Much More Than Gas & Diesel

Last Friday, June 6, 2008, the price of a barrel of oil hit a new high and closed at $138.54. Adjusted for inflation, that price on Friday put the price of a barrel of oil at its highest price, passing the previous high set back in 1980.

Inflation is a fact of life. As we run our government and in turn our economy, inflation is going to be present and a factor that all of us will have to try and deal. That inflation takes a toll on different members of society in different ways is just another reality of the not so level playing field that exists out there for many of us. What do they say? The rich get richer and the poor get poorer. It sure seems that way for many people now with the sudden and steep surge in the price of gas and diesel.

For those of us who have been in the investment business for a generation or more and have followed the various industries that use oil as a raw material in the manufacture of their products, the sudden and steep increase in the price of a barrel of crude does not surprise us when we read about the effect the most recent increase has had on the costs of production. On Friday, June 6, 2008, the DOW Index was down 400 points for the day, as investors realized that the sudden and dramatic spike in the price of oil by $11 was going to have consequences on the profit margins of many companies. This crisis has taken us beyond the simple increase in personal transportation costs and the cost of moving freight. The sudden increase in the price of oil as a raw material used in the manufacture of so many products from tires to soap to packaging and so many more, that companies are now searching for substitutes, raising prices to their customers and retailers or laying off workers, or all three.

What is the answer? Where do we go from here? Those are two really good questions, and while I have some of the answers, I do not think I have the skills to get us from A to Z.

The concept of diversity in the management of wealth is an old concept. Money managers have for years distributed the assets of a portfolio so that all the “eggs” were not in one “basket”. Some portfolio managers use a rule of thumb that says to put no more that 10 percent of the assets of an equity portfolio in one stock. There are even some money managers that have guidelines for how much to put in one industry, say for example oil or energy.

A well run country, with the natural resources of the United States, would have recognized the importance of diversity in our energy portfolio and would have never let foreign oil consumption become such a large component of our oil needs. Such dependency is a fundamental weakness in the way we run our country. A few volumes could be written about our lack of a comprehensive energy policy and our need to control our resources in the United States.

In my opinion, it is easy to build a case that OPEC and the largest oil producers such as our friends Saudi Arabia, do not want to see the United States drilling for oil. With their wealth, they can lobby our government through various organizations to over state environmental concerns while they continue to bleed us at the other end. I ask, why not? If you were sitting on some of the largest known oil reserves in the world, would you want me to drilling or exploring for oil and cutting into your oil business?

In September 2002, I was attending a private equity fund annual meeting in Washington, D.C. At lunch on one of the days of the meeting, I found myself sitting next to a former high official in our government. In that it was roughly the one-year anniversary of the attack on the World Trade Towers and the Pentagon, that we all now refer to as nine-eleven, the subject of the attack natural came up. Many of us at the meeting in 2002, were attending the same annual meeting the year before when the attack occurred. We all remember where we were and what we were doing when we heard the news. For me, I was sitting in the basement of a hotel in Georgetown attending this private equity fund annual meeting, when two large screens at the front of the meeting hall came to life with the live pictures from New York City of the one tower smoking. I then watched as the second plane came into view and watched as the terrorist banked the jet and flew it into the second tower.

The subject at lunch a year later turned to the fact that 15 of the 19 terrorists were from Saudi Arabia. A man on the other side of this former high official at the table gave me a look as we listen to this former high official tell us that Saudi Arabia was our friend. Saudi Arabia recycles enough petrodollars that they can make anyone believe they are our friend. But the fact remains, when President Bush went to Saudi Arabia recently and asked the king politely if they would please pump more oil because the shortage of supply was hurting our and the world’s economy, he was politely told to go pound sand.

So diversity, whether of supply or assets invested is an important element of good portfolio management. Whether you are running money or a country, diversifying is fundamental to good management. We need to take control and responsibility for our own energy needs and that includes our needs for oil. Oil is much more that gasoline and diesel, oil is the raw material that cleans our clothes, packages our food and makes our tires. We all want a clean environment and we all want to maintain our standard of living. We can do both, we just need to make that commitment. Our “friends” are not going to do that for us, we must take control and the responsibility for that ourselves. Stay tuned.