Bubble, Bubble, Oil, and Trouble

I want to start out this note with a citation from a very old book:

Mackay, Charles. 1852. Extraordinary Popular Delusions and the Madness of Crowds (NY: Noonday, 1932).

  55: One projector set up a company to profit from a wheel for perpetual motion.  Another projector proposed “A company for carrying on an undertaking of great advantage, but nobody to know what it is.”  “Next morning, at nine o’clock, this great man opened an office in Cornhill.  Crowds of people beset his door, and when be shut up at three o’clock, he found that no less than one thousand shares had been subscribed for, and the deposits paid.  He was thus, in five hours, the winner of 2000 pounds.  He set off the same evening for the Continent. He was never heard of again.”

This same sort of psychology is at work in the economy today.  This kind of mentality is often a symptom of an impending economic meltdown.

So here is an example from a recent Wall Street Journal article.

Davis, Ann. 2006. “Bubbling Crude As Oil Prices Rise, Investors Pour Into Risky Energy Plays Hedge Funds, Private Equity.” Wall Street Journal (4 August): p. A 1.

“Barry Kostiner traded electricity and natural gas for eight years on Wall Street.  Last fall, he reinvented himself — as a Texas oilman.  With no assets beyond plans to buy oil and gas fields, he set up shop as Platinum Energy Resources Inc.  He had never worked in the oil industry or managed a company.  Yet he carried out an initial public offering of stock and within two months persuaded several New York hedge funds to buy a large chunk of the shares, raising $115 million in all.”

“Energy-related endeavors of all kinds are a magnet for cash these days, thanks to the gravity-defying rise of oil prices and the recent boom in investment pools that cater to deep-pocketed institutions and the wealthy.  Some energy investments, to be sure, are relatively low-risk and involve industry veterans.  But private-equity firms, hedge funds and other professional speculators are also pouring billions into unconventional loans, management teams with limited track records and IPOs on lightly regulated stock markets.”

“Here in Houston, the boom’s U.S. epicenter, veterans of major oil companies and their bankers are abandoning longtime employers for startups.  Eric Mullins, a former investment banker at Goldman Sachs Group Inc. in Houston, recently persuaded some big endowments and pension funds to sponsor his career change — to the tune of $450 million.  Now Mr. Mullins, 44, hunts for oil and gas assets as co-head of Lime Rock Resources; the other co-head has an exploration background.”

“The fevered pitch reminds some of the Silicon Valley boom a few years back. “Energy’s about as hot right now as tech was in 2000,” says Ben Dell, an energy analyst with Sanford C. Bernstein & Co.”

“Jeffrey Currie, head of commodity research at Goldman Sachs in London, says participants are taking more risk now because the energy industry long underinvested in new capacity and supplies have grown extremely tight.  “We believe it could take more than a decade to resolve these supply problems before commodity prices can retreat on a more persistent basis,” Mr. Currie argued in a recent piece.  “Do not expect this investment phase to end soon.”


[My comment: This last comment is extraordinary.  The oil companies have enjoyed record profits & their exploration efforts have been minimal.  Hedge funds are the corrective?]

“One popular trend: management teams with virtually no assets other than big and costly ideas.  Joseph Bryant, a former top executive with BP PLC and Unocal Corp., is creating an elite team of deep-water oil explorers to hunt the last frontiers of the Gulf of Mexico and other hard-to-reach environs.  Searching such virgin territory is mainly the province of big oil companies. Before Mr. Bryant’s Houston startup, Cobalt International Energy, drills for his first drop, he must acquire seismic data and state-of-the-art software to research the ocean floor, purchase exploration rights and lease floating rigs that cost as much as $500,000 a day — all for naught if he hits dry holes.”

“Yet Mr. Bryant had his pick of sponsors. “It wasn’t a question of whether we could get money, but which to take,” he says.  He picked Carlyle-Riverstone [yes, part of the infamous Carlyle Group] and Goldman Sachs Capital Partners, which together committed $500 million.  He recently accepted an additional $100 million from investors led by Canada’s KERN Partners Ltd.”

“Exotic new loan markets are another energy investment trend. Some energy companies that don’t yet have positive cash flow are borrowing from hedge funds or others at double-digit interest rates.  The loans are sometimes called “second-lien” loans because in the event of trouble the hedge funds have to line up behind more-traditional lenders that have first rights to any collateral.”


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