My ‘Worry’ List for 2011

Year-end is always a time to look back and take stock of what happened as well as offer predictions for the period ahead.  As a forecaster by profession this is a comfort zone that exists year-round with long term views refreshed typically twice yearly and short-term views more frequently. Predictions, on the other hand, are educated—or uneducated—guesses made based upon gut, instinct or aspiration rather than insight.

This is neither a forecast for 2011 nor predictions.  It is instead my ‘worry list’ of signposts to be studied for their meaning for the future. My ‘worry list’ evolved from my belief in scenario analysis as a powerful tool for managing uncertainty so I look for ‘signposts,’ as Dan Yergin called them at CERA, as clues for the scenario pathway ahead and thus implications for strategy.

The problem with qualitative scenario analysis as we practiced it at CERA is you could not quantify the impacts to make strategies actionable, so at Global Energy Decisions we used our simulation software and data to model our scenarios and compare the resulting impacts on energy expected prices across scenario cases.  This proved the ‘secret sauce’ for strategic planning, transaction analysis and risk management for clients.

These days I no longer have the great team of Global Energy Advisors who poured over the data and tortured it until it confessed insights about implications of changing fundamentals then played my ‘what if’ games across scenarios. That extraordinary team is now doing its work in scores of places and I am left with my ‘worry list’ of things I used to walk the halls and worry aloud in people’s ears.

What if?

I was constantly asking people ‘what if’ not to be contrarian but because we KNOW forecasting is not an exact science and stochastic analysis only help us define a band of confidence—not the answer.

So here is my ‘worry list’ for 2011:

1.       Rising oil prices are a sign of fear about the market future not of confidence. As I write this oil pushed past $90 per barrel and I started hearing predictions of $5 per gallon gasoline by summer.  This suggests that speculators are hedging their bets believing that commodities are a safer haven than equities.  This is true even as domestic oil production increases due to the unfolding potential of unconventional oil and gas. Thus I worry that rising oil prices are a signpost of fear not growing demand born of confidence in the market.

2.       Falling housing prices undermine consumer confidence and dampen spending. The result is we don’t see any material pick-up in the pace of recovery.  This forces both banks and underwater homeowners to make ugly choices creating a self-fulfilling prophesy of housing woes. Fear is also encouraging individuals to deleverage and pay down debt which is good long term but hurts short-term.  How the housing problem is resolved affects everything else. This isn’t just our problem in the US—it may actually be worse in China.

3.       Everyone is buying time with the debt rollover game to keep going. Our high deficits are worrisome but the greater risk is that some combination of events will make it more difficult or costly to rollover the debt—that is keep borrowing—long enough to actually regain confidence and resolve the financial problems the lack of it causing for growth.  We are at serious risk of major volatility and that is the Fed’s biggest fear.  QE is the only game left to keep liquidity sufficient while we work our way out of this mess.

4.       The only difference between a ‘game changer’ and a ‘game breaker’ is whether it works. The economy is slowly climbing back but is subject to shocks that jolt confidence.  This is not a win-lose contest between the US and China, between Democrats and Republicans, between democracies or dictators.  We are going to all win or all lose so we must find ways to work collaboratively until the crisis passes and confidence is able to sustain rebuilding for growth. My sense is that some combination of the following might work:

The US tackles its deficit and focuses on return to growth and market confidence.

China manages its bubbles and steadily moderates growth just enough to do so.

EU manages the PIIGS and tries to hang together as a currency union.

Central banks keep backing each other up to manage volatility.

Business, sensing adult global supervision is real, starts spending hoarded cash.

5.       The energy implications ahead are onerous and fundamentals will matter again.  A return to growth and getting from modest recovery to the build-up stage of the energy business cycle requires policy change, capital investment, and more certainty about the scenario signposts ahead.

The greater risk today is for energy shortages ahead driven by current policies. The combination of our current policies of endangerment findings and antipathy toward coal; a lack of enthusiasm for nuclear, the variability of renewables and their dependence on unsustainable Federal subsidies means we risk being energy short as growth returns. We have a growing dependence on natural gas and its traditional price volatility.  A faster return to growth will swamp the renewables boat just as EPA regs and AB32 actions impose new emissions limits as costs on fossil fuels. We need a renewed focus on energy equilibrium and the hard choices for how to achieve it.

Energy efficiency is our friend. The lesson from California’s experience worth learning is that energy efficiency standards worked to reduce energy intensity.  If the rest of the nation had followed California’s lead we’d have energy intensity nearly half today’s US average.

Baseload generation is essential to sustainable growth. We can’t achieve the growth rates we desire if we keep choosing the highest priced marginal resources.  We need a mix of energy supply that encourages long term growth in manufacturing here at home to reduce emissions, reduce deficits, reduce volatility in our economy.  If we don’t want more coal then we need to have more nuclear energy for baseload.  Today the US is essentially out of the nuclear power plant game.  If we don’t want to import the next generation of nuclear power plants from China we should do a deal with South Korea and Japan and re-open the American market for baseload generation construction.

Domestic Oil & Gas Production—Use it or Lose it. There is underway today a quiet but growing land rush by companies acquiring access to the unconventional oil and gas resources across North America and around the world.  Today the US dominates these technologies which rely upon horizontal drilling and hydraulic fracturing but unless the US Government and the States get out of the way of domestic E&P that technology will go elsewhere in the world at our peril.  In a natural gas driven electric future we need more domestic natural gas to avoid being sucked into a global cartel of LNG suppliers from Russia and other sources exacerbating our energy dependence.

6.       The Public Interest Balance of Energy, Environmental and Economic Interests. It is time to quit turning every decision into a zero sum contest of economic interests versus the environment.  The truth is we need both a healthy environment and a healthy economy to assure a sustainable future.  Our national, state and local policies should reflect that and NIMBY or endless litigation should not be able to frustrate the broad public interest.  The only way to achieve that is to require that our environmental laws and our energy and development efforts be subject to the same test of reasonable balancing of the interests of the parties including the public interest.

Happy New Year!