Military Protection of Commodities

Russia's Call to Arms
July 13, 2007

Russia's Parliament has given gas giant Gazprom the right to form armed units to patrol the country's oil and gas pipelines.

Imagine that… A private company sports it's own private military.

The law, backed by 341 deputies in the 450-seat State Duma (the lower house of the Russian Parliament), gives the two state-controlled giants Gazprom and Transneft, Russia's pipeline monopoly, the right to employ and arm their own security units.

Russian authorities claim the law protects critical Russian infrastructure against militant attacks. That's certainly one way to look at it. I'm not quite sure which militant would be brazen enough to attack Vladimir Putin's greatest national (probably personal) asset. But then again, I'm no militant.

Alexander Gurov, one of the deputies who drafted the law, said: "A couple of terrorist acts and an ensuing ecological catastrophe would be enough to immediately declare Russia an unreliable partner and supplier of energy resources."

To some extent, he may have a point… Russia owns 27% of the world's natural gas reserves. And those reserves account for 44% of European Union gas imports and about a quarter of Europe's total gas consumption. Europe already depends on foreign supplies for about half of its energy demand and that ratio is set to rise to 70% by 2030.

And it's become common knowledge that the world is facing a legitimate energy crisis. We're in a new era where energy supplies will constantly be challenged. A majority of the world's energy sources aren't secure! They never will be.

To add to that minor inconvenience, there is little tangible evidence to suggest that alternative energy can be developed fast enough to rein in the demand for the big three hydrocarbons: coal, oil, and natural gas. Gideon Rachman, a columnist for the Financial Times, cites a recent Oxford Research Group report that argues: "Four new nuclear reactors a month would have to be built from now until 2070 to make any difference to global carbon emissions."

Do you know how long it takes to throw up a nuclear reactor? Let's just say we'd have a better chance of rebuilding the Great Wall of China with nothing more than some bricks, blunt instruments and bamboo shoots before that mighty nuclear feat will ever be achieved.

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Rachman goes on to recite some troubling words recently spoken at the London School of Economics from Sir Nicholas Stern, former chief economist of the World Bank, the U.K. Treasury and author of an influential report (The Stern Review) on climate change. Sir Nicholas anchored some disturbingly deep fears. He concluded that finding and deploying alternative energy fast enough to avoid climate disaster would be, in his estimation, very difficult. "It is possible," he said… "And if it's not possible, we're in real trouble."

I tend to agree with Rachman… We're in real trouble.

However, the world's awareness to the global warming threat needs no further introduction in this humble forum. Thankfully, the issue has firmly reached the main stream. Even the most hardened skeptics seem to be waking up.

And let's be clear: We're not cheering China along as it prepares to leapfrog the U.S. as the world's largest emitter of greenhouse gasses just because we own shares of Chinese energy stocks. Your editors here at the Penny Sleuth fully support any and all tangible benefits the alternative fuel boom may garner.

But having said that, we must concede one undeniable fact: Hydrocarbons are here to stay. To think alternative energies will quickly supplant King Coal is delusional, a naiveté of convenience and nothing more. There is no amount of rationalization that can convince a sober mind that one plus one equals three.

Shareholder activism will never change that fact. Selling your stake in Yanzhou Coal won't stop the Chinese from constructing a new coal-fired power plant every week just to keep pace with domestic demand.

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Don't the Chinese deserve McMansions adorned with multiple air conditioners, flat screens and iMacs like the rest of us?

You see, until we reach a stage of technological innovation in which the major engines of economic production — things like steel mills, skyscrapers, street lamps and SoHo lofts — can be consistently and efficiently fed with enough electricity (the fundamental lifeblood behind human progress and economic growth, via "green" sources like nuclear, solar, wind and switchgrass), our current means of production will remain the most efficient.

Meaning, energy stocks will continue to do well.

Now I'm sure that alternative energy stocks — swank "green" hedge funds and their excessive fees, and other "insider" investments ranging from algae to fuel cells — make a great story. It makes you feel good to proudly tell your neighbor that your broker just slipped you into some exclusive, private nanotechnology company that promises to turn the Earth on its axis, reverse the spin and solve the world's energy problems all at the same time.

Meanwhile, the boring value investor will keep his money invested with the company holding a sizable grip on the world's proven energy reserves! He'll practice patience. He'll drip the annual dividends and watch his capital grow.

It's not sexy…but it makes sense.

Less we forget… Chinese oil consumption keeps growing at more than 7% per annual clip. It's no wonder the International Energy Agency says the world is facing an oil supply "crunch."

So it should come as no surprise that the Russian Duma supports legislation that encourages private companies to operate independent armies. If that can't persuade you to the long-term economic importance of hydrocarbons, we're convinced nothing will.

Until next time,
Christopher Hancock

P.S.: The Russian gasoline empire is something I've been watching very closely for a long time, as well as Chinese oil prospects. These are the kinds of plays you can expect to find in my newsletter, Free Market Investor. In fact, I have another Asian play that could pan out to be much bigger than oil. I describe it in this free report. Read it here.