by: Zacks.com
November 20, 2009
I want to talk about the challenge of exponential growth in a finite world. This is a concept that, while on its surface seems easy to get, most people don’t fully grasp.
Any growth rate that is positive will lead to a doubling in size eventually -- the higher the growth rate, the quicker the doubling. A quick "back of the envelope" method of figuring it out is known as the rule of 70. If you divide a growth rate into 70, it will roughly give you the time for something to double. Thus, if something is growing at 2% a year, then it will double in about 35 years, at 5% only 14 years, etc. If you want to be more precise, you can always use your Y^x button on your calculator, but the rule of 70 will do for this discussion.
Clearly, exponential growth is what we are looking for when we invest -- better known as compound interest -- and it is vital to anyone’s financial health that they stay on the right side of it. People who get on the wrong side -- for example, by carrying a credit card balance -- are eventually headed towards financial oblivion. If that is you, then your best investment is probably not one of the stocks or ETFs that I recommend, it is paying down your damn Visa bill.
It is also why I try to watch the downside when I make investment decisions. It is far more important to avoid 50% losses than it is to have a 50% gain. After all, if you had a 50% gain in one year, but in the next year you suffered a 50% loss, at the end of two years that dollar would have turned into just $0.75 -- a 25% loss.
However, far more important to the world is the dark side of exponential growth. Let's start with the obvious one: population growth. The table below comes from Wikipedia, but is based on UN data. Note that from 1750 to 1800, the world population grew from 791 million to 978 million -- an increase of 187 million, or 0.4% per year. From 1850 to 1900, it grew from 1.262 billion to 1.650 billion -- an increase of 388 million or at 0.53% per year.
Thus, even very small growth rates can result in some very large increases extended long enough, and as the base grows, the absolute increase gets larger each year even if the rate of increase stays the same. Now look at what has happened more recently. From 1950 to 1999, world population increased by 3.457 billion, more than doubling from 2.521 billion, an increase of 1.78% per year. Lately we have seen a slowdown in the growth rate; from 1999 to 2008 it was just 1.29% per year, but that has meant an increase of 729 million in just nine years, or 92% of the entire world population in 1750.
Looking forward, the U.N does see a further reduction in the rate of growth, to just 0.68% per year, or almost back down to the growth rate in the very earliest days of the Industrial Revolution. But the base is so much larger, the absolute increase is 2.2 billion, or almost the world population of 1950. The effect is that a long-term graph of world population looks like a picture of a rocket launch. And unless you believe in the Mayan calendar or the equally silly "end times" nonsense, this is going to cause some very big problems (not that the end of the world in 2012 wouldn't be a very big problem on its own).
Now look at where the growth is coming from. The combined populations of North America (Mexico is included in the Latin American numbers, so basically the US and Canada) and Europe are actually expected to fall from the current 1.069 billion to 1.020 billion. All of the growth is coming from Asia, Africa and Latin America.
The only thing that can keep up with exponential growth is something that itself grows exponentially. Fortunately, the one thing that grows exponentially at a very fast rate is computing power, which in turn allows for technological advances. So far, technology has managed to hold off the worst of the problems that one might expect. After all, this analysis is not exactly original. It was first made by Thomas Malthus back before world population hit the one billion mark.
However, you can eat potato chips, not computer chips. One of the things that technology has done is level the playing field, so that people in Asia and eventually Africa will have the same shot at success as people in the U.S. and Europe. They can see how we live, and surprise, surprise -- they would prefer to live the way we do, and are increasingly able to do so. As they do, the economic growth opportunities will be huge.
That is why I like the emerging markets story so much. However, given the challenges of trying to research foreign firms who might be best positioned to take advantage of these trends, it probably makes sense to use ETFs such as the I-shares MSCI Emerging Market Fund (EEM) or more country-specific variants like the Claymore China Small Cap ETF (HAO) or the Wisdom Tree India Earnings ETF (EPI).
(Click to enlarge)
One of the things that has been absolutely key to our ability to have higher living standards today than back in say, 1850, is that we use a lot more energy.
So let’s take a look at energy consumption per capita (the data I’m using comes from here if you want to investigate further). In 2005, people in North America used the equivalent of 8157.9 kilograms of oil per year (kgoe/y) per person, up from 7942.9 kgoe/y in 2000. Thus while our rate of increase in energy consumption was just 0.54% per year, it was on a high base so the absolute increase was 215 kgoe/y over that time.
Now look at Asia (excluding the Middle East). In 2000, they were using 865.2 kgoe/y, and by 2005 it was up to 1051.5 per year. That is an increase of 3.98% per year, or to go back to the rule of 70, it means that if it keeps up Asia’s energy consumption per capita will double by 2022. Combine that with a population that is expected to grow at 0.6% per year, and Houston, we have a problem.
However, note that the absolute increase in energy use per capita in Asia was just 186 kgoe/y, or just 86.5% of the increase in North America, despite the far higher growth rate. However, if the relative growth rates continue, that will not last. If we extrapolate out the growth rates of 2000 to 2005 then by 2015, Asia’s per capita consumption will grow to 1,553.0 kgoe/y, an increase of 501.5, while the absolute increase in North America will be "only" 451.4 kgoe/y.
Put another way, right now we use 7.76x as much energy per person as in Asia (keep in mind these figures include relatively rich countries like Japan and South Korea, as well as basket-cases like Burma and Bangladesh), and by 2015 that ratio will fall all the way down to 5.54x as much.
Now, the peak year for actual oil discovery in the world was in 1964, and as you pump oil out of the ground it is gone. Once you reach the point where you have pumped half the original oil in a field, it is basically impossible to increase the annual output from that field without causing serious damage that eventually results in that oil being trapped forever. Most of the currently producing fields are past their peak. As the International Energy Agency (IEA) found last year:
"Output from the world's oilfields is declining faster than previously thought, the IEA said in its annual report. Without extra investment to raise production, the natural annual global crude oil depletion rate is 9.1%. The findings suggest the world will struggle to produce enough oil to make up for steep declines in existing fields, such as in the North Sea, Russia and Alaska. The effort will become even more acute as prices fall and investment decisions are delayed. Even with investment, the annual rate of output decline is 6.4."
Now, the situation is better for natural gas (NG) than it is for oil, but eventually that will run out as well. However, we have much more time thanks to the new shale plays here in the U.S. We need to shift to more usage of NG as a bridge towards the eventual goal of producing most of our energy from renewable sources like wind and solar. But given the tiny fraction of the world’s energy they now represent, we will need many years of very fast growth in them to make a substantial dent in world energy needs.
Natural gas also has the benefit of being located here in North America, rather than in rather unstable and hostile areas of the world, the way oil is.
The U.S. cannot continue to run massive trade deficits with the rest of the world. The trade deficit is the source of our external debt, not the fiscal deficit. Our external debt is now (as of 6/30/09) at $13.454 trillion -- up from just $7.744 trillion five years ago. That is a growth rate of 11.7% per year, and is clearly not sustainable (that might be overstating it since it is a gross number; we do hold some debts of other countries that offsets it in part). Still, even if the net growth rate is half that amount, it is clearly unsustainable, and is one of the reasons the dollar is going to be under long-term pressure.
Putting this all together it seems clear to me that the price of energy must continue to rise over the long term. Companies that are going to be able to increase their production of oil, such as Petrobras (PBR) are going to be exceptionally well positioned.
While natural gas should see a big growth in demand, it is not a perfect substitute for oil. Still, big gas producers like EnCana (ECA) have a very bright long-term future. I would also note that what I am saying about oil also holds true for other commodities. Energy and commodities are going to be the real stores of value and of wealth over the next few decades.
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