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Eric Fry, reporting
from Laguna Beach, California…
The S&P 500 slumped 3.3%
yesterday, bringing its loss for the once-promising month of January
2009 to 6.4%. Your editors observe the carnage, shake their heads and
sigh, "Will this misery never end?"
For the last year and a
half, every trading bounce has produced a new decline; every hope a new
disappointment; every bailout announcement a new disclosure of corporate
greed. Everywhere an investor turns, the forces of impoverishment seem
to be winning over the forces of enrichment.
The investment landscape
features a treacherous combination of delusion and danger. It is a
mirage atop a landmine. We investors have become so parched for good
news from any quarter that our minds dance hopeful images before our
eyes, only to lead us into harm's way.
In such an environment,
cowardice is a virtue. Those of us who refuse to trust the mirages,
finish each trading day with all ten fingers and all ten toes,
financially speaking. Meanwhile, our courageous counterparts return from
the daily campaigns with missing limbs…or worse.
We have become
conscientious objectors to the battle on Wall Street. But since the
forces of wealth destruction are attacking us, we do not have much
choice in the matter…except to decide which weapons to use. In this
regard, your editors lack creativity. They prefer the reliable weapons
of earlier financial campaigns over the hi-tech weaponry used by most
combatants.
We like cash-rich value
stocks, for example – the kinds of stocks that Benjamin Graham was
buying in the 1930s and the kinds of stocks that our colleague, Chris
Mayer, has been recommending during the last few months. We also like
gold, wheat, crude oil and almost any other asset that a CEO cannot
destroy.
Gold has performed
admirably during the last several months, but oil has been a disaster.
Maybe that's about to change.
At $42 a barrel, crude oil
is a very compelling investment…for two reasons. From a defensive
perspective, oil is an attractive investment because it provides a hedge
against dollar depreciation. But that's not all. Oil also functions as a
kind of call option on global economic growth.
As an investment,
therefore, oil is both offense and defense. In the column below, our
resident oil expert, Byron King explains why a new bull market in oil
might begin very soon.
— When Fear =
Profit: A Special Volatility Report —
Bailouts…Deleverging…Government Shenanigans…Unprecedented Volatility…
Put simply, the markets are
bucking and kicking like we've never seen before .
With such unpredictability,
it is difficult to know where to invest, if at all.
There is, however, one man
who has been relishing the recent whipsawing market conditions...
Take a different approach
and learn how to make fear in the markets work FOR you with Steve's
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--------------------------------------------
Why Oil is Too
Cheap
By Byron King
Things are happening at
warp speed out in the U.S. and global economy. This is the fifth version
of today's update that I have composed. Each time I think I have a note
ready for you, something else goes supersonic and rattles the windows.
Today, the sonic boom comes from the oil trading pits.
In the past couple of
months, energy has NOT been getting scarcer. At least that's not what
the price signals are telling us. Really, just what ARE those price
signals telling us?
For example, prices for
crude oil are way down. Down from what? Last July, oil traded at $147
per barrel. Yesterday, a barrel of oil swapped out at $43 and change. So
in the past five months, oil is down over $100. That's a 71% decline.
And I've seen predictions from diverse sectors of the oil-trading
business -- from Wall Street commodity desks to the inner sanctums of
large integrated oil companies -- forecasting oil as low as $30 or $25
per barrel within the next few months. Wow.
Let me borrow from Charles
Dickens. The first half of 2008 was the "best of times" for oil. (You
probably did not think that when you pulled up to the gas pump.) And
now, we are in "the worst of times" for crude oil. It's a "Tale of Two
Oil Markets." What happened?
Let's back up and look at
the thinking behind the idea of scarcity. What happened in the big world
out there? And what has happened to the investment theme for this
newsletter? Is it still valid? I'm going to discuss this today and on
Monday, in Part II.
Back in the early 2000s,
people worried that raw geology would place eventual limits on world oil
output. It was the "Hubbert's Peak" idea. And to be sure, the overall
Hubbert methodology has been proven correct. It has worked for oil
provinces, for nations and even on a global scale. (OK, I know, it's a
long discussion for another time.) But the Hubbert model of eventual oil
scarcity -- however accurate in the long run -- has been overtaken by
other events.
The Hubbert geology-based
model of scarcity morphed in the past couple of years. The more recent
concern has become aboveground issues. There are things like politics
(Venezuela, for example); war (Iraq); insurrection (Nigeria); access to
sites (Russia); other macro-investment trends (the rise of national oil
companies -- NOCs) and broad issues, like limits to industrial capacity.
Houston's most famous
investment banker Matt Simmons is one of the great advocates of this
aboveground focus, particularly on the issues of industrial capacity. To
be fair, Matt discuses the Hubbert-like geological constraints. But Matt
devotes much of his argument -- correctly -- to nongeological issues in
the oil patch. For example, Matt discusses how there is not enough oil
field equipment, from rigs to high-strength subsea valves. Or there are
too few trained personnel, or not enough well-drilling, or there's just
plain systemic corrosion ("rust") that will limit future oil output.
And Simmons is entirely
right about his points. It's always an informative use of time -- and a
true pleasure -- to watch Matt give a talk. Over the long term and at
the rate things are going, Matt is exactly on target. There will not be
enough oil to meet eventual world demand, because of underinvestment in
drilling, inadequate personnel, insufficient industrial capacity and
other inefficiencies in the overall industrial process.
But right now -- for the
past few weeks, say -- the "scarcity" issue has morphed again. The
immediate issue is that aggregate oil demand is declining. This is
because of the worldwide economic recession. So oil prices are falling.
Certainly, for the short term -- for the next year or so -- there is
just "too much" crude oil floating around, figuratively as well as
literally. Russia's Vladimir Putin does not think that things will turn
around until mid-2010, and he may well be right.
World oil stockpiles are
actually growing. Recently, I've seen stories about large operators like
BP and Shell leasing tankers just to store oil at sea, evidently hoping
for higher prices in the future. This has to scare the bejesus out of
the nice people at OPEC. Really, how can you run a decent oil cartel
when there are large stockpiles of your main product out there just for
the asking? It's bad for business.
The current decline in
demand for oil is, of course, related to the breakdown of the modern
financial paradigm. In the olden days, people with capital met up with
people with ideas. Between the two of them, they built industries.
(Hello Mr. Carnegie, Mr. Rockefeller, Mr. Mellon…)
In our modern era, the
investment bankers hijacked the process. The investment bank "industry"
pretended that it could add far more value to the process than its
services were ever worth. And the whole Wall Street thing turned into a
systemic fraud. (Another discussion for another time, as well.)
The bottom line is that the
floor just fell out from under the financial machinery of the energy and
resource industries. It all happened very fast, in a matter of weeks
this past fall.
The microeconomic issues
include the loss of purchasing power by households and businesses. The
credit binge of recent years allowed a lot of people and firms to spend
themselves dry as a bone. So current demand is dying the death of a
thousand cuts, particularly as deleveraging drives down asset prices.
Business models don't work anymore. Overall, we're poor.
And at the macroeconomic
scale, the central issue is contraction of aggregate demand as credit
markets have dried up. It's the micro issues added up over and across
the national and world economies.
So we get back to those oil
prices dropping 71% from the summer high.
What does it all mean? Oil
at $147? $77? $47? It's not that one oil price is better or worse than
another. On any given day, the price is just the price. You pay your
money and you take delivery. But days turn into weeks and months and
years. The energy industry -- the oil industry, in particular -- works
in time frames of decades. So the wild swings in short-term pricing make
long-term planning nearly impossible.
For example, if you are an
upstream operator or frontline investor, do you go ahead with new
projects and lay down cash for capital investment? Or do you defer? And
if you defer, will you miss huge opportunities? If you are cautious
today, will you be caught short- or empty-handed in a year or two when
things turn around? And when things turn around, will they turn around
gently and predictably? Or will they skyrocket?
In the U.S., for example,
these current "low" oil prices could wreak havoc on national energy
output. There are at least 1.5 million barrels per day of oil output in
the U.S. at direct risk right now. That is, thousands of small operators
might collectively decide to close in some of the 300,000 or so stripper
wells that produce a few barrels each per day or week. These strippers
are the marginal wells. They may have been drilled decades ago (one just
north of Pittsburgh was drilled in 1861). These wells yield low volume
and often require high labor inputs. So the economically prudent small
operator might just plug and abandon the high-cost, low-volume wells.
But the overall impact will be a lot of U.S. oil output just going away
forever, in all likelihood.
And there are many
high-cost marginal projects out there as well. From deep-water
exploration in the Gulf of Mexico to big tar sands projects in Alberta,
operators are deferring projects. Oil at $43 just won't support certain
kinds of investment. (Petro-Canada's recent $17 billion cancellation of
a tar sands upgrade project comes to mind.)
That's certainly bad news
for the medium and long term. When the world needs that output in a few
years, it won't be there. And the lack of supply will put OPEC back in
the driver's seat.
So yes, the current oil
pricing is signaling that petroleum is in surplus. But it's just a
relatively short trip -- a year or two - back to the world of scarcity.
Joel's Note:
This presents a fabulous opportunity for investors with a bit of
patience and foresight. It's a well-known fact that great investors
don't make money buying stocks at their tops. They buy them when they
are beaten down, kicked to the curb and lying in the "do not touch"
pile. Byron has amassed a spectacular list of beaten down energy plays
that, while well off their highs right now, should stand to deliver
outstanding gains when fundamentals kick in and the world is once again
thirsting for energy...energy that will be scarce and expensive.
Now, you could wait to buy
these companies in a couple of years, when they are on all the front
pages and every broker's lips, or you can take a gander at Byron's
portfolio right now and beat the rush. If you're interested, check out
his report
right here
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[Rude Endnote:
Finally today, a contribution from our unpaid cartoonist correspondent.
Don't feel too bad for
these guys though - if what Byron says is right they'll have plenty to
sing and shout about soon enough.
Until next time...
