% or so of the world. And that their disturbances will produce an increasing number of desperate food and poverty refugees as reflected in last year’s (October 4, 2013) shocking shipwreck off Lampedusa. I also believe that these continued reverberations will disturb our peace and make it difficult to fully enjoy the incredible advantages we in North America have, not just in income, but in real wealth – plentiful fertile land, plentiful water (six times per capita more than the Chinese, hence their different behavior to resource availability), and, relatively speaking at least, plentiful resources in the ground. (The bottom line, rather unexpectedly, is that the price of oil, which is half the value of all traded commodities and a major cost input into the rest, was up slightly for 2013. Natural gas in the U.S. was up a lot and, most unexpectedly, the global prices of iron ore, which is almost half of the top line of the miners and was surrounded by pessimism all year, actually had a very small rise for the year.)

Another Look at U.S. GDP Growth 
U.S. GDP growth had a wonderfully long run on a remarkably steady 3.3% trend line, from about 1880 to 1980. Although admittedly nowhere near recent Chinese growth, the duration and consistency was remarkable. Annual growth of 3.3% for a hundred years will multiply your income by 26 times! But 1880 to 1980 appears, with hindsight, to have been the Golden Century. In the 20 years from 1980 to 2000 that followed the Golden Century, the growth of GDP slowed materially (and was skewed to the top 10% and 1% in a way that had not been seen for 70 years), but still the country was compounding at a solid enough 2.8% a year, a rate that in a century would still compound to 16 times. For the last 13 years, in contrast, the growth has really slowed – to only 1.4% a year, and this despite a considerable bounce-back in capacity utilization since the bottom of the financial crash in 2009. To put it into perspective, 1.4% a year turns a dollar of income in 100 years not into $26 or $16, but into $4!

An important question here is how integrated is this substantial and unprecedented economic slowdown into everyone’s thinking, from average businessmen to the economic experts of the IMF and the Fed? The answer seems clear: not very. But this data, the accuracy of which is not challenged as far as I know, is the background for my recent forecast that the next 30 years of U.S. GDP growth is likely to “look like 1.5%,” on current GDP accounting; a growth rate, incidentally, that is slightly higher than that actually experienced in the last 13 years. Despite this comparison, my forecast of late last year was generally treated as unreasonably bearish, although no one really challenged the two basic propositions on which it was based: first, a growth in future person-hours offered to the workforce of 0.2% a year based on estimates of the U.S. Bureau of Census; and second, that the productivity of the last 30 years of 1.3% a year would be sustained, which, given the steady decline in the share of the subset of manufacturing, a subset of the total with much higher productivity gains (over 3% a year) than the average, is actually a friendly assumption.

At this point I can’t resist reviewing once again my forecast in 2009 of “seven lean years,” in which I suggested 2% a year would be a hard level to reach or exceed. And it will turn out that way. But the biblical idea of seven lean years, which felt so brave back then in 2009 seems likely to be a red herring: the time period would be better left open-ended. “Permanent lean years” is not as memorable but probably more accurate. Let me add here that “lean” is only a useful concept to compare with the previous Golden Century. Growth of 1.5% a year is simply not that bad. (Indeed, to the earner of the average hourly wage, which, remarkably, has been dead flat since 1970, 1.5% a year would have delivered an increase of almost 70% and would have gone a long way to removing some of the middle class malaise.) It is, however, important that we readjust our mental targets unless we want to enter an era of perpetual disappointments, which would seem to be a very bad idea. False optimism leads to very poor investment decisions. It will also encourage yet more dangerous policies at the Fed. We can imagine, for example, in 30 years some “son of Yellen” as it were, introducing QE 27 in a vain attempt to squeeze blood out of stones. But long before then, I fear an overstimulated system will have bitten us a few more times on the leg.

Investment Lessons Learned: Mistakes Made Over 47 Years

Chapter 1 (the first of several future chapters) 
When I was a teenager, my parents had their friends over on most Sundays for a drink. (Actually, it was a 1950’s version of “a few drinks.”) During these sessions I was impressed by the confident expressions of current and future success laid out by my stepfather’s closest friend. His firm was a manufacturer of scaffolding, a patented easily-assembled variety, for which he was the main international salesman. After two or three years I could stand it no longer and at 16, because my parents did not invest in the market and for lack of a better idea, I arrived at a bank branch in a south London suburb with the bank book from my “home safe account,” which was designed for children’s savings and which I had had for as long as I could remember. Asking to see the branch manager, I surprised and amused him by asking for his help in investing everything in my account – £16. I remember the investment well: Acrow A shares. It was his first experience with investing for a home safe account but he could see no problem and without parental confirmation or any fuss at all did the trade. And so my first commission was paid out. And, by the way, £16 was a lot. I had been extremely frugal. (The exchange rate was 4:1 and $64 of buying power in 1954 translates to about $560 today .)

So far, so good. Years came and went as they do and presently I was 26 and unexpectedly heading to business school in America. Equally unexpectedly and very generously I had been kept on the payroll of my employer, Royal Dutch Shell, but at £1,200 a year this was only going to cover one-quarter of my two-year expenses. As a result, everything I owned – as in every last thing – was cashed in. By this time my shares had blossomed to about £100 of value and my mother was by now also an investor. Encouraged by the unabated enthusiasm from our neighbor (who, after all, we had argued must surely know the innermost secrets of his firm, particularly because we knew for a fact that he had most of his wealth tied up in the company’s shares), and no doubt reinforced by past stock performance, my mother made me a proposition: to avoid paying the notorious commissions, we would transfer my shares to her account and she would pay me that Wednesday’s closing price. So, off I went to the U.S. with enough to buy my ticket on a VC10, a faster crossing than you can get today by the way, but brutally expensive for a one-way trip. (My parents had bravely allowed me to take out a mortgage on their house to draw down as I needed to balance the books.)

The following year, with little preamble “our” company imploded to zero. My mother took a few hundred pounds’ hit in her only (and last) stock holding, and our friend, right on the cusp of retirement, lost the great majority of his formerly comfortable nest egg. Almost until the last day he had known nothing about his impending doom, about big bets made and reckless debts assumed to make the corporate great leap forward. His own sales efforts in South America had continued promisingly into the last few months.

Lessons Learned: 
1) Inside advice, legal in those days, from friends in the company is a particularly dangerous basis for decisions; you know little how limited their knowledge really is and you are overexposed to sustained enthusiasm.

2) Always diversify, particularly for your pension fund.

3) Fraud, near-fraud, or colossal incompetence can always strike.

4) Don’t buy stocks yourself if you’re an amateur: invest with a relatively rare expert or in a low-cost index.

5) Investing when young will start your brain turning on things financial.

6) Painful errors teach you more than success does.

7) Luck helps and finally…

8) Have a convenient mother to be the fall guy.

Jeremy Grantham is co-founder and chief investment strategist of GMO, a Boston-based money management firm.


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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