Hurtin Worldwide:Outlook, Countries, Commodities & Geo-politics
Let's get the week's collection(s) - emphasis plural there's so much but it all interacts together - on
the international situation up as part of the context. After the break you'll find some rather harsh views on the worldwide outlook setting up some specific country news, including Japan, Hong Kong, India and China. In these two parts there are several critical harbinger stories you need to think about. But the overall foundation or context is defined, courtesy of Northern Trust in the accompanying chart. While all of that chatter about the rest of the world beginning to lead its' own separate existence was going on last year the US was an increasing share of the world's GDP. Now that flattened out in terms of growth but still left the US economy, i.e. US consumer excess consumption, as a driving engine of growth. As it's been tanking so does that source of growth.
In the two sections pay particular attention to the discussion of US exports though - which have
primarily helped out the agricultural sector and not the rest of the economy. Which actually doesn't bode well for positive feedback to the domestic economy beyond a narrow range. Also pay attention to the discussion of falling commodity prices and a rising dollar helping out with developing world inflation. That's all true but then you need to couple it with the downstream consequences. First, a rising dollar will dampen, along with declining world economic growth, demand for US exports and negatively impact all those big company earnings that have coasted on foreign sales and currency conversions. Second many of the major foreign players CAN NOT AFFORD to have their economies weaken to far for political reasons and are shifting the emphasis back to growth oriented policies. Which means a likely rise in domestic inflation, increases in commodity prices re-igniting if not in the short term, a fall in their currencies and a relative strengthening in the dollar and so forth. Which means that we may have seen all the air come out of commodity prices that we're going to for a while until developing world inflation re-kindles the whole feedback cycle all over again.
Yet a drop, for example, in China's growth from 11% to 9% doesn't make the demand for commodities go away. All it does is cause huge swings on the margins. In the long-run we're in a structural bull market for commodities as long as so many have structurally constrained supplies and increasing demand. Remember they're priced on the margin and on the margin these are big swings. We're likely shifting into a world where top-down macro-trends and speculative influences will still be important but where the Supply/Demand balances situations in individual commodities will be more so. And as you can see from this cute little chart, just to take China, they will continue to account for a lot of the marginal swing. Which also means that as they re-inflate their economy that demand for whatever they're buying will go up.
As an illustration and specific example of how this might all play out in the oil market consider the
accompanying chart of oil prices thru last Friday's close. You might want to pay attention in the excerpts to some of the BNN vidclips where this sort of thing is discussed in more detail and very astutely IOHO. In any case what you see is a 1-Year chart of oil prices (W.Tx. Intermediate - WTIC) with three price limits guesstimated in. There's a technical theory running around based on something called Fibonacci numbers, named for an Italian mathematician who noticed recurring ratios and patterns in nature. For example in the spirals of Nautilus shells. Technowonks use it give themselves comfort by applying those ratios to estimate how much of rise or fall is likely to be re-traced. For whatever reasons, aside from warmth and comfort, they seem to work a little. So you you see three oil prices - the lowest of which would still be vastly above where it was and economically painful. Meanwhile we'll point out OPEC is starting to cut back production to protect the $100 price level. You might consider this as representative of what'll go on in all the commodity markets.
One key part of which is Oil where the increasingly dominant characteristic is things we've talked about before. First off the world oil majors command less and less of the world's oil reserves which means that oil is increasingly insulated from pure market forces and more and more managed, at least in part for geo-political reasons. Second, wherever it's at Oil is increasingly hard to get to and it takes more and more investment to both find it and produce it. Third more and more of the world's reserves are sequesterred behind political barriers which, in turn, has adverse impacts. The oil that's developed in Russia for example is in fields in pronounced decline. The oil that is developable is in areas hard to reach and extremely expensive to develop. Which then means, in turn, that Russia's recent display of military aggression could backfire on it, the world oil supply and therefore on us. Just as a way to capture the dynamics of these all plays together we'll offer up this little exercise in conceptual graphics. It shows various bands of known and developed energy/oil resources at increasing non-linear costs, including alternative energy sources,e.g. oil sands. When Russia cuts off Central Asian oil and natural gas they're cutting off big chunks of that new swing supply. The other thing you need to know is that while the whole Peak Oil argument is debatable in the aggregate it's proven out well in the known and developed fields, i.e. the stuff we've already brought on line. Bottomline - resources we can get to are in decline. Resources we haven't gotten to are unknown. Think about it. If the key point(s) don't leap out - if it's behind a red band then it's hard to get to. And if it's behind a red band we need to get to or increasingly go without.
World Economic Outlook
Global Recession & Falling Energy Prices The probability is growing that the global economy �" not just the United States �" will experience a serious recession. Recent developments suggest that all G7 economies are already in recession or close to tipping into one. Other advanced economies or emerging markets (the rest of the euro zone; New Zealand, Iceland, Estonia, Latvia, and some Southeast European economies) are also nearing a recessionary hard landing. When they reach it, there will be a sharp slowdown in the BRICs (Brazil, Russia, India, and China) and other emerging markets. This looming global recession is being fed by several factors: the collapse of housing bubbles in the US, the United Kingdom, Spain, Ireland and other euro-zone members; punctured credit bubbles where money and credit was too easy for too long; and the severe credit and liquidity crunch following the US mortgage crisis; the negative wealth and investment effects of falling stock markets (already down by more than 20% globally). Some other contributing factors are: the global effects via trade links of the recession in the US (which still counts for about 30% of global GDP); the US dollar’s weakness, which reduces American trading partners’ competitiveness; and the stagflationary effects of high oil and commodity prices, which are forcing central banks to increase interest rates to fight inflation at a time when there are severe downside risks to growth and financial stability. This G7 recession will lead to a sharp growth slowdown in emerging markets and likely tip the overall global economy into a recession. Those economies that are dependent on exports to the US and Europe and that have large current-account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession. Those with large current-account deficits (India, South Africa, and more than 20 economies in East Europe from the Baltics to Turkey) may suffer from the global credit crunch. Commodity exporters (Russia, Brazil, and others in the Middle East, Asia, Africa, and Latin America) will suffer as the G7 recession and global slowdown drive down energy and other commodity prices by as much as 30%. Countries that allowed their currencies to appreciate relative to the dollar will experience a sharp slowdown in export growth. Those experiencing rising and now double-digit inflation will have to raise interest rates, while other high-inflation countries will lose export competitiveness.
Eurozone plight creates global tipping point There are moments in the financial markets when, abruptly, the conventional wisdom among investors about where the global economy is, and where it is headed, gets severely disrupted. Last week was one of those moments. All at once, a raft of preconceptions about the state of the world economy and its prospects was thrown into a state of flux, sparking seismic upheavals across the financial markets. The catalyst for last week's drama was the realisation that the outlook for key industrial nations, and the global economy as a whole, had become much darker than previously imagined. A double whammy of bleak news came from the eurozone and from Japan, with official figures revealing that both economies shrank in the second quarter.The figures shattered the misplaced assumption by many participants that the worst of the financial and economic trauma besetting America and Britain could remain largely confined to the Anglo-Saxon world. The entire developed world was shown to be teetering on the brink of recession. Developments in the eurozone most disrupted the slightly complacent consensus in the markets. An admission earlier this month by Jean-Claude Trichet, the President of the European Central Bank, that the eurozone had been caught out by the pace of deterioration in conditions in the 15-nation bloc had caused some concern among investors. However, Thursday's confirmation that gross domestic product (GDP) in the eurozone economy had fallen in the second quarter by 0.2 per cent, its first contraction since the inception of the single currency in 1999, forced many investors into a drastic reappraisal. With the eurozone's annual growth rate also cut to an anaemic three-year low of 1.5 per cent - less than half the pace set 18 months ago - the illusion that Europe could remain if not immune then at least substantially insulated from the economic woes afflicting the United States in the wake of the credit crisis was destroyed. The big question now confronting the markets and policymakers is how much worse things in the eurozone might become.
Falling Commodities Prices Ease Fears of Inflation in Developing Countries A sharp drop in commodity prices is raising hopes that inflation is peaking in many parts of the developing world, especially in Asia, providing welcome relief for the fragile global economy. Lofty prices for oil, food and other essentials remain a big challenge, especially for poor developing countries such as Haiti, Egypt and India, where earlier this year soaring costs triggered violent street protests, transport strikes and other unrest. But recently, many of those prices have fallen significantly. Oil fell $1.24 a barrel on Friday to close at $113.77, 22% below its record price earlier this year. Rice, a staple for the developing world, is down about 40% since May, while palm oil, a source of cooking oil, is down a similar amount since peaking in March. Wheat, copper and a host of other commodities also have seen sizable drops. With economic growth slowing across the world, including in China, and demand for raw materials easing, many analysts believe it is unlikely the commodity-market highs of earlier this year will be tested again soon. That is an important change for developing nations, whose industrial economies are often far more commodity-intensive than the U.S. and Europe, and where inflation rates are heavily influenced by the direction of commodity prices. Economists caution that volatile commodity prices could easily rise again, especially if fresh geopolitical problems or unforeseen weather disasters emerge to drive them higher. Even if prices don't rebound, they are still dramatically higher than a year or two ago, meaning continued hardships for many poor consumers. At its current price, rice is still nearly twice as expensive as in 2007. But the downturn in prices for many commodities marks a sharp change from earlier this year, when inflation seemed to be spiraling out of control, especially in China and other parts of Asia, leading to fears of "stagflation" -- a dangerous phenomenon in which growth is sluggish but prices keep rising.
Export Boom Helps Farms, but Not American Factories A surge in U.S. commodity exports is a relief in an otherwise bleak economy, but it is an unreliable prop for an industrial power. Exports are the bright spot this year in an otherwise bleak economy. But the world is not suddenly snapping up made-in-America goods like aircraft, machinery and staplers. The great attraction is decidedly low-luster commodities like corn, wheat, ore and scrap metal. This helps explain why manufacturing jobs are continuing to disappear by the tens of thousands and factories are closing even during a miniboom in exports. While the surge in commodities is a welcome relief, it is an unreliable prop for an industrial power. Commodity sales have been helped greatly this year by rising prices, particularly for grains, and also by the decline in the value of the dollar, which reduces the cost of American exports in other currencies. Both trends, however, have recently reversed, suggesting that the rise in commodity sales will not be sustained, and that exports might shrink, weakening the economy another notch. An analysis of trade data by the federal Bureau of Economic Analysis illustrates just how lopsided the gains have been between manufactured goods and unprocessed commodities. All exports of goods and services in the first half of the year rose at a $52 billion annual rate, adjusted for inflation, up 7.1 percent. Commodities accounted for 41 percent of the increase and manufactured products contributed just 12 percent, the bureau reported. (The figures strip out such items as arms sales and exports to American territories, like Puerto Rico and the Virgin Islands.) Such unevenness, favoring commodities, is unusual, given that manufactured products, even by this definition, account for 40 percent of the nation’s exports, while commodities make up only 26 percent and services 30 percent. Indeed, not since the bureau began compiling detailed trade data in 1977 have commodities outpaced manufactured exports for two consecutive quarters. Weakening demand abroad accounts for some of the decline. But the manufacturers themselves acknowledge that they gradually undercut their ability to export as they moved more and more production to factories overseas. Bringing that production back to this country, so that it could be exported, would dismantle global networks constructed relentlessly over the last 25 years. Many American manufacturers argue that as factories spread across the globe, exporting is no longer an effective means of competing against sophisticated and ever more numerous local manufacturers. In addition, as American companies set up operations in, say, China, they insist that their suppliers locate nearby, for quick and efficient delivery — and that draws more manufacturers overseas.
Countries
Japanese Downturn Appears Likely to Be Shallow but Lengthy Just how bad will Japan's economic downturn be? Economists say it likely won't be too sharp -- but might carry on for a while. Japan posted its worst quarterly report on gross domestic product in seven years last week: The world's second-largest economy contracted at an annualized rate of 2.4%. A look at the causes shows no single, large problem hammering down, but a number of factors coinciding to push the economy into contraction. This, economists say, means Japan likely won't be battered as hard as it was during its most recent previous downturn, but it could take a long time to recover.The current quarter and the October-December quarter will see just 0.1% expansion over the previous quarters, forecasts Kiichi Murashima, an economist at Nikko Citigroup. If Mr. Murashima's prediction turns out to be right, Japan won't meet the common criterion for a recession of two straight quarters of economic contraction. But it would put it on course for anemic growth in 2008. Mr. Murashima predicts expansion of just 0.8% this year, followed by 0.6% in 2009. "The recovery won't come until the second half of 2009," he says. The stagnation "will likely be protracted." A long, moderate slowdown would mean no quick, V-shaped recovery to boost stock prices. Tokyo's Nikkei Stock Average of 225 companies has fallen 15% so far this year, and analysts hold out little hope for improvement soon. The index climbed 0.5% Friday to 13019.41. It also would mean Japan's super-low interest rates continue for even longer than expected. After abolishing an emergency target of zero for short-term rates in 2006, the Bank of Japan last raised its target in February 2007 -- to just 0.5%. Some economists now think it won't raise the rate until 2010, meaning limited increases in long-term borrowing rates and less support for the yen. The bank is expected to leave its rate target steady at a two-day policy-board meeting that ends Tuesday, but it might downgrade its assessment of the economy.
Hong Kong's quarterly drop in GDP marks first in 5 years Hong Kong's economic growth slowed more quickly than expected in the second quarter, showing its first quarter-to-quarter decline in five years as the effects of financial problems elsewhere spilled into the territory. Gross domestic product dropped by 1.4% on a seasonally adjusted quarter-to-quarter basis -- the first such decline since the second quarter of 2003, when Hong Kong was hit by an outbreak of severe acute respiratory syndrome, which brought some segments of the economy almost to a halt. The government said GDP rose by 4.2% when compared with the second quarter last year, but was down sharply from a revised figure of 7.3% for this year's first quarter as the territory started feeling the pinch from slowdowns in major economies and turbulence in financial markets. The growth figure came in well below a median forecast of 5.3% from 12 economists surveyed by Dow Jones Newswires, and marked the slowest year-to-year growth rate for any quarter since the third quarter of 2003. The government acknowledged the economy likely will keep slowing until next year.
Growth Wanes for India's Tech Titans India's information-technology industry, the engine of the nation's economic resurgence, is losing steam. A decade ago, a host of Indian companies -- led by Infosys Technologies Ltd., Wipro Ltd. and Tata Consultancy Services Ltd. -- shot to global prominence by helping fix the "millennium bug" that threatened to crash many of the world's computers at the end of 1999. Often growing at 40% a year or more since, they quickly helped build a global tech-outsourcing industry that has changed how the world does business and how it views India. Now that growth is slowing sharply. The credit crunch and spending slowdown in the U.S. are hurting the companies' biggest market, while a cheaper dollar shrinks their profits. Longer-term problems are surfacing. Competition is rising from other low-cost nations, ranging from Eastern Europe to the Philippines and Vietnam. And India's own success has raised labor expenses, cutting into the companies' low-cost advantage just as their revenue growth is slowing.Infosys expanded its corps of software engineers by one-third between 2006 and 2007, adding 15,000 people. Its average salaries are rising 12% a year, and increasingly high turnover is forcing the company to spend more on training. Growth in profits fell to 18% in the most recent fiscal year, which ended March 31, compared with 56% the previous fiscal year. Tata Consultancy Services posted just a 4.9% increase in net profit in its latest quarter, compared with 37% in the same period a year earlier. Wipro's earnings growth slowed similarly, to 11.6% in the fiscal year ended March 30, down from 42.3% in the previous year.
China priming the pump -- Beijing is likely to implement post-Olympics stimulus measures to offset a slowing economy and spur jobs growth, taking advantage of a benign inflationary backdrop and an energized national mood in the wake of the Games. Tuesday's announcement that Beijing would raise wholesale electricity prices roughly 5%, effective immediately, is the first of likely several new measures due to be unveiled in coming weeks, analysts said. The higher tariff, marking the second time China has lifted electricity prices in two months, does not apply to retail prices, thereby isolating consumers and businesses from higher costs. Still, the rate hike will help power producers offset higher fuel costs, while electricity wholesalers will bear the squeeze on margins.Beijing is considering a stimulus package of as much as $58 billion, in addition to other monetary-policy-easing measures, according to a research published by J.P. Morgan Tuesday. "The top leadership is carefully considering an economic stimulus package of at least 200 billion yuan to 400 billion yuan [or $29 billion to $58 billion]," wrote the brokerage's head of China Research, Frank Gong.Gong said the spending is in addition to plans to spend up to 600 billion yuan on rebuilding earthquake-affected areas and could include tax cuts and other moves to shore up the financial and real-estate markets. Easing inflows of hot money, a shrinking trade surplus and cooling inflation are providing a backdrop conducive to monetary easing, Gong said, setting the stage for a possible reduction of in the ratio of reserves banks must set aside as deposits, in addition to lower interest rates, later this year. Monetary-policy makers tasked with managing the nation's $1.8 trillion stockpile of foreign-exchange reserves were also coming under growing pressure to pull funds out of the U.S. debt market and put them to work at home, Gong added.
Currencies & Commodities
Dollar's Rebound Offers Conflicting Investor Paths The dollar's rise should help damp domestic inflation and interest rates and put the brakes on commodities prices -- a plus for profits. But U.S.-based multinational companies such as GE and Coca-Cola will face additional earnings pressure. After struggling for several years, the dollar is back in vogue. It has gained 8% against the euro in the past month. On Friday, the dollar rose again and one euro equals $1.4673. Last month, a euro was at $1.60, and bullish analysts say a euro could be $1.40 by next summer. The dollar has rallied the same amount against the British pound and a bit less against the yen.
Behind the surge: slowing economies across Europe. Data released last week show the euro-zone economy contracted 0.2% in the second quarter, the first decline since before the euro's introduction in 1999. Falling oil prices have helped, too, since softer energy costs reduce inflationary pressures and make it easier for the European Central Bank to begin cutting interest rates to deal with the slipping economy. Earlier this summer, investors were betting the ECB would raise rates to combat inflation. Currency moves have broad and often conflicting impacts on interest rates, corporate profits, commodity prices, and mergers and acquisitions, particularly if investors believe the trend will continue. Here's how a rising dollar could play out:. But a stronger dollar could hurt U.S.-based multinational companies such as General Electric Co. and Coca-Cola Co., because profits earned overseas will be worth less in dollars.These companies already are facing earnings pressure from the economic weakness that is spreading from the U.S. to Europe and Japan. When the dollar was in the dumps, U.S.-based multinationals didn't complain because the goods and services they sold overseas brought in an increasing number of greenbacks. That flowed through to the bottom line. That is the short-term impact. If the dollar continues to strengthen, the boom in exports that the U.S. has experienced in recent years could end as U.S.-made goods get more expensive.
Buck Up In terms of markets, the most obvious change over the past three weeks has been the stunning rally in the US dollar. While Macro Man has previously noted that his anticipated three themes for August were in some ways correct, he will readily concede that he did not foresee the dollar's reversal of fortune. Now that it's occurred, of course, the two obvious questions are 1) Why has it happened, and 2) What happens next? Macro Man intends to sketch out his initial thoughts below. WHY HAS THE DOLLAR RALLIED? While an exclusive focus on post-hoc explanation can be misplaced, Macro Man is a firm believer in the concept that you have to understand what you have seen before you can forecast what you're going to see. In that vein, Macro Man understands the dollar's rally as a confluence of five different factors:
The key to our wild market: Asia At the core of the current wave of volatility are investor worries that growth is slowing in the Asian economies, which have been driving the global economy forward since the U.S. economy dropped into low gear in the fourth quarter of 2007.Investors have been expecting that Asia's export-driven economies would follow suit. Lower growth in importing economies must lead to a slowdown in exports from Asia, right? Recent figures suggest the slowdown has finally arrived. Growth in China slowed to an annual rate of 10.1% in the second quarter of 2008 from 11.9% in 2007. The pattern is similar in other Asian economies, big and small. India, where gross domestic product grew 9.1% in the fiscal year that ended in March, will see growth of 7.1% this fiscal year, according to Morgan Stanley. All the economies of the developed world, including the United States, would kill for growth rates like those, but it's not the absolute level that matters. A drop from a 9.1% growth rate to a still high 7.1% is enough at the margin to cut demand for the commodities that fuel these economies. And that explains the price drop in commodities from oil to fertilizer to copper. But while the slowdown in growth in Asia is pretty much what Wall Street has been expecting ever since the U.S. economy started to slump, the slowdown doesn't seem to be happening because growth in the U.S. economy has slumped. Instead, soaring inflation in Asia seems to be at the root of the slowdown, and the damage to Asia's economies is largely self-inflicted. We're seeing the beginning of a shift away from the fight against inflation that has contributed to a slowdown in economic growth in Asia back toward more growth-at-any-cost policies in the region. In the short run, that will act to stabilize prices for most commodities near current levels. And even after recent 20% drops, those levels are well above the prices that Wall Street analysts are projecting for 2008 and 2009. That means, in my opinion, that on the fundamentals we've seen most of the decline in the prices of commodities. In the long run, the shift away from fighting inflation and toward growth at any cost is going to accelerate global inflation. Note that the battle against inflation in an economy such as China's has hardly been won. Inflation dropped to 6.3% in July at the consumer level but is running at 10% or better at what's called the factory gate in China (roughly equivalent to producer prices in the United States). That means the next wave of inflation will begin from a higher base rate. A move back toward growth in Asia at this time almost guarantees that global inflation will accelerate to dangerous levels in the next few years. In that environment, you want to own commodity stocks and other inflation hedges.
Endurance test DURING the six months to the end of June commodities posted their best performance in 35 years, rising by 29%. In July they had their worst month in 28 years, falling by 10%. The slide continues: an index compiled by Reuters, a news agency, shows that prices are almost a fifth below the pinnacle reached in early July. The Economist’s index, which excludes oil, has fallen by over 12%. Breathless headlines have hailed the bursting of a bubble. But most analysts are more reticent. They cite various reasons for the recent drop in prices, chief among them the darkening economic outlook in rich countries. In recent weeks it has become clear that Europe and Japan are faring even worse than America, and so are likely to consume less oil, steel, cocoa and the like. But that does not necessarily presage a collapse in commodity prices, they argue, thanks to enduringly strong demand from emerging markets such as China. Oil consumption, for example, has been falling in rich countries for over two years. Goldman Sachs expects them to use 500,000 fewer barrels a day (b/d) this year than last. But it reckons that decline will be more than offset by an increase of 1.3m b/d in emerging markets. It predicts China’s demand for oil will grow by 5%. A similar story could be told of many commodities. Marius Kloppers, the boss of BHP Billiton, a huge mining firm presenting its results this week, argued that emerging markets were much more important to the firm’s fortunes than rich ones were. Developing countries, he said, consume four to five times more raw materials per unit of output than rich ones do. He predicted that China’s use of steel, already greater than any other country’s, will double by 2015. China’s continuing and rapid industrialisation, he argued, would outweigh any temporary slowdown in exports owing to the weakening world economy—although demand for metals that are used in consumer goods, such as aluminium and nickel, may suffer somewhat.
As Mr Kloppers pointed out, emerging markets, and China in particular, now account for the lion’s share of growth in global demand for raw materials, and a good chunk of overall consumption (see chart).
Oil
New oil network very capable An oil terminal and pipeline network expected to be built off the Texas Gulf Coast in about two years would be capable of handling nearly 20% of the nation's daily imported oil. Demand from expanding refineries along the coast, from Freeport to Port Arthur, is driving the $1.8 billion project, executives of the joint partnership said Monday. It will be the second offshore port in the Gulf of Mexico. The Texas Offshore Port System, or TOPS, is a joint venture of Enterprise Products Partners LP and Teppco Partners LP, both based in Houston, and Oiltanking Holding Americas Inc., a subsidiary of Germany's privately held Marquard & Bahls AG. The terminal will allow huge oceanic tankers to unload crude about 36 miles off the coast of Freeport, avoiding sometimes fog-shrouded coastal areas and other hazards. Two floating buoys at the terminal will be connected to a pumping facility anchored in 115 feet of water, which will move the oil to shore via an undersea pipeline. Once ashore, another pipeline network will carry the oil to storage tanks and refineries. Altogether, the pipeline network is expected to be 160 miles.
As Oil Giants Lose Influence, Supply Drops Oil production has begun falling at all of the major Western oil companies, and they are finding it harder than ever to find new prospects even though they are awash in profits and eager to expand. Part of the reason is political. From the Caspian Sea to South America, Western oil companies are being squeezed out of resource-rich provinces. They are being forced to renegotiate contracts on less-favorable terms and are fighting losing battles with assertive state-owned oil companies.And much of their production is in mature regions that are declining, like the North Sea. The reality, experts say, is that the oil giants that once dominated the global market have lost much of their influence — and with it, their ability to increase supplies. “This is an industry in crisis,” said Amy Myers Jaffe, the associate director of Rice University’s energy program in Houston. “It’s a crisis of leadership, a crisis of strategy and a crisis of what the future looks like for the supermajors,” a term often applied to the biggest oil companies. “They are like a deer caught in headlights. They know they have to move, but they can’t decide where to go.”
The sharp retreat in all of the commodities’ prices over the last month, about 20 percent, reflects slowing global growth and with it reduced demand for more oil in the short term. But over the next decade, the world will need more oil to satisfy developing Asian economies like China. The oil companies’ difficulties suggest that these much-needed future supplies may be hard to come by.
Oil production has failed to catch up with surging consumption in recent years, a disparity that propelled oil prices to records this year. Despite the recent decline, oil remains above $100 a barrel, unimaginable a few years ago, causing pain throughout the economy, like higher prices at the gas pump and automakers posting sizable losses. The scope of the supply problem became more clear in the latest quarter when the five biggest publicly traded oil companies, including Exxon Mobil, said their oil output had declined by a total of 614,000 barrels a day, even as they posted $44 billion in profits. It was the steepest of five consecutive quarters of declines.While that drop might not sound like much in a world that consumes 86 million barrels of oil each day, today’s markets are so tight that the slightest shortfalls can push up prices. Along with mature fields, the companies have contracts with producing countries whose governments allocate fewer barrels to oil companies as prices rise.
- The Street : Energy Gut Check Oil has slipped more than 20% from its all time high in July. Ann Kohler, managing director, Caris & Company, discusses why it could fall even further.
- Power Breakfast: Petrobank Energy Unconventional energy assets are becoming a mainstream source of supply. BNN talks to John Wright, president and CEO, Petrobank Energy, about his company's presence in the hot new frontiers of exploration.
To mix oil and profits, think small There's a crisis in the oil industry -- at least among the publicly traded oil companies of the United States and Western Europe. Falling oil prices aren't the cause of this crisis. And rallying oil prices aren't going to fix it. I think this summer's correction in oil prices is just a pause in the long-term upward trend. I stand by my April prediction that oil will hit $180 a barrel by April 2010. But higher prices won't solve the production problems facing the big international oil companies. The stocks that most investors think of when they think of investing in oil -- and the oil stocks that make up the biggest share of energy exchange-traded funds and mutual funds -- aren't going to be the best performers in the sector over the next decade. I think you'd do much better owning a mix of the shares of more-obscure and smaller oil producers, the shares of a few publicly traded national oil companies and the shares of oil drilling and service companies. In this column I'll explain why I think investments in those shares will outperform money plunked into the shares of the Western majors and give you some stocks to consider for your portfolio. The crisis facing the major Western oil producers isn't the result of the 22% drop in the price of a barrel of crude from the intraday high of $147.27 on July 11 to the Aug. 19 close at $114.53. That Aug. 19 close was, after all, still a huge 59% above the August 2007 spot price of crude, according to the U.S. Energy Information Administration. The big oil companies are in crisis because their production is falling. You'd figure that with oil at $114 or $147 or even last August's $72 a barrel, the big companies would be doing everything they could to pump more oil to boost profits. And that they'd be doing everything they can to find more oil and to get the new discoveries into production. But that's exactly what isn't happening. For the second quarter of 2008, the five biggest publicly traded oil companies -- ExxonMobil, BP, Royal Dutch Shell, Chevron and ConocoPhillips (COP, news, msgs) -- reported earnings of $44 billion and a decline in oil production of 614,000 barrels a day. The decline marked the Western majors' fifth consecutive quarterly drop in oil production. During the same period, the oil producers that make up the Organization of Petroleum Exporting Countries have been able to jack up production to an estimated 32.6 million barrels a day in July, an increase of 2 million barrels a day, or about 7%, since June 2007. That increase in supply plus a drop in demand in the U.S. and Europe due to higher prices and slower economic growth led to this summer's retreat from the July high. (OPEC now seems to be in the process of unwinding that increase in order to prevent oil prices from falling much further.)
Geo-politics
Escalating Russia tensions yet to hit market One of oddest things about financial markets is how they can overreact to a rainstorm in the Gulf or the earnings forecast of a tech company yet completely overlook something like the beginnings of a global political crisis. The Russian siege of Georgia provoked yawns on Wall Street in its first few days last week, overshadowed by the Olympics in China and a brief summer rally in financial stocks. As my colleague Darrell Delamaide points out in his political column this week, that's because many global investors see Russia as an emerging market, where Russia sees itself as an aggrieved superpower. Make no mistake. The hostilities in Georgia might soon come to an end. But a major fault has opened up in relations between East and West that threatens not just global securities markets, but the economic health of Europe and the foreign policies of the major industrialized countries. Markets cannot ignore this forever. Continued Russian aggression -- right or wrong, depending how you look at Russia's point of view -- has the potential to impact emerging markets, established markets, debt markets, commodities markets, currencies markets and any other markets that cross borders. The flare-up may well settle down. But the issue is now squarely on the table, for Bush, the next president and all global markets. For now, it's a war of words, blusters and veiled threats. If Russia decides to play its energy card, and threaten Europe's oil, it becomes much more. When markets have slept through events like this in the past, they usually have awakened with a jolt, and it's never pretty.
Investors Looking To Leave Russia? On Friday, Russia's central bank announced that its foreign currency reserves — a key part of its economic stability and an indicator of foreign investor support — had plunged $16.4 billion in the most recent week, to $581.1 billion (see chart). Until Russia's move into Georgia, there seemingly had been only massive capital inflows, thanks mainly to the rising price of oil, which makes up 20% of Russia's gross domestic product. Now, it seems, investors are fed up with the rampant militaristic nationalism, red tape, corruption and anti-investor sentiment in Vladimir Putin's Russia. Some have decided to head for the door and take their money with them. Last week's decline was the largest since Russia's 1998 currency crisis, which led to a collapse of the ruble and rampant triple-digit inflation. So far this time, there's no major visible impact on Russia's economy. But if the flow of money leaving Russia turns into a flood, it could send Russia's markets into a tailspin, creating massive problems for Prime Minister Putin and his handpicked president, Dmitri Medvedev. Any continued movement of capital out of Russia could prove disastrous. As we noted above, Russia really is a hollow economy, its growth kept afloat by soaring oil prices and a commodity boom which have both boosted investment in Russia and made its overall economy look much better than it is. In fact, Russia is an economic nightmare in slow motion. Due to poor health care and widespread alcoholism, its population is declining by 500,000 a year — a trend that's expected to accelerate in coming years. Inflation is revving up again, after declining for several years, and now is growing at about a 14% yearly rate — and rising. Moreover, data from the European Bank for Reconstruction and Development show that, despite the oil-fed boom, Russia's GDP per capita is just 2% above where it was when the Berlin Wall fell. That means, essentially, there has been no growth at all for 20 years. Of the 15 former Soviet republics that got their freedom after the collapse of communism, 11 are growing faster than Russia. This is Russia's big vulnerability under Putin. With oil prices falling, Russia's reserves will come under more pressure — and the import boom that has kept the new class of Russian oligarchs happy will come to a screeching halt.