The Energetic Sheik - value in changing times, Q2 2023

Near the shore of the Caspian Sea in a low-lying peninsula was a sort of natural depression in the ground. This was a tar pit, belching gas in slow motion and reeking of sulfur and tar. The sand was black with oil for dozens of yards around and there was no vegetation. Nearby waited a camel with a young boy sitting backward on its back. Just down the slope stood a man with a ladle on a very long handle, dipping thick, black crude from the very cauldron. Sweat made paths through the oily coating on his face. His rough clothes, and those of his son were soaked with it. Dip after slow dip, the man brought the steaming liquid out of the pit and swung his long device over to the skin bags hanging on the camel. The boy’s job was to hold the bags open when the ladle came near and maneuver the camel as needed. The camel was less than impressed. His eyes and nose were pinched shut in an expression the boy thought looked very much like his grandmother biting into a spoiled date. The obstinate creature insisted on shifting sideways just as the man was about to pour his prize into the bag, forcing the boy to constantly reach back to jerk on the reins while trying to hold the bag open for his father. After hours of shouting and panting, the bags were full, oozing slightly at the seams. Then began the long trip north to an alchemist who would buy the gooey substance and distill it to something like kerosene, which burned cleaner than whale oil and sold for less at the market in the city. As the man trudged off, tugging the unwilling beast behind, he had no idea how much, nor how soon this deserted area would change. He only knew that the men who lit the lamps in the monasteries and churches of Donetsk and Volgograd were happy to pay him to do the dirty work so they could have a nice, clean flame. If you had pointed out the hard labor of the boy and camel, he would have looked at you strangely and said that any labor was better than starvation. The year was 1843.

The Industrialization

Only a few years later, the place where he had struggled to make a meager living would be transformed into a center of unimaginable infrastructure and wealth. Oil rigs capable of drilling deep down to the source would sprout around the perimeter of the vast lake. As the industrial revolution swung into motion, steam, and eventually gasoline and diesel engines would create demand at an unprecedented, global scale. With the insatiable demand came more money, more technology, and pipes. By the 20th century, pipes in the millions of miles would network the globe, with many of them converging on the low-lying peninsula where the man and boy had dipped their living. A city, called Baku, flourished. The few gallons in skin bags would increase to many millions per hour and become known as black gold. Wars would be fought with it and for it.

By some measures there was progress everywhere you looked. For many around the world, the standard of living changed dramatically. What might have surprised the man most of all would be the fact that neither boy nor camel were needed to transport the substance overland. Pumps could send it through pipes to every city on earth. The wealth generated would create new jobs for the camel driver in every sector of the economy. A man could make a better living with less effort. As mankind learned to leverage their efforts with fossil fuel energy, productivity increased by orders of magnitude. As productivity increased, financial systems evolved apace, which we will return to shortly.

Today’s Assumptions

A century and three quarters later, no one can remember a world before oil wells. Abundant, energy dense hydrocarbons pervade our lives to the point of assumption. There has always been plenty of air to breathe, water to drink, and oil to feed our energy intense lifestyle. Perhaps there always will be. Included is the assumption that geopolitics will always be dominated by a never-ending thirst for the same. When the Bush administrations went to war in Iraq, many people later concluded the motive was as much about control or at least the stability of the oil supply as it was about liberation or chemical weaponry. Lesser known but perhaps of greater impact was the Clinton administration’s brilliant, bloodless negotiation of an east west pipeline out of the Caspian Sea area. This foreign policy achievement resulted in a strategic foothold in the area, at great cost to the Russians*. The costs of all the above seem to sit lightly on the national conscience. Our collective shrug seems to say that our oil is worth whatever it costs someone else. It is on par with water and air as an existential necessity.

As the usage and demand for oil increased globally, so also the need for a currency and financial pipeline that could flow anywhere, just like oil. For many years the British pound carried the honor. London, with the world’s most sophisticated financial centers, as well as proximity to the world’s largest oil reserves, was the natural hub. The development of fractional reserve banking, credit, futures, and equity markets, not to mention insurance, took massive steps forward there*. After World War two, the British economy was so weakened that the venerable pound was beginning to lose some credibility. The United States saw this as an opportunity and gladly stepped into the void. Eventually the Bretton Woods agreement, tying all oil transactions globally to the dollar, ultimately made it the overwhelmingly dominant global currency, in spite of the fact that the same agreement literally reneged on our agreement to back our own currency with a fixed amount of gold. With this dominance came yet more assumptions, at least on our side of the pond. The dollar would always be desirable, both domestically and abroad. Therefore, foreign goods, but especially foreign oil, would always be cheap. Not only that, foreign credit would be readily available as well, making it possible to finance almost any amount of excess in the form of national debt. This in turn has led to an abundance of social programs and a bloated military industrial complex. Worse, it has led to the universal belief that productivity no longer needs to be matched to money supply. We have come to believe we should be able to borrow our way out of any fix both at a personal and national level.

Yet our (somewhat) innocent national hubris may be arriving at a natural checkpoint. All the assumptions may need to be reevaluated. COVID proved that global supply chains can come to a screeching halt. Congress’s fiscal policy response to the same proved that an economy can indeed be diluted with money. (That is called inflation.) The Federal Reserve’s monetary policy response to inflation has shown that the genie can be very hard to put back in the bottle once she gets out. Interest rates are, after all, a short lever on a long problem. Further, the war in Ukraine and the United States’ foreign policy response to it (freezing Russian dollar assets) is reshaping how every nation on earth interacts with the Superpower and its mighty dollar. Once it became clear that the dollar is no longer a neutral commodity in the world, everyone began to think in terms of spreading out their risks.

How this affects you

What does the upending of so many assumptions mean to today’s business man? As the globe transitions to a different set of alliances, will the US’s hegemonic status in both energy and currency come into question? What does a future look like where neither foreign oil nor foreign credit are as readily available?

We believe the national conversation and indeed the national investment landscape in the coming decade, will be dominated by one word in two forms. Energy.

The first form refers to the transforming of commodities into leveraged human efforts. Traditionally this has meant the burning of carbons such as coal, oil, or their derivatives in an engine. Even with the early examples of steam engines, there was less total effort in digging coal from the ground and using it to power a steam tractor than there was in plowing the same field with a horse. Horses were not displaced by modern horsepower because men hated horses. It was because the burning of carbons could get more work done with less effort.

Today, new sources of useful energy are being explored, developed, and brought online. In the process, carbons will become one of a basket of sources rather than the source. Much to the relief of whales no doubt, whale blubber is no longer considered an essential commodity in the energy market. Oil may eventually be consigned to the same place in history, although it will take a long time for that to happen no doubt. Regardless of your personal philosophy about such a transformation, as these new technologies are developed and brought online there will be new opportunities for businesses, especially in the construction arena. We have already seen this take place with the installation of wind and solar grid applications. There will likely be many more such in the form of upgraded transmission infrastructures, battery, hydrogen, geothermal and perhaps even nuclear installations.* The need for all the above will be compounded as foreign manufacturing, another result of the so-called “deglobalization”, is reshored.

All the above leads us to a second and more critical form of energy. Human beings willing to work. Return with me for a moment to our “Energetic Sheik” at the beginning. A great deal of work by both man and beast went into the extraction of the precious commodity. Through innovation we were able to make that and many other tasks much easier. But no one anywhere has figured out how to get oil to extract itself. Through the application of technology, we can get more productivity from our efforts, to the point where we may start to subconsciously believe that an energy source and capital are all that are needed to produce goods and services and thus support our lifestyle. The recent explosion of AI has probably enhanced that perception even further. Surely, we are not far away from smart robots doing everything for us right up to and including putting the fork in our mouths.

This philosophy could not be further from the truth and therein lies counter culture opportunity. Now more than ever, there is an acute need for people willing to get out of bed and go to work. Technology and easy credit might obscure that fact for a time, yet the unchanging principle remains. Nothing in this world happens by itself, regardless of appearances to the contrary.

The path forward

I once heard a man say he believed every able-bodied person should spend most of his waking hours doing something useful. I believe that to be true. America has had its long run of economic prosperity partly due to the principle from 2nd Thes. 3:10* being ingrained in our collective psyche. “...this we commanded you, that if any would not work, neither should he eat.”

Yet that principle has lost some traction in our society. It is easy to get sidetracked by employment statistics that merely show total employment numbers. But if you really want to know what is ailing the country, look at labor participation statistics. These charts show a steady, decades long decline in people willing to work, currently hovering at just under 62%. While this on one hand is a sad commentary on societal decay, on the other hand, it represents enormous opportunity for those willing to put their hand to the plow. When investors with capital want to put that capital to work, it will flow to those willing to sweat, solve problems, and get things done. Just as it has always been.

Technology and geopolitics may be changing the global landscape, but there is nothing stopping the energetic from using muscle and mind to benefit himself and those around him in the process.

Seize the day!

The Arrow Team 

*References – The Oil and the Glory – Steve Levine, The Ascent of Money – Niall Ferguson, Congressional testimony of Dr. Kathleen Hogan and Dr. Geri Richmond May 10, 2023,  and The Holy Bible