Book Review: The Energy World is Flat
The Energy World Is Flat: Opportunities from the End of Peak Oil. 2015. Daniel Lacalle and Diego Parrilla.
In The Energy World Is Flat: Opportunities from the End of Peak Oil, Daniel Lacalle and Diego Parrilla explore 10 forces that drive the future of energy. Both authors have extensive experience in the energy field. Lacalle’s background is in energy portfolios as an economist, energy sector analyst, and fund manager. Parrilla is a hedge fund manager with experience in commodities and trading.
The expression “the energy world is flat” means that although geopolitical or other events may cause energy prices to spike in the short term, energy prices invariably return to normal levels over the long term — hence, the term flat. Past spikes in energy prices have been offset by such events as the building of storage buffers, switching to alternative energy sources, new oil and gas discoveries, and technological innovations. The authors discuss the internet revolution of the late 1990s and the subsequent dot-com bubble. They see the same general lessons learned from the global flattening caused by the internet revolution as applying to global energy.
Recent events have lent special importance to The Energy World Is Flat. When the book was published earlier this year, oil prices had just dropped by half. Besides inflicting earnings declines throughout the energy industry, the price collapse had major implications for fracking, natural gas production, oil sands development, liquefied natural gas (LNG) construction plans, and transportation, including railroads and pipelines.
Lacalle and Parrilla call the following 10 forces “flatteners,” devoting a chapter to each:
- Geopolitics, the two sides of the energy security coin
- Energy reserves and the resources glut (no peak oil or peak gas)
- Horizontal drilling and fracking
- The energy broadband
- Overcapacity
- Globalization, industrialization, and urbanization
- Demand destruction — transportation, electricity, and industrial
- Demand displacement
- Regulation and government intervention
- Fiscal, monetary, and macroeconomic factors
Some chapters are brief, but two (on Flatteners 9 and 10) are quite long, together occupying almost a third of the book. The following comments address flatteners of particular interest.
In the chapter on energy reserves and the resources glut, the authors discuss the size of world energy resources since the beginning of the Industrial Revolution, including current proven and probable oil as well as estimates of other likely oil deposits. The authors review costs of production, including such unconventional production as oil sands and deep offshore drilling. They also discuss the concept of “peak production,” detailing the history of predictions going back to the early 1970s and concluding that neither oil nor gas is facing a peak.
Horizontal drilling and fracking account for a major increase in US oil production. Lacalle and Parrilla, however, say very little about the environmental impact of fracking. They touch on methane, a standard emission from shale oil wells, but never mention Jeremy Grantham’s comment that methane, a greenhouse gas, is estimated to be 72 times as harmful as carbon dioxide. Nor do the authors address the huge amount of water required by fracking, the acid content of that water, or the short life of shale oil production. Thanks to the new technology, US production has replaced a substantial amount of imports from Saudi Arabia, but the authors pass over most of the safety and environmental concerns about fracking. A typical fracking operation also involves explosives, 50,000 gallons of hydrochloric acid to dissolve limestone, 1,000 gallons of antibacterial solution to kill microorganisms that destroy pipe, and two million pounds of sand to prop the fractures open. Finally, the cost of a shale oil well averages $6.3 million in the Bakken Formation, compared with about $500,000 for a vertical well of similar depth. Shale oil production declines very quickly — at least 30% a year and sometimes twice that rate. All of this results in a breakeven cost for shale oil wells in the range of $60 a barrel, making the process unprofitable at today’s oil prices.
The chapters on demand destruction and demand displacement focus on various aspects of energy efficiency and also address the replacement of conventional energy consumption with such substitutes as electricity in all types of vehicles.
The book’s final chapter offers a number of investment suggestions:
- Natural gas will be a winner in terms of sales volume but not necessarily price, so one should be cautious when considering natural gas as an investment.
- As Warren Buffett has stated, “Buy a good asset at a fair price rather than a fair asset at a good price.”
- Avoid “value traps” in energy (i.e., stocks that are cheap for good reason).
- Look for scarcity; stocks with low demand growth often perform well.
- Timing is very difficult — indeed, practically impossible — so be prepared for unanticipated movements.
- The energy industry is procyclical; without the energy industry, there is no industrial or economic growth.
On the whole, The Energy World Is Flat contributes materially to our current understanding of an important commodity group and investment sector. It can be profitably read in conjunction with two other classics in the field. Anthony Sampson’s The Seven Sisters: The Great Oil Companies and the World They Shaped (Viking Press, 1975) describes the seven leading oil companies that discovered and developed oil in the Middle East, especially Saudi Arabia, which was the world’s largest oil producer until recently. Daniel Yergin’s Pulitzer Prize–winning The Prize: The Epic Quest for Oil, Money, and Power (Simon & Schuster, 1991) is a history of the oil industry and its geopolitics.
More book reviews are available on the CFA Institute website or in the Financial Analysts Journal.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
