In this article we will review one of our investment themes, agriculture. We take a high-level overview of our investment framework, specifically how and why we look for out-of-favor investments with strongly anchored fundamentals. We assign a confidence level to our global warming research and extrapolate what this means to water production, energy production and agriculture. We take a high-level look at the implications of this major global trend.
Over the years we have found value in digging through the noise and frequent misinformation that commonly surrounds controversial topics such as energy, climate change, and deficit spending to name a few. We’ve seen articles from highly credible sources that attempt to prove one point of view, while others of comparable stature debunk the same topics. Our work in digging deeper than most advisers is of value to clients, as we are able to take advantage of market miss-pricing founded on biased and emotionally charged conclusions.
The investment opportunities exist because the public in general, as well as most investors, take little time to actively consider the implications associated with important matters. In general an investment opportunity exists every time there’s a chasm between what people believe and reality. This is especially true with global warming as shown by a recent Gallup poll. According to the poll, approximately half of Americans doubt that global warming is attributable to man’s activities on Earth (*1). Perhaps more striking the subject of “Peak Oil” is not even being surveyed by the Gallup organisation, as most people have never even heard of the concept. The public is apparently ignorant of one major issue and 50/50 divided on another, however there are some who have little doubt.
Defense agencies around the world are less divided than the easily misguided public. As a notable example, the U.S. Department of Defense 2010 Quadrennial Strategic Review is unequivocal: “Climate change will contribute to food and water scarcity, will increase the spread of disease, and may spur or exacerbate mass migration.” (*2) Notice that the word ‘will’ is used twice in the above paragraph, not the usual “maybes”. Of course it is possible for the DoD to be wrong, so finding an open-platform repository of data and reports would allow us to look into this important issue ourselves.
The Berkeley Earth Surface Temperature Project is just such a platform. This is the first open-platform analysis of C02 levels and temperature that allows open access to data, source code and peer review. Thanks to their work we can discount both volcanic and solar activity, and extrapolate temperatures into the next decade as China and India catch up with Western CO2 atmospheric contributions. The data shows that the correlation between CO2 levels, volcanic activity and surface temperature is very strong. (*3) Additionally, there is the risk that climate change is undergoing a positive feedback loop as indicated by the unexpectedly quick melting of Arctic ice. (*4) The data certainly leads us to believe that during the next ten years we should expect significant social and financial stress.
Global warming will impact more than agriculture, as virtually all forms of energy production need water in one manner or another. We are already seeing nuclear power plants having to reduce power output because their cooling systems are overheating. On 12 August Dominion Resources’ Millstone Nuclear Power Plant, situated on Connecticut’s Niantic Bay, was forced to shut down one of two reactor units because seawater used to cool down the plant was too warm. (*5) In its 37-year history the plant has never had to shut down due to excessive temperatures. Hydroelectric is also affected. The Hoover Dam provides power to 1.3 million people, and Lake Mead is at very low levels. Pat Mulroy, General Manager, Southern Nevada Water Authority has noted “We’re teetering on the first shortage right now. How quickly [Lake] Mead goes down [is based on hydrology] probability. But the whole probability analysis, because of climate change, has been thrown out the window. We’re experiencing anomaly after anomaly.” Researchers at the University of California in San Diego predict that the lake has a 50 percent chance of decreasing to a point too low for power generation by 2017. (*6)
It seems that nothing is going to be unaffected by this, as oil and natural gas production through hydraulic fracturing are being impacted as well. Hydraulic fracturing or ‘fracking’ as used by oil and natural gas producers to extract oil and gas requires a lot of water. According to CNN Money “Each shale well takes between two and 12 million gallons of water to frack. That’s 18 Olympic-sized swimming pools worth of water per well.” (*7) One hydraulic fracturing operation in the Barnett Shale has had to resort to purchasing water from out of state and having it trucked to their site.
We are caught in a variant of “The Prisoner’s Dilemma”. The dilemma persists because food and energy are highly interrelated as global commodities, and each nation that reduces its carbon footprint through austerity or efficiency in effect reduces prices for “the other guy”. As we know lower prices encourage additional consumption so it’s a lose-win proposition. A lose for the nation that encourages it’s citizens to reduce consumption, as emerging markets consume ever more per capita. No, in fact it’s clear that our leadership understands basic game-theory and is taking the “nuclear option”: Encourage citizens to consume more, more quickly before the other guy modernises. They figure that either way the carbon gets into the atmosphere, so we might as well enjoy the good life.
Thankfully the next generation is not playing games. A 13 year-old recently achieved his goal to plant a million trees in his native Germany. Felix Finkbeiner was recently interviewed at the United Nations in New York, and when asked about Global Warming sceptics he told delegates “We children discussed this often. We have an answer. If we follow the scientists that tell us there is a crisis and we act, and in 20 years we find out that they were wrong, we didn’t do any mistake. But if we follow the sceptics and in 20 years we find out that they were wrong, it will be too late to save our future.” His efforts are being duplicated globally with a goal of expanding to 131 countries. (*8)
A key element of successful contrarian investing is keeping an open mind and always questioning where we could be misled or mistaken. We must keep an eye on further developments from the Berkely Earth Surface Temperature Project as the results of their analysis undergoes peer review. Moving forward there are no guarantees, and such contrarian investing frequently under-performs for what seems like a long while before substantial results materialise. Nevertheless, we have found that following the crowd almost invariably leads to poor investment performance in the long-run.
(*1) Gallup Poll on Global Warming
(*2) DoD Quadrennial Defense Review (pages 84-88)
(*3) Berkeley Earth Surface Temperature Project
(*4) Arctic ice melting at ‘amazing’ speed, scientists find
(*5) Warm seawater forces Conn. nuclear power plant shutdown
(*6) US Power Supply Will Be Impacted By Water Shortages
(*7) Drought strains U.S. oil production
(*8) The 13-year-old who has the world planting trees