Air date: October 15, 2004
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Reshaping energy
GEOFF COLVIN: Oil close to $55 a barrel -- gasoline over $2 a gallon -- would be big news at any time, but in the final weeks of an ultra-close Presidential race it is fuel on the campaign fires. $50 oil means America is spending $1 billion a day on oil imports. Both George Bush and John Kerry say they'll make alternative energy sources a big part of the solution, but can those technologies make a significant difference anytime soon? Where are the best opportunities for investors? And how are record oil prices reshaping an energy industry that touches every American?
Mayo Shattuck is CEO of Constellation Energy, which provides electricity and natural gas to millions of customers and is, among other things, America's largest energy trader. David Kurzman covers the alternative energy industry for Needham and Co.
Mayo Shattuck, why is oil nearly $55 a barrel?
MAYO SHATTUCK: Well, the energy complex around the world seems like it's going crazy. It's not just oil. It's gas. It's coal. There are pressures on the demand side from countries like China, which is the largest coal user in the world.
COLVIN: The largest coal user in the world.
SHATTUCK: As well as going up 15 percent in the past year, so you can see some pressures from the demand side. And at the same time I think that the disruptions to the supply chain, if you look at individual countries that maybe on the margin only represent 3 percent of the production, Venezuela, Nigeria, everyone's familiar with issues in Iraq. Everyone's familiar perhaps with the Gulf of Mexico disruptions because of the hurricanes. When you look at affects like these, it scares the participants in the oil industry, and that's why we're seeing prices like we are now.
COLVIN: So on the supply side there, it's not just the shortages themselves. It's fear of continued or greater shortages?
SHATTUCK: I think that's right. I mean I think that our position would be that these prices could sustain themselves for quite some time, and the volatility could sustain itself until you have some relaxation in the view that these supply chains have calmed down.
COLVIN: David Kurzman, both candidates have been talking a lot about this energy situation. Let's analyze what they've had to say, listening first to what President Bush said recently.
PRESIDENT BUSH: Listen, to make sure this economy continues to grow, Congress needs to pass my energy plan. I put a plan up there that encourages conservation, that understands we can use renewables, like ethanol and biodiesel. It's a plan that also recognizes that we can explore for natural gas in environmentally friendly ways. It's a plan that recognizes we can use clean coal technology. At the heart of my plan is the understanding that in order to create jobs here, America must become less dependent on foreign sources of energy.
COLVIN: Okay, so he actually mentioned a number of alternative energy sources in that comment. Start with ethanol. A lot of people think that has a reputation as a boondoggle for corn producing states and so forth. What's the reality of ethanol today?
DAVID KURZMAN: Ethanol is actually used in a number of different fuels today, from E10 and E5, which is the gasolines that you can currently get at the pump. And as a result, the ethanol industry has already been able to secure itself as a player in this market.
COLVIN: And he mentioned biodiesel, which I think is a term an awful lot of people aren't familiar with. What is it?
KURZMAN: Biodiesel is taking a renewable energy such as soy oil or corn oils and using them to mix and blend with existing diesels so they burn cleaner and thus are partly renewable, or in some very selected cases you can use 100 percent renewable soy oil.
COLVIN: Mayo Shattuck, your firm, Constellation, generates a lot of power. Are these things significant sources or could they be for you?
SHATTUCK: I think they could be. We have 4 percent of our generating capacity now in renewables. That includes things like wind and solar and geothermal.
COLVIN: That is probably higher than the national average, right?
SHATTUCK: It is. I think our view is that we have to force it to 8 percent, we have to force it to 10 percent. It's important that we increase the fuel diversity across the landscape. One aspect that some members of the industry feel very strongly about is the nuclear component, which is not looked at as necessarily consistent with environmental objectives, but it is a clean burning fuel and it's 20 percent of our overall capacity in the United States. And those of us that are nuclear operators, and Constellation is the seventh largest in the country, really feel that it's imperative that in addition to standard renewable sources and new technologies that nuclear is reinvested in for the next generation.
COLVIN: Let's take a listen to what John Kerry had to say and contrast his views with President Bush's. Let's listen.
JOHN KERRY: In most parts of the country a gallon of gas is somewhere around the $2 mark, up 30 percent since George Bush took office. We will create 500,000 new clean-energy jobs in America immediately by providing incentives to invest in clean energy technologies and encourage job creation; here in New Mexico, places like the new wind farm in Craig County. You've seen how investments in renewable energy protect the environment while they also produce new jobs.
COLVIN: I want to ask both of you, since both of the Presidential candidates talked about energy dependence on foreign sources, big picture -- and you both look at the big picture in this regard -- what is the outlook for America's dependence on foreign energy, and can it be substantially reduced any time in the next several years?
KURZMAN: Several years is a vague number.
COLVIN: Five years.
KURZMAN: My answer to that is it's very unlikely. I think our dependence upon foreign oil is going to remain high. Natural gas, most of that, nearly all of it is domestic, domestically produced. Coal, we have 200 years' worth of reserve, so that's domestic. So the real issue here is where are we going to get our oil, and for the most part we have tapped out the easy finds in the U.S.
COLVIN: Well, where are we going to get our oil? Or are we going to find substitutes for the oil that are going to be significant, and will they be?
KURZMAN: Well, if you're looking to the alternative energy space, I think you need to look towards what is already here now, and that is hybrid energy technologies. A lot of folks have been promising fuel cells for many years. Those are technologies that I believe are perpetually five years from commercialization and availability.
COLVIN: Are there any companies in the alternative energy field that you would feel comfortable recommending to investors?
KURZMAN: The way I've recommended that investors take a look at this space is to find those companies with a clear path to commercialization and a clear path to profitability. One of the companies I think is highly interesting is Intermagnetics General Corporation.
Its primary business is using superconductor technology to produce MRIs, which is a medical application, but they're developing high temperature superconductors to improve our grid. A lot of people understand when we say there was a blackout in 2003 what affect that had. Not a lot of people understand that the problem is that we don't have the ability to deliver all this electricity. Intermagnetics says that by the end of this decade, and perhaps even sooner, they could have a solution.
COLVIN: Great. Mayo, what do you see in the big picture of America's dependence on foreign sources of oil? Significant change in let's say the next five years?
SHATTUCK: Oil you can't see an easy solution to, but on the other hand, we do have gas and we do have coal, we do have technologies that can lead to more renewables. And I think when you mix that with a recommitment to nuclear, which is vital in I think the electric industry's opinion, then I think we have enough of a balance to matter.
COLVIN: Mayo, I want to ask you about Constellation, because it is on the FORTUNE 500. Last year on our FORTUNE 500 it was number 352. This year it was number 203, a jump of 149 places. As far as we can tell, that's the biggest one-year jump any company has ever done. Did all that growth and revenue result from higher energy prices? Or did it come from other sources?
SHATTUCK: It actually came from other sources. What we decided to do a couple of years ago is to enter other states that had gone competitive with their electricity. And there are about 20 states around the country that have deregulated, which means that customers can have choice as to whether to use their utility or another provider. We entered what was a huge vacuum as a lot of companies got in trouble in the 2001-2002 period, set up operations, sales offices and so forth, to sell power and to sell gas competitively to large customers that are in the commercial industrial area, as well as to utilities that had divested their generation. So we've become the leading provider at both this wholesale and retail level by entering these states, selling power, selling gas, and that accounts for the increase in revenue.
COLVIN: Now one thing you do a lot of is energy trading. I know that a lot of investors and a lot of other people hear that and bells ring because they remember the things that happened in 2001 and 2002. It was a part of what Enron did, but there were other companies as well that were in energy trading and they ran into trouble. What's the difference with you?
SHATTUCK: Well, I think there are a couple of differences, and I'd have to say that I think probably every industry in the '90s had their bad actor, and certainly Enron was our lead bad actor in this industry. But the development of these competitive markets meant that traders could move electricity from place to place, buy it forward, create these liquid markets, and that has been a very important element to the development of a competitive industry that has lowered the cost of power for many, many consumers. I mean in the mid-Atlantic alone there have been billions of dollars saved at the customer level because of the competitive environment.
COLVIN: Finally, both of you, a year from now, oil higher or lower than it is today? Mayo?
SHATTUCK: Well, I'm going to say higher. I think that we feel that these disruptions in the marketplace and the intensity of focus by financial traders and their participation in these markets actually cause for quite a bit of volatility and high oil prices for the near term.
COLVIN: David, what do you think?
KURZMAN: I don't know, but I sure hope it's going to be lower for the sake of most of the lower income folks that, you know, it hits them a lot harder to their pocketbooks than it does the higher income. But when I take a look at how long it takes to get new supply added to the market, it can take 12 to 18, 24 months, I think the likelihood that Mayo's prediction that it might be higher, there's a lot to support it.
COLVIN: David, Mayo, thanks so much.
SHATTUCK: Thank you very much.
COLVIN: Mayo Shattuck, David Kurzman, thanks so much.
Boomer bonanza
GIBBS: It's no secret that we live in a youth obsessed culture. All you need to do is turn on a TV or open a magazine to have that idea slammed in your face. But now as the first wave of baby boomers are hitting what used to be known as the retirement years, everything is changing. Corporate America is starting to wake up to that fact, that people over 50 are sitting on roughly $7 trillion. Ken Dychtwald has spent a career trying to help companies figure out how to get a piece of that pie. He's president of Age Wave and author of numerous books on the topic, most recently Age Power. William Sterling created a mutual fund, Trilogy Advisors, designed to capitalize on that boomer plus spending power. Gentlemen, welcome.
Well, Ken, let me ask you, how are boomers affecting the retirement years or the so-called golden years?
DYCHTWALD: First, the boomers, because of their enormous size, and remember this is the generation of 76 million people born right after World War II, every time they've migrated across the lifeline, their enormous demographic heft has forced companies to wake up and take notice. And those that have been clever enough to position in front of this wave have made a fortune. So whether that was Gerber's baby foods or Johnson & Johnson or McDonald's or Ford Mustang, anybody who could catch that wave at the right moment is going to profit. So number one, the fact that the boomers are no longer kids but are beginning to look towards their 60th birthday as the next major milestone is beginning to cause the marketplace to take notice of this knew stage of life. Second, the boomers have no intention of growing old as their parents did. They intend to grow old youthfully with the spirit of adventure, with an idea of personal reinvention, with the hope of maintaining all the things they like in life, but just for longer.
GIBBS: Bill, what does this push, this momentum that baby boomers are bringing to the marketplace, mean for corporate America?
STERLING: If you look at where the growth in the population is going to be most pronounced over the next five to 10 years, it will be in people above the age of 55 or people sort of in their late 40s to late 50s. There's an actual bust, baby bust in the number of people in their mid-30s to mid-40s, and then there's also an echo boom. The children of the boomers are now in their teens to mid-20s, so that's the other area of greatest population growth. So this basic pattern is boom, bust, and echo, and we think it's going to have implications for lots of different industries.
GIBBS: Ken, what about the implications for the economy?
DYCHTWALD: Well, it depends on which scenario one buys. If we assume that when the boomers reach their 62nd birthday, as today's elders have done, and retire and cease earning, then there's a pretty scary scenario for the economy. Because what it implies is that you'll have a huge population of taxpaying, high-earning, high-spending people who will go into a state of frugality and spend down. I don't believe that's what's going to happen. I actually think the boomers will continue working, even if it's part or phase work or flex retirement, for decades. And so I actually think the boomers will continue to be very active in the marketplace. The economy will continue to grow.
But I think, as Bill is pointing out, you're going to see a decline in those enterprises oriented towards youth. As you mentioned, we've been a youth-focused culture, but that must come to an end. During the 1990s, the number of 18-to-34 year olds in America actually shrank by 9 million people, while the number of people over 50 grew by 12 million. So while you might see a decline in youth-focused businesses, you're going to see an enormous growth in products and services that cater to the 50-plus crowd.
If you look around, you see Sean Connery is approaching 80 and he's still considered a sex symbol and Sophia Loren is around 70 and she's still pretty terrific, and the average age of the Rolling Stones right now is 60, Sting just hit 54. What's happening is that we're beginning to kind of relax our notion that people over 50 or 60 are kind of over the hill. Alan Greenspan runs the Fed at 78. We're beginning to get the idea that maybe some of our notions about aging are old fashioned and simply wrong. And in its place we're presenting a more boomerish notion that a 50 or 60 or 70 or 80 year old still may have quite a bit of life in them.
GIBBS: You bring up a very important point. You know, it does look like a rosy picture, but one of the guys you mentioned, Fed Chairman Alan Greenspan, is not quite as optimistic. In fact, recently he warned Congress that baby boomers are starting to retire in a few years and house spending continuing to soar, our budget position will almost surely deteriorate substantially in coming years if current policies remain in place. That means that we're going to have to see a shifting of expectations, whether it is in the boomers or whether it's in society as a whole. Am I right, Ken?
DYCHTWALD: Yeah, let's keep in mind that Social Security was crafted first of all in an era when there was a 25 percent unemployment, and so the reason Social Security was put in place was not so much to give people 20 years of entitled leisure but rather to move them out of the way to make room for the young. There were 40 workers for each recipient, and the life expectancy was only 63. Thanks to the triumph of increased longevity, we now have only 3.4 workers to each recipient. And I think what Mr. Greenspan is indicating is that as we live longer and longer and as this boomer generation becomes the new mature generation, we're going to have to rethink a lot of our entitlement programs because we simply can't afford to cover so many people who are going to live so long.
STERLING: The origins of Social Security actually go back to Otto von Bismarck in Germany when they introduced a 65-year-old retirement age, but the average life expectancy there was 49. So from our point of view, that would be like saying, well, we'll give you Social Security when you're 95 or 100. It wasn't a big deal then, but it's obviously a much bigger deal now.
GIBBS: Well, whether politicians are willing to admit it or not, you did mention not only the swelling number of baby boomers but the increase in life expectancy. So what sectors, Bill, are poised then to benefit from this seminal shift?
STERLING: Well, I think the sectors that are favorably positioned, you know, first of all, if you do the demographic numbers, what we try to do is look at how people's spending patterns change as they age, and then we use the age projections to factor in what industries will grow most rapidly. The top of the list is health care. You know, some comedian recently said that the famous rock stars now are taking more drugs now than they did in the '70s, but they're doing it all with Medicare drugs. And the problem with that is that the drug industry demographics look so great, but it's actually a problem for the industry because the government, which is funding, you know, roughly half of the purchases, is saying we can't do this, so the pricing pressure on the big pharmaceutical companies I think could be tremendous. As investors, we're looking at sort of other areas in health care, like medical devices and medical equipment, orthopedics. We think a big theme for investors will be the sort of spare parts for aging baby boomers.
So a company like Zimmer Holdings, which focuses on orthopedic implants and the like, we think is very well positioned for this age wave that's coming.
There are, outside of that area, for example, there's a diabetes epidemic that's very much associated with the age wave. There's actually a German company called Fresenius which, even though it's located in Germany, operates the biggest chain of dialysis treatment clinics in the United States. We think that's a very well positioned company for the age wave.
If you look beyond health care, the other industries, leisure and retirement spending, most people don't have a vacation home until they're in their 50s. We've had a boom in recent years in vacation homes, and I think that's likely to continue for the most decade. Most people don't take an ocean cruise until they're in their 50s, and I think that's probably a pretty well positioned industry because of this pattern. So leisure, retirement spending, health care.
GIBBS: Ken, let me ask about two things, corporate America and we talked about big pharmaceuticals and how they are responding to the aging of America. Have you seen any specific ads that kind of ring your bell in terms of big pharma and diabetes in particular?
DYCHTWALD: Yeah, diabetes as you mentioned is a good example. There's 18 million diabetics in America. That's half the population of Canada as a comparison. A very clever ad appeared recently that had B.B. King in it, and B.B. King is himself in his 70s, he is a diabetic, and he doesn't particularly want to be hurting his fingers with the old traditional technology of taking samples. A very clever use of an older icon in a growing problem.
If I could add to what Bill's saying, that I think you're not only going to see anything having to do with the body, such as health and health care and anti-aging and spas and fitness and wellness and medical devices, but I also think the financial services industry itself is going to rise up as tens of millions of boomers start to play a little catch up game with their wealth accumulation. There's also going to be somewhere between $10 and $20 trillion of inheritance passed over this next 15-year period, and so the whole idea of estate management is going to be a growth area as well.
I also add the whole notion of experience activities. When we're young we want to accumulate things. It makes us feel we've arrived. Once you've lost a loved one or you've achieved either success or failure in your life, at around 50 you take a deep breath and you realize that the experiences you have are way more important than things. So whether that means time at the theater, adult education, lifelong learning, family vacations, remodeling your home, learning to cook, you're going to see a mature population moving towards an experience-based purchasing pattern versus a thing-based purchasing pattern. And I think that companies who can line up with that are going to do great.
STERLING: One stock we like on that very theme, sort of the leisure and entertainment company of the future, right now is InterActive Corp.
The stock's down this year, but it's run by Barry Diller. It has a very interesting portfolio of businesses, all the way from the online Expedia travel company to Ticketmaster to Home Shopping Network, kind of great businesses for either couch potatoes or people who want to get experience. It's an Internet company essentially, but with businesses that make money, and it's also got about a billion dollars of cash on the balance sheet. But I think it's a portfolio of companies that are targeted toward the needs of the aging boomer generation. It's a pretty interesting play we think.
GIBBS: What other companies jump out at you?
STERLING: Well, you know, we also think that again in the leisure entertainment area, we like some areas of consumer electronics, and that's partly getting back to the echo boomers as well. But when we look around the world for what we think is probably likely to be a great story in terms of a new brand emerging in consumer electronics, look at Samsung. Samsung is a Korean company.
They've actually made a great hit in terms of the cell phones with these cell phones that take pictures and the like. The Net appeals to all age groups. That's not just a demographic story. But they have about 13 percent of the world market now compared to Nokia's 36, but they're pretty determined to catch up or exceed Nokia by the end of this decade. We think they have a terrific sort of brand that's being built right now, and it's a stock trading at about 13 times earnings.
STERLING: Casinos, believe it or not, gambling is one of the, you know, it's a low-impact sport. It's like not aerobic, but it is low-impact. And the demographics for that whole resort sort of casino industry look very favorable.
GIBBS: Ken Dychtwald, Bill Sterling, wonderful conversation. Thanks very much for joining us.
DYCHTWALD: Thanks, Karen.
STERLING: Thanks.
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