The news focuses on the new -- new industries, new technologies, new energies. But has the world really moved as far away from old energy and manufacturing as the news and market caps might lead you to believe?
On this week's episode of Industry Focus: Energy, analyst Sarah Priestley talks with special guest Mark Mills, a senior fellow at the Manhattan Institute, CEO of Digital Power Group, and regular writer for The Wall Street Journal and Forbes, about the underrated industries that are oil, gas, manufacturing, and materials. Find out how oil and gas still have plenty of room to grow in efficiency while green energies are nearing their peaks, how new technologies in these old spaces are changing the world quietly, why huge tech companies might do well to invest in old stalwarts such as Ford (F -0.40%) or BMW, and more.
A full transcript follows the video.
This video was recorded on Oct. 26, 2017.
Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. It's Thursday, Oct. 26. It's the Energy and Industrials show. Today we have something a little different from how we usually do things. A couple of weeks ago, we had a very interesting visitor to Fool HQ, Mark Mills, who's a senior fellow at the Manhattan Institute. Mark kindly took time out of his day to talk to us about all kinds of things -- policymaking, how technology will unlock efficiency in the oil and gas industry, the underappreciation of the year U.S. manufacturing industry -- and even touches on some tech stocks. So sorry about that, Dylan!
I'm joined in the studio today by Mark Mills. He's a senior fellow at the Manhattan Institute, a faculty fellow at the McCormick School of Engineering and Applied Science at Northwestern, and a member of The Advisory Board at Reilly Center for Science, Technology, and Value. He's CEO of the Digital Power Group, a partner in Cottonwood Venture Partners, a venture fund focused on the digital oil field. He co-founded and acted as chief strategist for Digital Power Capital. He writes regularly for the Wall Street Journal and Forbes. He also co-authored a book, The Bottomless Well: The Twilight of Fuel, the Virtue of Waste, and Why We Will Never Run Out of Energy. Mark has testified before Congress, served as of Staff consultant to the White House and to President Reagan. But Mark, you began your career as an experimental physicist, and I wondered what made you apply your skills to develop a policy and investing in the way that you have?
Mark Mills: That's a left field thing. I'd have to say it was an accident.
Priestley: [laughs] All the best careers seem to be.
Mills: I didn't mean to do it. Well I've always been fascinated by forecasting, and trying to figure out what's going to happen in the future. As a kid, I read a lot of science fiction. I read the whole canon of people like Heinlein and Clifford Simak and Niven, many of the people that wrote at the time. And I wanted to be thinking about what could be done next in every domain. And what I learned when I began doing experimental physics and engineering, I got hired as a semiconductor engineer, in the early days, you could almost see the transistors with your naked eye. They were much bigger. I'm old enough to have built vacuum tube power supplies myself. My career spans all that. But, what I learned was that the policies of countries, companies, states, policy making itself was an extremely important component of trying to guess the future right. It wasn't just that you could ignore policy makers, if you weren't engaged in the policy making itself. You could have unhappy outcomes and end up delaying a happier future for people, or accelerating a better future for people. And since technology underlies essentially all of these tectonic shifts in history -- I don't mean wars aren't important and that revolutions like the American Revolution didn't matter, and the Magna Carta certainly made a difference. If you compared how we live today in our political system to how people lived 100 years ago, 200 years ago in very similar political systems, the differentiator and things that make most things a lot better is technology. So, that's a long answer. I evolved in getting involved with that as well. So, I do both now. I'm involved in policy, testifying before Congress episodically, writing policy papers for the Manhattan Institute. In our boutique tech venture fund, we're involved specifically in finding those innovators making software that will unlock the petabytes of unused data in the oil and gas business and the industrial markets.
Priestley: Yeah, absolutely. I saw that you said, I may make a hash of this, but I think you were saying that given the amount of unused data at the minute, especially around the shale industry, there's a potentially 20% efficiency improvement that could be unlocked in the next decade. How close do you think we are to actually unleashing something like that?
Mills: I think the unleashing is already starting. The oil majors have been doing this for a while. What's interesting isn't whether Exxon or BP, Chevrons of the world, use data to do seismic imaging and control drilling. It's when the unrecognized hundreds of others of oil and gas drillers and thousands of other companies in that ecosystem, which constitutes the shale revolution, when they begin doing it. When they begin adding efficiencies, a few percent better each year, then 10% better, then 20% better. In commodity markets, these are tectonic shifts in pricing. It makes a difference between not just survival but between being a little profitable and very significantly profitable. If you invest in a stock that did a 20% gain in a year, you'd be a pretty happy camper. And if you want to drive those kind of changes in an industrial market like oil and gas -- and they can be done. You don't have to get 10 times better to make a lot of money. 10% or 20% better a year is astonishing. And it's already beginning. We already see this both in the micro level with start-up companies. There's a company that I'm personally familiar with, I'm now biased because I have a vested interest in the fund called Novi Labs in Austin. This is an artificial intelligence driven play, pure software play, which you would say does the obvious. It looks it how an operator, where they drill and why they drill hundreds of wells. It generates thousands and thousands of megabytes of data. Surely you can use all that data to help the operator figure out the optimal place to drill a well. You only have to make a tiny change in optimizing to make a big change in the capital efficacy of drilling.
Priestley: And that's really where the focus is now on, the location of the drilling as opposed to -- we've achieved a lot of efficiency improvements in the fracking process, but now is the focus is much more on the location of these drills?
Mills: I would say, up until now, it's been true. I think we're going to see a reversal now. We actually know where oil and gas is now. We don't have to go finding it. There's still some finding and optimizing what part of the shale fields are richest, sweetest. I think we're on the beginning of a transformation that went from optimizing where to drill, which is the last decade of this brand-new revolution, to optimizing now how to drill and how to operate. We haven't really focused as much on that, except on the mechanical side, drilling longer, horizontally, wells, adding more sand and pressure in the wells to crack the shale to release oil and gas. These are mechanical changes. What we haven't done is optimize all of the equipment and how we operate it, the kind of things, when you would look at, if you're in a manufacturing plant, you'd say, "Obviously, I should optimize where my trucks are, when they arrive, how they operate, when I maintain them ..." All these things that are obvious in many industries have not been applied in the oil and gas business. When you do that, you add efficiencies and they become very significant.
Priestley: And correct me if I'm wrong, but reading a lot of your research and your commentary, your feeling is very much that, in the oil and gas industry, a small change, because it's such a scaled industry, is going to have such an outside effect, whereas a lot of the green energies that are developing, smaller changes are not having as outsized an effect.
Mills: Yes. That's absolutely true. First of all, the oil and gas business, for oil itself is the world's largest traded commodity. There's more money in trade and oil than there is in all the other metals and commodities combined. It's a big business. So, very small changes have big impacts on price and big impact on profits. And we see that. In fact, what most people don't realize is, when markets and traders guess the supply demand balance wrong by 1%, which amounts to about a million barrels per day, that's what causes prices to soar or collapse. Just 1% on the margin, getting this massive, multi-trillion dollar global industry wrong. The inverse of that will tell you that if I can bring efficiencies of 1%, it's pretty impactful, because we already know 1% is impactful.
Priestley: Yes, the last two years have shown that.
Mills: So-called green technologies, the interesting part about them which is generally unknown is, they're on a different part of the learning curve. There's a general belief that wind and solar are going to get as much better in the future as they did in the past, which is actually not true in the physics. There's been a phenomenal decrease in the cost to produce a solar kilowatt hour or wind kilowatt hour in the last 15 to 20 years. But what we've done is pushed those technologies close to the physics limits. Now they get better, but they get better incrementally. We actually know this for a fact because the kinds of things that dictate how much energy you can take out of the wind are well known. The blade can't take up more energy than the wind, than is in the wind. We're now near the physics limits of how much energy you can take out of the wind. Not at them, but we're near them. That wasn't true 10 or 15 years ago. With shale, it's actually the inverse. We know for a fact that we're only extracting single-digit percentages, at best 10%, of the amount of oil and gas that's in the rock that we're trying to get our gas out of. We have visibility to 10% gains in solar and wind. That's not nothing. And we have visibility to tenfold gains in oil and gas, eventually, on that side of the equation.
Priestley: And that's just the extraction. Then, there's also the use of it, too. We could get a ton more efficient in how we're actually using it.
I have another question for you that's a little bit of curve ball, but it's something that's close to my heart. In a Wall Street Journal article that you wrote recently, The Cyber Age Has Hardly Begun, you talk about investment dollars in tech vs traditional industry. I think this is a wonderful quote, and I'm sure you get bored with people quoting you back to you --
Mills: No, I love it. It's great. It means people are actually reading what I'm writing, which is very comforting.
Priestley: It says, "Apparently American companies can be organized into two camps -- smoking-hot tech firms and old economy roadkill." I love that. And you discuss how Amazon's (AMZN -1.45%) market value is twice that of Wal-Mart's, Apple's (AAPL -1.32%) valuation is twice that of Exxon's. Would you say, then, and I probably know the answer to this, that there's a systematic undervaluation of some of the more traditional manufacturing producing companies that we have in the U.S.?
Mills: I think there's no question. Both are happening. I'm preaching to the choir here at The Motley Fool, there's always a case of markets get into story mode and overvalue certain sectors and undervalue others, and the trick is figure out when it's going to turn and the inverse happens. We unequivocally are very enthusiastic about tech companies, for good reason. The information revolution has not stopped. I've written about this many times. I think we're in very early days in the information revolution. I don't think we're at the end. People think we're at the beginning of the end. What more could happen in computers? We're really, I think, at the end of the beginning of the next computing age. Computing, by and large, I think is pretty lousy still. Computing is useful when you don't have to figure out how you're going to use it. Just a little too much figuring out how to use the damn things.
Everybody complains. Which means that the engineers have done a lousy job so far. They'll do better. And once computing becomes as easy to drive as a car -- anybody can drive a car. A lot of people who shouldn't be driving cars are driving cars, but anybody can drive a car, kids can drive cars, we've made them very easy to drive. Computers are not easy to drive yet. They will get easy. And when they become easy and ubiquitous, we'll then achieve the revolution. That's coming. That's hard. I'm very bullish on Apple and Amazon still. That said, individual companies can get overvalued. You can get too far out of your skis. The growth rates, now, are maybe hard to sustain. On the traditional industrial side -- the economy is over 90% in non-IT stuff. That's where the GDP is.
Priestley: The press wouldn't let us believe that. [laughs]
Mills: Because we have all our attention focused on the new stuff, which is normal. And old stuff is old stuff. But we're not going to stopped needing cars or houses, food, materials, tables and chairs, all the stuff of the world. It's all stuff, it's all physical, things have to be dug up and moved and formed and shaped and made into things. The industries that are good at that do well. The industries that are undervalued are those that are going to figure out how to do that phenomenally better with new information tools such that they become the differentiator in that 90% of the economy. Maybe put another way, we saw Amazon buy Whole Foods. Grocery is a commodity business. Mackey differentiated himself by appealing to quality. His supply chain wasn't any different from anybody else's. It's still food. Now comes somebody with a different supply chain, information-centric. Very smart of Amazon to buy Whole Foods, because doing what Whole Foods did is hard. It's in the physical world. If I were going to predict the equivalent in the physical world, it was more likely that Amazon would buy Whole Foods than the inverse because of nature of the market's bet on Amazon.
Apple should buy Ford. Ford's a fabulously efficient, extremely talented company, knows how to make safe cars. It's hard to make a safe car at a high reliability. Most tech guys couldn't make a safe car if their life depended on it. And I include Tesla (TSLA -4.95%), because they're not making cars at the volume that Ford does at the level of safety and reliability. He'll get there, but he's not there now. If you wanted to leapfrog Tesla, nevermind what hype propels the car, if you want to be in the car business, if you want to be in the grocery business like Amazon did, you buy a Whole Foods. If you're a tech company and you want to be in the car business, buy yourself BMW. Most of them could buy it for cash because of the market disparities. That would make, Ford stock would trade up, so I'd be bullish on Ford, because Ford is a great company. It doesn't matter whether Ford buys Apple or vice versa, it's a bullish bet on Ford. Obviously, the capital sits on the Apple side of the equation. I think we're going to see a lot more of that in the next five years. And then you'll see a few of the old school industrial guys gobble up some software ones. You've already seeing, GM bought an artificial intelligence company, paid up pretty big, but not crazy, because if you want to put artificial intelligence in a car, the hard part is also the car. The AI guys, I'm not even sure most of them know how to drive a car, much less build one.
Priestley: We're seeing that in the industry, too, GE buying Baker Hughes. I think that's really the bet on utilizing this industrial internet to make Baker Hughes much more efficient. I know you have limited time. You're a very busy man. So, thank you very much for talking to us today.
Mills: A delight to be here. Thanks for having me.
Priestley: Yeah, we'd love to have you back. Thank you very much.
Mills: I'd love to come back if you'd let me come back.
Priestley: [laughs] Of course. Thank you.
Hopefully we'll be taking Mark up on his offer to come back and maybe talk to us a little more on the future of U.S. manufacturing. Until then, if you would like to explore any of Mark's ideas in more detail, his recent article for Forbes titled The Future For Oil Supply And Prices After The Amazon Effect Stimulates Shale 2.0 is a great read. Next week, we're hopefully doing a rundown of GE ahead of its much-anticipated November 13th meeting. Hopefully you'll join us for that. That's it from us today. If you would like to get in touch, please feel free to email us at [email protected] or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. I'm Sarah Priestley. Thanks for listening and Fool on!
