The January 2016 to April 2016 correlation between the CCI Index (especially oil component), and world equity markets, and the $US (inverse) has been widely noted. From late April the equities/dollar relationship has been maintained (both have mildly reversed) but unusually, the stronger dollar seems not to have had the same impact on commodity prices.

That a stronger dollar has not hit oil or gold is a little surprising.  This is especially the case for oil, which also faces the prospect of increasing supply, but how can gold be expected to continue its advance?  

 

Thank you for raising a question which I suspect many investors are puzzling over. I certainly have and I’m not sure there is a conclusive answer. In fact considering the lack of commonality I think the answer lies in treating each market on their individual merits. 

Oil rose from a two-week low on concern that supplies from Nigeria and Libya, holders of Africa’s largest crude reserves, will be disrupted.

Futures advanced 2.8 percent in New York. Royal Dutch Shell Plc and Chevron Corp. are evacuating workers from the Niger Delta because of deteriorating security, a union official said.
In Libya, some fields will be forced to halt output unless a port blockade is lifted, according to the National Oil Corp.

Canada’s oil-sands companies curbed supply as wildfires ripped across Northern Alberta last week. Gains accelerated as global equities rose.

"The market is getting support from the disruption in Canadian oil sands production and increased threats to output in the Niger Delta," said Gene McGillian, a senior analyst and broker at Tradition Energy in Stamford, Connecticut.

"The underlying fundamentals remain weak. If not for supply disruptions and the decline in U.S. production, prices would be lower."

Crude has rebounded from a 12-year low earlier this year on signs the global oversupply will ease as non-OPEC output declines and regional supply faces threats in Africa and Canada.

 

Oil prices have been the subject of a great deal of media coverage over the last few months not least because of Saudi Arabia’s court politics. There are so many moving parts to this market that we can really only be guided by the price action as an arbiter of what people are doing with their money. 

Global lithium S&D analysis highlights opportunity for high-quality assets
The emergence of the Electric Vehicle and Energy Storage markets is being driven by a global desire to reduce carbon emissions and break away from traditional infrastructure networks. This shift in energy use is supported by the improving economics of lithium-ion batteries. Global battery consumption is set to increase 5x over the next 10 years, placing pressure on the battery supply chain & lithium market. We expect global lithium demand will increase from 181kt Lithium Carbonate Equivalent (LCE) in 2015 to 535kt LCE by 2025. In this Lithium 101 report, we analyse key demand drivers and identify the lithium players best-positioned to capitalise on the emerging battery thematic. 

Global lithium demand to triple over the next 10 years
The dramatic fall in lithium-ion costs over the last five years from US$900/kWh to US$225/kWh has improved the economics of Electric Vehicles and Energy Storage products as well as opening up new demand markets. Global battery consumption has increased 80% in two years to 70GWh in 2015, of which EV accounted for 35%. We expect global battery demand will reach 210GWh in 2018 across Electric Vehicles, Energy Storage & traditional markets. By 2025, global battery consumption should exceed 535GWh. This has major impacts on lithium. Global demand increased to 184kt LCE in 2015 (+18%), leading to a market deficit and rapid price increases. We expect lithium demand will reach 280kt LCE by 2018 (+18% 3-year CAGR) and 535kt LCE by 2025 (+11% CAGR). 

Supply late to respond but wave of projects coming; prices are coming down 
Global lithium production was 171kt LCE in 2015, with 83% of supply from four producers: Albemarle, SQM, FMC and Sichuan Tianqi. Supply has not responded fast enough to demand, and recent price hikes have incentivized new assets to enter the market. Orocobre (17.5ktpa), Mt. Marion (27ktpa), Mt. Cattlin (13ktpa), La Negra (20ktpa), Chinese restarts (17ktpa) and production creep should take supply to 280kt LCE by 2018, in line with demand. While the market will be in deficit in 2016, it should rebalance by mid-2017, which should see pricing normalize. Our lithium price forecasts are on page 9.

 

A link to the full report is posted in the Subscriber's Area.

The cost of lithium ion batteries falling rapidly and the fact this is occurring at the same time solar cells costs have been trending lower is a major incentive for installations of both technologies; increasingly in parallel. With costs coming down and technology improving growth in demand is a major consideration as factories achieve scale and miners invest in additional supply. 

Meanwhile, net gasoline exports are at record high levels. Exports have increased 1,443 kbpd since June 2005.

So, consumption has increased but remains far below pre-2012 levels. Production is again approaching earlier peak levels but most of the increased volume is being exported. The belief that U.S. consumption is approaching record highs is simply not true.

Americans Are Driving More But Using A Lot Less Gasoline

Americans are driving more than ever before. Vehicle miles traveled (VMT) reached an all-time high of 3.15 trillion miles in February 2016 (Figure 2).

VMT have increased 97 billion miles per month (3%) since the beginning of 2015 and gasoline sales have increased 187 kbpd (2%). The rates of increase are not proportional.

For example, VMT was fairly flat from mid-2011 until oil prices collapsed in September 2014 yet gasoline sales fell more than 1 million barrels per day during the same period. Americans traveled the same number of miles but used a lot less gasoline. Even with the VMT increase since 2015, sales are still 539 kbpd less than in January 2009.

 

Generally speaking energy demand represents a constant long-term growth trajectory because so much of the global economy depends on energy consumption to fuel growth. However the evolution of electric and CNG vehicles, as well as increasingly stringent emissions regulations reflect an additional consideration that was not so much of a factor previously.

This time around, the discussion seems to be heading in a slightly different direction. Mr. Kibsgaard believes that the downturn will result in a “medium for longer” pricing scenario in which the national oil companies of OPEC can still generate significant returns for their owners due to the low cost base of their conventional resources. With this cost advantage and a desire to play for market share in a world of minimal demand growth, cost issues for producers will become very important. In his view, the procurement-driven contracting model is the main obstacle to creating the performance improvement desired by the customers. The problem comes from producer procurement professionals who believe the service companies don’t bring much to the engineering aspect of projects thus the only way the companies can be compared is by price, which means comparing them on the basis of their more commodity-oriented products. 

In Mr. Kibsgaard’s view, the procurement-driven model leads to suboptimal technical solutions and correspondingly poor project performance from both a design and executional standpoint. That also means financial returns will be negatively impacted. In light of this outlook, Schlumberger has been undertaking a revamping of how it competes based on collaboration and commercial alignment between the operators and the largest service companies. This preparation can be seen through their acquisition strategy during the past few years as Schlumberger has filled holes in its technology suite and extended its ability to do more of what was often contracted to others, which has become more important for retaining complete control of projects. 

Schlumberger is close to putting five prototype drilling rigs into the field to test its new drilling system that will capitalize on its downhole instruments to help guide and evaluate the formations being drilled and render information to the drilling equipment and the people at the surface. By automating the drilling process based on the downhole intelligence, wells can be drilled faster, cheaper, safer and with a greater productivity outcome. It is possible fewer workers will be needed on the rigs further reducing the cost of drilling wells and potentially helping both the operator and service company improve returns.

Competitors will be watching Schlumberger closely. Initial successes will pressure competitor management teams to consider broadening their product and service offerings followed by how to make them more integrated and profitable. Producers will be watching the experiment as they wrestle with how to increase their profit margins if oil prices remain in the $40-$55 per barrel range for a number of years. If producers cannot grow production because of low industry growth, they will need to strive to become more profitable in order to be rewarded by investors.

A link to the full report is posted in the Subscriber's Area.

Big declines in oil prices put enormous pressure on drillers to innovate. As exploration budgets are slashed customers demand more for less and new technology is the only way that can be achieved. Companies like Schlumberger have to constantly push the barrier of what is possible so they can gain market share and ensure a place for themselves when the oil majors come under cost pressure. 

Even if some SUNE obligations are not fulfilled, TERP expects to continue operating

Defaults may now exist under many of TERP’s non-recourse project-debt financing pacts (or such defaults may arise in the future) due to SUNE bankruptcy filing, delays in preparation of audited financial statements

Defaults “are generally curable"; TERP will work with its project lenders to obtain waivers and/or forbearance agreements

No assurances can be given that waivers, forbearance agreements will be obtained

 

SunEdison rallied impressively from its 2012 lows following the adoption of a quickstep leveraged strategy aimed at acquiring or building solar energy power plants while simultaneously divesting of the completed assets into two MLPs. This saddled the parent with the risk of acquisition and building without holding onto the residual cash flows from a working utility once completed. The strategy was predicated on the rapid pace of solar installations persisting indefinitely. They do not appear to have factored in the role a drop in oil prices would have on that business model. 

In light of that view, a critical question is whether a real economic transformation can be performed. An earlier attempt was made in 2000 following the late 1990s oil price downturn and the expensive Saudi-financed war to oust Saddam Hussein’s troops from neighboring Kuwait. The financial pain of that experience was washed away by the rebound in oil prices that ended that transition effort. That experience leads Saudis to expect something to bail them out from having to make hard economic and social decisions.  

Critical to this transition effort will be the mindset of the young Saudis who dominate the country’s population. By 2030, the youth group will add 4.5 million new Saudis to the labor force, nearly doubling its current size to 10 million workers. If the female labor force participation rate increases the number could be larger. This population demographic will force the economy to have to create three times the number of jobs for Saudis than it did during the oil boom of 2003-2013, which seems highly unlikely to occur. 

There are a number of social impediments to making this transition occur, including Saudi reluctance to take blue-collar jobs that are thought to be menial. Saudi workers enjoy the slow pace and shorter working hours of government jobs. There is also a problem associated with tapping the young females in the country who are constrained by the social stigmas of not being able to drive and not earning enough to employ a car and driver. Here is where modern technology is helping as Uber helps liberate some of these females. More females are taking white-collar jobs in the private sector. Instead of becoming teachers, many are become lawyers and professionals. The challenge is that many of them are willing to trade down to government jobs with shorter hours when they have children. There are also social and employment issues involved with marriage when a woman’s father prefers that a prospective husband have the security of a government job. 

Probably the greatest challenge for Saudi Arabia is that both the rulers and the ruled have been satisfied with the social compact that underlies the nation. The populace trades loyalty and obedience to the government in exchange for prosperity, which costs the government substantially. The new social compact will demand greater self-reliance from the people in exchange for their prosperity. Whether the populous understands how precarious their position is in continuing to depend on the government’s continuing largess because of the current and future market for oil. 

A link to the full report is posted in the Subscriber's Area.

Governance is Everything has been a idiom at this Service for decades and Saudi Arabia has a long way to go before it can be considered that governance is improving regardless of how low the base is. 

Environmental groups say the new rules don’t go far enough to safeguard marine life and the people who depend on it for their livelihoods. Friends of the Earth has called on the government to halt all auctions of offshore drilling leases.

“There’s no such thing as safe offshore drilling,” said Marissa Knodel, a climate campaigner for the Washington-based group. “Tougher rules aren’t going to mitigate the human and environmental costs of allowing more drilling to occur.”

Government Shortcomings
In a closed-door meeting last month, BP, the largest driller in the U.S., said the government underestimated the time and complexity needed to implement the rules, ignored the reduced production and stranded reserves that would result, and added unneeded operations that could boost risks rather than decrease them. The comments came in slides Exxon presented at the meeting and were posted on a government website.

The Deepwater Horizon disaster looms large over federal attempts to tighten requirements. The blowout at the $153 million well sank a $365 million drillship, paralyzed the Gulf region for months and cost BP more than $40 billion in penalties, compensation and restoration costs.

Exxon, in the closed-door meeting with White House and Interior Department officials on March 7, outlined its assertion that the rules will cost $25 billion and argued they would increase the danger of a blowout by wresting decision-making from on-site engineers with decades of experience.

 

Offshore and deep water oil prospecting, particularly in the Gulf of Mexico, represents an important source of current and potential future supply that is seriously at risk from the increasingly long reach of regulation. The move to take decisions about how best to proceed with operations away from experienced people on the rig and hand it to bureaucrats onshore represents a major victory for anti-fossil fuel campaigners and will result in a much higher regulatory burden for oil companies. 

3) Investors are piling into medium and longer-term U.S. bonds with increasing conviction that borrowing costs will stay low forever. The biggest exchange-traded funds that focus on such notes have experienced a surge of new money this year, with the volume of short interest on the ETFs' shares falling. This has helped fuel a 4.9 percent surge in Treasuries maturing in seven to 10 years so far this year, according to Bank of America Merrill Lynch index data.
 
4) The demand hasn't only come from ETFs and mutual funds. Big institutions and hedge funds have also bought more U.S. government bonds, particularly those maturing in the next decade, as they seek safe spots to park cash in the face of global economic uncertainty. 

How the Fed measures inflation does not appear to bear a great deal of resemblance to what we experience in our day to day lives. The cost of services such as insurance, education and healthcare have all trended higher and housing prices have recovered in many major cities but inflation measures have not responded. When I look at what I spend on a monthly basis that doesn’t make sense but the other side of the balance sheet also needs to be addressed.

Wages have been static for a long time and that means people have had to pay more for services but have cut back elsewhere to make ends meet. That is probably closer to how the Fed views inflation than any other explanation but it means wages are vital in how they decide to act. 

There is another aspect of U.S. production that is troubling given the rapid increase in oil prices during March. While we believe much of that increase was driven by speculators who had bet on oil prices falling and were rapidly covering those short positions as optimism about rising demand and falling output supporting higher oil prices grew. As oil prices rallied on the reports of steps being taken to reign in production growth and optimistic estimates for rising demand took hold, industry focus shifted to the question of at what oil price would producers resume drilling? Often overlooked in this process was how higher oil prices would encourage producers to begin completing previously drilled but uncompleted wells, or DUCs as they are referred to. DUCs will enable oil production to recover without an increase in the drilling rig count. It is this phenomenon that had us wondering whether we could see a repeat of what has happened in the natural gas market – steadily rising production despite fewer rigs drilling.
 

When we plot the price of natural gas and crude oil to the number of drilling rigs searching for each of these commodities, we find very close relationships. Those relationships are shown in the following exhibits.

What is equally interesting is the pattern between natural gas and crude oil production versus the number of active drilling rigs seeking the respective commodities. The chart in Exhibit 5 (next page), while busy, is instructive for its relationship between natural gas output and gas drilling rigs. One goes up relentlessly while the other steadily declines. In contrast, crude oil output, which had risen unchecked is now in decline, but only months later than the drop in drilling rigs began. The decline is now being hastened as a result of how few oil drilling rigs are working. What makes the volume-to-drilling-rigs relationship for natural gas different from that of crude oil? Most likely it is the impact of associated natural gas volumes. In 1993, associated natural gas from crude oil wells accounted for 26% to 28% of gross natural gas produced. The ratio declined steadily until 2013 when it was in the 15% to 18% range, but by the end of 2013 was up sharply to 20%.

In the case of natural gas drilling, the fewer rigs working are targeting the most productive areas of the formations. On the other hand, during 2014 and early 2015, oil drilling continued at a high rate adding, we suspect, additional associated natural gas. This probably explains why gas volumes have continued to climb. With crude oil output now falling and both oil and natural gas drilling off sharply, one has to believe that the associated natural gas component of supply will shrink, possibly finally stopping the climb in natural gas volumes. If that happens, look for natural gas prices to begin rising, even with the huge volumes of gas in storage. Should we get a warm summer and economic activity continue to grow, we could see a more positive response by natural gas prices heading into the fall of 2016. That might become the surprise of 2016. 

A link to the full report is posted in the Subscriber's Area, 

The fact natural gas is a by-product of crude oil production is a fact often ignored by analysts. With drilling activity expected to be moribund for the foreseeable future I agree this could be an important factor in gas pricing as the year unfolds. In addition, with prices so low, the incentive to use more gas has seldom been so compelling.  

The announcement of this meeting has been very supportive for the oil price as it led to a large short covering by financial players, since a deal to freeze production should limit the potential downside in oil prices. Now with the statements by MBS in the Bloomberg interview last week, the outcome of this freeze deal is much more uncertain. In the interview MBS said that Saudi Arabia will only freeze output if Iran and other major producers do so. If all countries agree to freeze production, we’re ready," MBS said . "If there is anyone that decides to raise their production, then we will not reject any opportunity that knocks on our door.” This stands in contrast to prior statements from the Saudi Oil Ministry and from Russia which had suggested that a freeze deal could happen without any commitment from Iran. The market took this statement very negatively for the oil market because Iran has made no indications that they will join the freeze deal and even if they did, most analysts would probably doubt that production from Iran would be frozen anyway.

If Saudi Arabia indeed see any chance that a freeze deal cannot be accomplished then it is relevant to ask the purpose of even arranging the meeting. If a meeting is held and Saudi does not accept a deal without Iran participating then we believe a deal will not happen and if a meeting is held without a successful deal, then the oil price may drop quite significantly on that kind of news. Would that be in Saudi Arabia’s interest. Would MBS like to see a lower price again to inflict even more pain on the other global oil producers and hence set the stage for higher prices later? It seems odd that MBS is not coordinated with the oil ministry in this issue, but could his statement have been meant for domestic politics? And is it not very strange if MBS in the last minute should undermine the Russian effort to achieve this now famous freeze deal? Is this a negotiating trick to achieve something in return from the Russians vs Iran in Syria or other places?

The problem with this statement from MBS is that he outranks everyone else in Saudi when it comes to economic policy as he heads the newly formed Economic Council. This implies that if he actually means what he is saying here, there will be no production freeze deal in Doha, because we are confident that Iran will not take part in any production freeze deal. Before this statement by MBS we were 90% certain that there would be a production freeze deal coming out of the Doha meeting, because why hold this meeting if a freeze is not already agreed? It would, as described above, send the oil price in tailspin if a meeting was arranged and ended up with no agreement. After the MBS statements we see the chances for a freeze deal meaningfully reduced, maybe down to 50%.

If the meeting to hold the freeze deal in Doha is cancelled or if it is held without a successful outcome we would reduce our short term (3-month) price target for Brent which is currently 45 $/b. We would however not do anything with out 6-month target of 55 $/b and our 12-month target for 65 $/b. Our 24-month target (currently 70 $/b) on the other hand may be adjusted slightly higher due to the extra damage that may be inflicted to the supply side of a potential revisit to 25-35 dollar oil prices.

On Monday this week the Russian Energy Minister Alexander Novak however stated that “Russia can conduct extra talks with Saudi Arabia on oil output freeze before the meeting in Doha on April 17th”. Novak also stated that he is confident that an agreement will take place. This suggests that maybe the statements from MBS in the Bloomberg interview last week may have been meant for his domestic audience. Also the Kuwait OPEC governor Nawal Al-Fuzaia said on April 5 that there are indications that oil producing countries in both OPEC and non-OPEC are poised to agree on a production freeze to January levels. This statement seemed to give the market some restated confidence that there could still be a freeze deal in the Doha meeting on April 17th. But nonetheless the MBS interview last week has added a lot more uncertainty to the April 17th meeting than what the oil market would prefer. 

A link to the full report is posted in the Subscriber's Area.

Brent crude prices firmed today on positive inventory data but the result of the April 17th meeting between major OPEC and non-OPEC producers is a major consideration for traders.

Saudi Arabia is fighting wars on three fronts and higher oil prices would certainly help with affording this adventurism as well as its highly accommodative domestic social programs. While Iran remains its greatest competitor for regional hegemony and the administration will not wish to give it any advantage, economic factors will probably take precedence. 

Yer man, while I often feel like I am part of the new old economy. I am not concerned in the near term that electric vehicles will have mass adoption. I am puzzled how the electrical grid will power all these new super cars? Coal which is the worst emitter of GHG's is the primary source of electrical generation in North America and that is being phased out for natural gas as you know. The environmental movement is flawed with hypocrisy and makes no economic sense. In Canada the govt has chosen to demonize the oil and gas industry which funds the majority of our social services and yet we bail out Bombardier and the auto industry. I sound like a grumpy old man.

Thanks for this topical comment to a piece I posted on Friday. It’s been a long time since we shared an apartment in London; when we were both new to London, and I’m glad you’re still in the heat of the action in Calgary. I think everyone finds it hard not to be grumpy when things are not going one’s way at any age. 

This article from the state.com from 2014 estimates that if every car in America was an electric vehicle it would represent only about a 30% increase in electricity demand because electric vehicles are more efficient. 

Mr. Burns, a long-time financial journalist and the creator of the “Couch Potato” investment portfolio, authored a column recently pointing out the dilemma faced by retirees who wished to finance their retirements without assuming any risk, or as he titled it, “How to cope with the great yield famine.”

The column, published about two weeks ago, pointed out that the last time anyone earned 6% on a six-month certificate of deposit (CD) was December 2000. The lowest yield on a six-month CD immediately after the dotcom market crash was 1.01% in June 2003. The highest yield on a six-month CD since June 2003 was 5.22% in July 2006. Today, according to Bankrate.com, the highest yield on a six-month CD nationwide is 1.10%, but the vast majority of banks offer less than 0.15%.

He then went on to figure out the retiree’s needs and how much capital was required to meet those needs risk-free. The monthly premium for Medicare Part B is $121.80, or $1,461.60 a year. To earn that much money from a 0.15% CD you would need to keep $974,400 on deposit. For most Americans that is a large sum, but it is not a problem since Social Security deducts the payment from your monthly check.

The official federal poverty level income for a family of two for 2016 is $15,930. To generate that income from a risk-free CD at 0.15% interest, you need to deposit $10,620,000. To finance a poverty-level retirement with a risk-free investment portfolio means you have to maintain $11,594,400 of your assets on deposit in those low-yielding CDs, which would place you among the top 1% of wealthy Americans. Think about that. If you don’t want to accept financial risk in your retirement, you must be in the top group of Americans in terms of wealth. The rich are poor! In order to keep our world spinning and boost its growth rate, there are no risk-free avenues available for ordinary Americans. Recognition of this condition, coupled with the stock market’s volatility, may be fuelling a portion of the anger we are seeing among the electorate today. This situation will also be an anchor on how fast our energy needs grow.

 

A lik to the full report is posted in the Subscriber's Area.

The impact on savers of the near zero and increasingly negative interest rates we are now presented with represents a major challenge for savers. A subscriber left this comment on a piece I posted Friday and I believe it is well worth repeating here:

“I find it very concerning that central bankers, like finance ministers, never discuss the distortions produced in the future savings markets by the NIRPs.

“Pension funds and insurance companies are suffering even more than banks, but no one is discussing this. It seems to me that in the medium term the dysfunction of markets under NIRP will continue to produce counterproductive effects on risk appetite, which will negate the aim to increase risk acceptance by investment in business assets (as opposed to just paper).”

One point I find extremely interesting is that the countries that always were low price buyers, trying to secure the cheapest Chinese product, have now been shut out due the price run-up in China and the VAT penalty creating a disincentive for exports.

I have been approached for help in securing product by companies in India and in similar markets, who in the past always sought the lowest price. These companies, faced with shutting down their plants, have offered US$28,000 – US$30,000/Mt, in advance, for lithium hydroxide.

Unfortunately, since they have no relationships, supply for these companies is hard to come by. What we considered the bottom of the market appears to prove that demand destruction is not a major concern. On the other hand, the Japanese have contracts at low prices for much of their 2016 volumes and seem to be in denial that they will have to pay much higher prices in 2017.
I see a return to a normalized global price range as a major theme for 2017. 

Any thoughts on how Tesla’s (under construction) giga-factory fits into global battery markets?

Yes, good question. The western press seems fixated on the Tesla giga-factory; however Tesla is really just one of many large battery projects worldwide. China has multiple projects, some of which, although smaller than Tesla’s planned operation, are already in production and will grow in phases.
I think what Tesla is doing is great, but it’s only part of the global story. 

Based on extensive meetings around the globe, are there critical events on the horizon that could shake things up?

As long as China continues a reasonable level of support for battery related initiatives and there is not a major global recession, I think lithium ion battery demand for non-consumer applications has reached a tipping-point, ensuring robust lithium demand for the next several years.

 

Until quite recently the market for lithium batteries was confined to the impressive growth rate for hand held devices. The increasing penetration of electric vehicles into the passenger transport sector represents an additional growth trajectory not least because major car manufacturers plan to have vehicles in the $30,000 bracket on the road within two years. A third strand for growth is represented by industrials and utilities seeking to smooth the pattern of supply and demand or to employ remote power generation facilities. 

A number of court injunctions have stopped Luiz Inacio Lula da Silva from taking a job in Rousseff’s cabinet, dashing hopes that the former president would use his political abilities to rebuild the government coalition and defuse the impeachment threat.

The decision to block Lula’s appointment “will deprive Rousseff’s government of a crucial power broker capable of rallying her base,” Neil Shearing, chief emerging market economist with Capital Economics, wrote in a note to clients. “Her term in office looks increasingly likely to be curtailed.”

The first injunction against Lula’s nomination was issued by a federal judge just one hour after his swearing-in ceremony on Thursday. It was later struck down by a higher-court judge but the legal battle is set to continue, with several others cases being considered all over the country, including in the Supreme Court.

Rousseff said her government respects the courts but that the judicial system “can’t be politicized.” She lambasted federal judge Sergio Moro’s decision to release phone recordings that critics say show she appointed Lula to shield him from a corruption probe.

According to Brazilian legislation, only the Supreme Court can probe, indict or imprison presidents and cabinet members.

 

With the kind of protections from prosecution enjoyed by the President and cabinet of Brazil there is no chance Rousseff will resign of her own accord. To do so would immediately result in her being indicted for her role in the Petrobras bribery scandal as well as a number of other payment schemes that have come to light since she became President. That means impeachment is the only route to a new government. 

Have you seen this :- World First: Graphene Battery Plant Gears up for 2016 Commercial Production Spanish company Graphenano has introduced a graphene polymer battery it says could allow electric vehicles to have a maximum range of up to 497 miles. The battery can also be charged in just a few minutes, is not prone to explosions like lithium batteries, and can charge faster than a standard lithium ion battery by a factor of 33. The batteries are expected to be manufactured in Yecla, Spain and will have an energy density of 1,000 Wh/kg. For perspective, conventional lithium batteries have an average energy density of just 180 Wh/kg. To top it all off, the battery does not exhibit memory effect, a phenomenon in which charging a battery multiple times lowers its maximum charge

Thank you for this snippet and no I had not previously heard of Graphenano but it captured my attention because it sounds almost too good to be true. 

The issue stems from the fact that Linn is taxed as a master limited partnership, or MLP, rather than a corporation, a popular arrangement among energy companies when oil prices were soaring.
In good times, that status allowed income to flow straight through to investors without the Internal Revenue Service taking a cut at the corporate level. Linn distributed some billions of dollars of cash to investors as U.S. energy production boomed.

But the collapse in oil and gas prices has exposed the structure’s double-sided risk: Investors with potentially worthless shares—or units, as they are known—may nonetheless owe taxes on debt that is forgiven in a bankruptcy or an out-of-court restructuring.

That is because MLPs pay no corporate taxes and instead pass certain tax burdens, along with a share of their income, to investors. Debt forgiven in a restructuring counts as noncash income, or “cancellation of debt income,” which creates a tax liability for investors without an associated cash distribution.

The roughly 60% plunge in oil prices since the summer of 2014 already has sent a number of energy companies into bankruptcy court, and more are expected to follow. Fitch Ratings expects the default rate for U.S. high-yield energy bonds to rise to 11% by the end of the year, compared with 1.5% for bonds outside the battered energy and metals-and-mining sectors.

A gusher of bankruptcies and debt restructurings could be especially painful for MLP investors, most of whom are individual investors. Big institutions like BlackRock Inc., as well as many endowments and foreign institutions, can’t legally own partnership units or don’t want to, given their complexity.

 

I’ve given talks and conducted The Chart Seminar all over the world but I was never asked about the tax implication of a decision to sell until I came to the USA. The tax code is complex, rates are high and sometimes tax savings can reside where you might not expect them such as in trusts. The details described above highlight some of the reasons why the MLP sector underperformed so acutely while oil prices were falling but with such a panic to get out, is the bad news already in the price?

But the biggest breakthrough is in the area of energy storage. “I think that’s one area where we have delivered big time,” Williams told the Guardian.

The battery storage systems developed with Arpa-E’s support are on the verge of transforming America’s electrical grid, a transformation that could unfold within the next five to 10 years, Williams said.

The most promising developments are in the realm of large-scale energy storage systems, which electricity companies need to put in place to bring more solar and wind power on to the grid.

She said projects funded by Arpa-E had the potential to transform utility-scale storage, and expand the use of micro-grids by the military and for disaster relief. Projects were also developing faster and more efficient super conductors, and relying on new materials beyond current lithium-ion batteries.

The companies incubated at Arpa-E have developed new designs for batteries, and new chemistries, which are rapidly bringing down the costs of energy storage, she said.
“Our battery teams have developed new approaches to grid-scale batteries and moved them out,” Williams said. Three companies now have batteries on the market, selling grid-scale and back-up batteries. Half a dozen other companies are developing new batteries, she added.

 

Battery technology is the missing link in the supply chain between generating electricity via wind and solar and meeting requirements for base load. Until the last decade investment in batteries was puny compared to what has gone into other sectors. However the high oil price environment created an incentive to develop more efficient ways of generating and storing energy. Some of that is now coming to fruition and it is likely to have a transformative effect on electricity costs and the potential for electric cars. 

To demonstrate how dramatically the outlook for petroleum demand growth has changed, we compared common year demand estimates from the 2004 and 2015 AEO forecasts and found the following data points: 2015 – 43.94 vs. 32.76 QBtus; 2020 – 46.97 vs. 33.16 QBtus; and for 2025 – 50.42 vs. 32.64 QBtus. These represent forecast differences between the 2004 and 2015 AEO forecasts of -25.4%, -29.4% and -35.3%, respectively. 

It is our belief that this dramatically altered long-term outlook for petroleum is at the heart of the Saudi Arabian oil strategy. High oil prices have hurt demand growth prospects while at the same time encouraging the development of high-cost, long-lived petroleum resources. These high oil prices have provided an umbrella for expensive alternative energy sources and, given the global embrace of climate change and anti-fossil fuel policies and mandates, made petroleum’s long-term outlook even less rosy. In the U.S. where producers could sell everything they produced, few gave any thought to the shifting demand outlook globally and the role that domestic production growth would play in altering that outlook. 

Recognizing that the outlook for petroleum demand is lower requires a mindset change for oil company CEOs; something we sense is just now beginning to sink in. While oil CEOs talk about lowered production growth forecasts as a result of low oil prices and the forced reductions in their capital spending plans, recognition that there are substantial low-cost oil reserves in the world held by countries desperate for income is beginning to resonate. Zero production growth in a declining demand business may not be the worst outcome for oil companies. Without production volume growth, maximizing profitability becomes even more important. Determining how to organize and manage a company in this new black-swan-world of shrinking oil demand will be the real challenge. 

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I have not previously seen historic figures for how expectations of demand growth have inflated over the last decade. We know that China’s booming steel industry encouraged new mines to open and existing iron-ore miners to increase supply. The exact same thing happened in the energy market and the problem now is that those demand growth forecasts have to be recast in the light of China’s moderating growth rate and the increasingly efficient use of energy on a global basis. 

"Brazilian stocks have already risen a lot these past days as investors reverted bets on the worsening of the economy," said Alvaro Bandeira, economist at Banco Modal. 

"The market clearly wants a better government, one that’s credible and stable, and able to change economic policies that have led the country into this recession."
Some market watchers warned the rally could be short-lived as the process to impeach the president drags on, potentially plunging Brazil deeper into chaos.

“The market is reacting like Brazil woke up today as a whole new country, but a corruption investigation is hard, long and full of surprises," said Adeodato Volpi Netto, head of capital markets at Eleven Financial Research. "There’s room for profit taking on stocks as short-term investors play to make money, not to discuss politics."

I had hoped Dilma Rousseff would lose the 2014 election but that was not to be the case and her success resulted in a loss of investor confidence that Brazil could deal effectively with its challenges. The collapse of oil prices highlighted how much of a piggy bank Petrobras had become for the ruling elite and pictures today of former, and well-loved, president  Lula da Silva being arrested highlight just how high up the payments may have gone. As the above segment suggests impeachment is not a simple process so we can expect this saga to persist a while longer unless of course she resigns which appears unlikely given the protections from prosecution afforded the president. 

Details of this trade are posted in the Subscriber's Area. 

That’s why Goldman Sachs calls lithium the “new gasoline”. It’s also why The Economist calls it “the world’s hottest commodity”, and talks about a “global scramble to secure supplies of lithium by the world’s largest battery producers, and by end-users such as carmakers.”

In fact, as the Economist notes, the price of 99%-pure lithium carbonate imported to China more than doubled in the two months to the end of December—putting it at a whopping $13,000 per ton.

But what you might not know is that this playing field is fast becoming a battlefield that has huge names such as Apple, Google and start-up Faraday Future throwing down for electric car market share and even reportedly gaming to see who can steal the best engineers.

Apple has now come out of the closet with plans for its own electric car by 2019, putting it on a direct collision course with Tesla. And Google, too, is pushing fast into this arena with its self-driving car project through its Alphabet holding company.

Then we have the Faraday Future start-up—backed by Chinese billionaire Jia Yueting–which has charged onto this scene with plans for a new $1-billion factory in Las Vegas, and is hoping to produce its first car next year already.

Ensuring the best engineers for all these rival projects opens up a second front line in the war. They’ve all been at each other’s recruitment throats for months, stealing each other’s prized staff.

And when the wave of megafactories starts pumping out batteries—with the first slated to come online as soon as next year–we could need up to 100,000 tons of new lithium carbonate by 2021. It’s an amount of lithium we just don’t have right now.

 

Describing lithium as the “new gasoline” is an interesting take on the projected demand for electric cars. Last week’s Bloomberg article proclaiming batteries would cause the next oil crisis would appear to be in the same vein. These estimates are based on the fact that large battery factories are going to come on line in the next 18 months and not just Tesla’s giga-factory in Nevada. With additional supply, prices can be expected to decline and demand should rise. Home batteries and home charging stations are likely to become much more visible and utilities are already installing industrial scale batteries to tackle intermittency of renewables and to become more efficient with fossil fuel use. 

As a hedge against a weakening currency, we think Chinese gold demand will continue to increase, and whilst we do not forecast a repeat of 2013, physical demand could grow in the order of 10% or 100 tonnes. Chinese demand has increased by 14% CAGR since 2005. In the recent bout of RMB weakness we have seen increased trading volumes on the Shanghai Gold exchange, suggesting a higher propensity to buy gold as a hedge against a depreciating currency. Chinese buying remains tactical with the most activity occurring on the dips. We note that since the strong rally in gold, we have seen activity drop off on the SGE.

Gold holds its own in a US recession
Although we are not as bearish on the US to suggest that the entire economy will lapse into a recession, there are certain manufacturing sectors that are in a recession. Assuming the worst case scenario where the US slips into a recession, dragging the global economy with it, the USD normally performs very well as investors search for safe havens and US investors repatriate funds onshore. Gold is normally inversely correlated to the USD, but under these conditions i.e. extreme risk aversion, gold also performs relatively well. We outline the performance of the USD in the past two global recessions.

 

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Gold rallied as negative yields made it attractive based on what is now a positive carry. That alerted people once more to its characteristics as an uncorrelated asset class which was ignored while prices trended lower. 

Have you' received any comments on developments with Cyanobacteria? The website of Joule Unlimited is intriguing. There is a short video which is worth watching. It is early days with this technology but I wonder if any of your subscribers have any realistic ideas about the potential

Thank you for this question which I suspect is of general interest to the Collective. If subscribers have any additional information we would be glad to see it.

You might remember Exxon Mobil invested about $600 billion in algae experiments in 2009 only to lose interest after a couple of years, as fears about peak oil faded. Using algae as the catalyst for producing biofuels was a popular idea almost a decade ago but the problem for companies like Joule is their process is only efficient when oil is above $50. That is just not low enough for widespread roll out in the current environment. 

For example, the surprise decision by Southwestern Energy (SWN-NYSE) to lay off 40% of its staff, or more than 1,100 employees, and shut down all its drilling rigs after having recently moved into a massive new headquarters building shocked the industry. Likewise, ConocoPhillips (COP-NYSE), after defending its dividend through the first year of this downturn even at the cost of laying off staff, finally caved and cut its quarterly dividend by two-thirds from 74-cents to 25-cents per share. ExxonMobil (XOM-NYSE), after reporting weak earnings results for its fourth quarter, followed up last Friday by announcing it had failed to replace its production last year for the first time in 22 years, announced a 25% cut in its 2016 capital spending plans and the suspension of its share repurchase program. These steps are designed to reduce the drain in the company’s cash balances. Another optimist, Pioneer Natural Resources (PXD-NYSE), after signaling late last year that it might actually increase its 2016 capital spending by 20%-30% as a result of the multiple attractive exploration opportunities it has in its Permian Basin acreage, announced a 10% capex cut this year, which means it will be forced to cut in half the number of drilling rigs it operates, going from 24 at year-end 2015 to 12 by mid-year 2016. The latest industry bombshell was Devon Energy’s (DVN-NYSE) announcement just last week that it was slashing its 2016 capital spending by 75% and laying off 1,000 employees, or about 20% of its staff. The shock from this announcement had barely been digested when Devon announced the sale of up to 69 million shares of stock and raising potentially $1.6 billion in cash to shore up its balance sheet. The cash infusion also helps the company by reducing the pressure to depend partially on selling assets to help fund capital spending. 

The sale of stock by Devon is another example of the continuing ability of energy companies to tap capital markets, something a growing number of observers believe is prolonging the needed spending reduction that will cause oil output to fall off materially and set the stage for a recovery in prices. According to Bloomberg, the energy industry has announced plans to raise $4.6 billion in new equity, accounting for nearly 30% of all new equity raised so far this year. The amount of equity being raised is almost evenly split among three deals – Pioneer Natural Resources, Hess Corporation (HES-NYSE) and Devon. Each of these deals was upsized from their original announcement reflecting high levels of demand from investors betting not only the individual companies surviving but that their share prices will soar when the oil price rises and energy industry fortunes improve. 

The $4.6 billion equity raise so far this year compares with the $7.8 billion raised by exploration and production companies during the first two months of 2015, the fastest pace in raising new equity in over a decade. An interesting question is whether the capital raised in early 2015 has been wasted? If we consider what has been happening to companies within the E&P and oilfield service sectors, the oil price collapse is finally ending the corporate and investor strategy of “pretend and extend.” That strategy means that company executives have been selling lenders and investors on the view that a turnaround is just around the corner, so if they will just give them a little more time (and money?) the companies will be fine. As this strategy evaporates, the battle lines are drawn between managements and their owners. A change in the past is that many of the owners of the companies are investors who specialize in distressed securities. As a result, the struggle over how to redo the capital structure of energy companies becomes more intense as debt-owners, who have legal claims against the assets of the company, fight to gain the most ownership and thus stand to benefit the most whenever the share price recovers. 

Many of these recapitalization struggles are being fought in the esoteric world of corporate bankruptcy law. The last great boom for the local bankruptcy industry occurred in the period of the 2008 financial crisis and the recession that followed. For energy, the greatest bankruptcy boom was the demise of the industry in the 1980s bust. A recent article about the state of the bankruptcy business, in response to the collapse in oil prices, was in The Houston Chronicle. The article included a graphic showing the number of Chapter 11 (the section of the bankruptcy law that provides for restructuring of financially distressed companies rather than liquidations of companies that is conducted under Chapter 8 of the code) filed in the Southern District and the State of Texas. In 2015, the number of bankruptcies filed in the Southern District approached close to those filed in 2008, the start of the financial crisis. The article cited a survey of 18 bankruptcy legal experts by The Texas Lawbook calling for a doubling of filings this year. 

The fallout from the low oil prices and the hefty cash outlays producers have been making to play the shale revolution and/or to continue to generate cash flows is showing up in the growing number of exploration and production companies filing for bankruptcy. The Houston energy practice of the law firm Haynes & Boone is tracking those filings for both E&P and oilfield service companies in the United States and Canada. As of the listings on their web site, as of early February, 48 E&P companies and 44 oilfield service companies have filed since the start of 2015. The total of secured and unsecured debt involved in these bankruptcy filings totals $25.1 billion, split $17.3 billion for E&P companies and $7.8 billion for oilfield service companies.

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This is the most comprehensive reporting of the measures taken by Texas energy companies to preserve capital I have seen. I chose to reproduce it because it should serve as a useful record for subscribers look as this transition unfolds. 

Our call for a final leg down in metals prices is based on weaker-than-expected oil prices and the potential depreciation of the Chinese renminbi. Metals currently are factoring in oil at $40 a barrel – not today’s prices of low $30s. Furthermore, a weaker Chinese currency is likely to drag down commodity currencies even further. But that is likely to be the end of this deflationary cycle.
Management teams may be able to take out more costs, but we are at the point where these cuts would be unsustainable, ultimately leading to lower output in the future.

Why is that? Because current spot prices are 40 to 50 per cent below so-called incentive prices, which are the prices required to earn a 12-15 per cent rate of return on a project. As a result, capital spending on new capacity has simply dried up, with industry capex down over 60 per cent versus the peak in 2012. Ore bodies are depleting assets and current capex levels are not sufficient to sustain current output for more than two to three years. In copper, for example, the world needs two new large-scale mines every year just to offset the reserve depletion.

While oil prices are low, current spot prices for metals are well below the marginal cost of most producers. As an extreme example, nearly two-thirds of the nickel industry is under water. That has placed mining company balance sheets under intense pressure. We estimate the net debt of the largest companies will approach an uncomfortable 3.5 times ebitda by the end of the year. This could force an industry tipping point and, indeed, supply curtailments have already started to gather momentum. In aggregate, around five per cent of the industry’s capacity is in the process of closing. We need at least ten per cent of the capacity to be shuttered to reach critical mass. Given the stresses in the industry, we think this will occur during 2016 and will stabilise prices. It may take a little longer for capital constraints to become apparent, but as they do, metal price deflation will quickly turn to inflation. 

 

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I was talking to a Scotland based nickel buyer in Heathrow a couple of weeks ago who testified to how difficult the business of buying scrap has been over the last few years. Prices have been falling in a jerky fashion, which complicated their hedging strategy making it largely ineffectual. They are now surviving on thin margins and really hope for a turn in the price environment soon to ensure survival. 

“It strikes me as a business that’s right up his alley,” said Jeff Matthews, an investor and author of Buffett-related books. “It’s a business that’s going to last for a long time,” he said. And the stock has “gotten crushed,” creating an opportunity to buy at an attractive price.

Oil drillers, gold miners and rig operators have sacrificed dividends to conserve cash amid tumbling prices in oversupplied commodity markets. When Kinder Morgan cut its dividend, it pledged not to issue any new shares through the end of 2018.

Shares Jump
Kinder Morgan jumped 7.5 percent to $16.79 at 6:50 p.m. in extended trading in New York. Berkshire’s portfolio is closely watched by investors for clues into how the billionaire chairman and his backup stock pickers are thinking. Newly disclosed holdings often send shares higher.

One of Buffett’s deputy investment managers, Todd Combs or Ted Weschler, could be responsible for the investment. Both have been building portfolios at Berkshire and tend to make smaller bets than their boss.

“Our guess is that it’s Todd or Ted,” said Tony Scherrer, director of research at Smead Capital Management, which oversees about $2.1 billion including Berkshire shares. “It’s not insignificant, but it doesn’t smell like a straight-up Buffett move to us.”

Energy Bets
Other closely watched investment managers added holdings in the energy industry during the fourth quarter. David Tepper’s Appaloosa Management bought shares of Kinder Morgan and Energy Transfer Partners LP, while Seth Klarman’s Baupost Group increased its positions in Antero Resources Corp., an oil and gas producer, and Cheniere Energy Inc

At the Daily Journal AGM in 2014 Charlie Munger mentioned that Berkshire was set to become the biggest utility in the country. The acrimonious dispute with solar companies in Nevada highlights its participation in that power market but that only gives a small window on the kinds of businesses Berkshire seems to buy. The short answer could be that they tend to buy companies whose products are used every day. That’s as true of Coca Cola as it is of railroads, electricity and now pipelines. 

Supply discipline is the only resort, but looks difficult to achieve 
Another 518k TEU of mega vessels will hit the water in 2016 (with 800k more in both 2017 and 2018), which will force Asia-Europe capacity to grow c.10% in 2016 (vs. est.2% demand growth). Liners’ supply discipline has also become increasingly difficult to achieve, given the widening cost gap. While the latest mergers (Coscon+CSCL; CMA CGM+NOL) should further consolidate market share, pricing competition typically intensifies post mergers, based on prior experiences. This is due to liners seeking to preserve market share while cargo owners seek to diversify their risks. Moreover, the existing alliances are set to break up post mergers, creating short-term instability for the industry. 

How deep and long will this downturn last? 
The sector has traded down to 1.0x P/B, vs. 2016E ROE of -19%, which still looks expensive. During the GFC, the sector troughed at 0.5x P/B vs. ROE of -20%. More importantly, investor interest has waned over the past several years as the sector’s oversupply was widely expected to persist. This explains why the sector’s P/B range has not only moved down but also contracted. We expect a prolonged downcycle; hence, value will only emerge when P/B is closer to the GFC trough of 0.5x.

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Bull markets begin when new sources of demand emerge amid an environment where supply is constrained. Likewise they peak when supply has caught up and overwhelms demand. We occasionally get periods of time when demand falls but then prices retreat enough to encourage consumers to participate again. As a result supply is a more important factor than demand when thinking about how a market is likely to evolve. Bearing that in mind it has often puzzled me why people tend to think about the Baltic Dry Index as being an indicator of demand rather than supply; since that kind of interpretation is contrary to how we tend to look at just about every other commodity related market. 

Talking of Oil and Gold, last week we showed a long-term graph of Oil in real adjusted terms, showing that the average real price since 1861 was $47. Following on from that, one ratio we occasionally look at is the ratio of various assets to the price of Gold. So today in the off we update the Oil/Gold ratio back to 1865 and find that the Gold price has just hit an all-time high at around 44 times the price of Oil. The previous high of 41 in 1892 has just been exceeded. For perspective, the ratio was at 6.6 in June 2008 and only 12 in May 2014. The long-term average is 15.5. While this says nothing about where the ratio is going in the short-term surely this looks a good trade to exploit over the longer-term for those who care about such things.

A big reason behind the rally in Gold this year has been a flight to quality and the fading expectations of further Fed tightening in the next twelve months. Yesterday Yellen stuck largely to the script in acknowledging market concerns emanating from tightening financial conditions, while at the same time refusing to fully close any doors still open to the Fed later this year. That said the overall tone was certainly of a dovish leaning. Much was made of the passage suggesting that ‘financial conditions in the US have recently become less supportive of growth, with declines in broad based measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar’. Yellen said that should these developments prove to be persistent then they ‘could weigh on the outlook for economic activity and the labour market’.

 

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When gold was used to buy oil the ratio between the two would have been a powerful indicator of sentiment towards the economy and relative value of savings over investment. That may no longer be the case in an era of fiat currencies but when the ratio hits new highs it tends to turn heads. 

"It makes a lot of sense to cover shorts after plunging to new 12-year lows," said Bob Yawger, director of the futures division at Mizuho Securities USA in New York. "We had one of the more reliable people in OPEC say that it was willing to cooperate in making cuts. I don’t believe anything will come of it but you have to pay attention."

And

“Prices are not appropriate, I won’t say for the majority only, but for all producers,” U.A.E.’s Al Mazrouei said in the Sky News Arabia interview in Arabic on Wednesday. “The people who have spent money and have this investment, it’s natural that they won’t make cuts alone unless there is complete cooperation from everybody in that area.”

Oil is cheap right now and many producers are uneconomic at these levels. The question then is only about when this supply will be taken out of the market not if that happens. The lower prices go, the greater the potential is for that to happen. Russia signalled in January that it was willing to discuss cutting supply and now several OPEC members are discussing it which is a confirmation they are not immune to the decline in prices. These prognostications are helping oil prices to steady but substantive action is probably needed to act as a catalyst for a more impressive rebound. A lot will depend on what Saudi Arabia is willing to do. 

Construction of the plant is nearly complete, and the next 18 months will be spent installing the reactor components, running tests, and loading the fuel before the reactors go critical in November 2017, said Zhang Zuoyi, director of the Institute of Nuclear and New Energy Technology, a division of Tsinghua University that has developed the technology over the last decade and a half, in an interview at the institute’s campus 30 miles south of Beijing. If it’s successful, Shandong plant would generate a total of 210 megawatts and will be followed by a 600-megawatt facility in Jiangxi province. Beyond that, China plans to sell these reactors internationally; in January, Chinese president Xi Jinping signed an agreement with King Salman bin Abdulaziz to construct a high-temperature gas-cooled reactor in Saudi Arabia.

“This technology is going to be on the world market within the next five years,” Zhang predicts. “We are developing these reactors to belong to the world.”

Pebble-bed reactors that use helium gas as the heat transfer medium and run at very high temperatures—up to 950 °C—have been in development for decades. The Chinese reactor is based on a design originally developed in Germany, and the German company SGL Group is supplying the billiard-ball-size graphite spheres that encase thousands of tiny “pebbles” of uranium fuel. Seven high-temperature gas-cooled reactors have been built, but only two units remain in operation, both relatively small: an experimental 10-megawatt pebble-bed reactor at the Tsinghua Institute campus, which reached full power in 2003, and a similar reactor in Japan.

Regardless of the cost, China needs to import fossil fuels. From a national security perspective that’s a problem. Despite the fact the pace of growth is moderating the requirement the country is going to have for energy means they have little choice but to fund any and every potential technology to supply their market. Nuclear is a big part of that and China is now the largest test bed for new reactor designs in the world. They will inevitably seek to capitalise on that investment and China is going to be a major competitor in the construction of nuclear reactors globally. 

Chief Executive Officer Elon Musk needed some good news for stockholders, who had been shedding shares amid fear that cheap gasoline and competing electric cars would undercut sales. While affirming that the Model 3 is on schedule, Musk also said that sales will be better than expected this year and that money- losing Tesla is “in striking distance” of positive cash flow.

“We’re really looking forward to the unveiling of the Model 3 at the end of next month,” Musk said during the fourth-quarter earnings call Wednesday. “I think it will be well received, and then getting into production and delivery at the end of next year.”

Musk said in a tweet last night that Tesla will take deposits of $1,000 for a Model 3 starting in showrooms on March 31 and online on April 1.~

Tesla is pinning its hopes of getting out of the red and into sustainable profitability on the Model 3, whose lower price will broaden its appeal to more buyers. The Model 3 will have a price tag of roughly $35,000 before incentives like the federal tax credits or state rebates, but Tesla will initially roll out a highly optioned version, as it did with its Model S sedan and Model X SUV.

 

At its current valuation, even after the two-month slide, Tesla cannot afford to get anything wrong. The announcement that it is within striking distance of positive cash flow is certainly welcome and the expectation that it will deliver more cars than forecast this year is also beneficial. The fact that the loss widening in the last quarter is a further indication that the company cannot simply rely on hype and popularity to drive performance. It needs results. 

One aspect of the presentation we found interesting as a sign of Saudi Arabia’s thinking about the long-term outlook for the oil business was a discussion of research efforts underway at the company’s newest research center located in Detroit. That facility was opened last November. Its focus is fuel technology and improved engines, but also strategic transport analysis. The latter effort involves scenario analysis of future transportation markets including ultimately issuing white papers on the topic.

With respect to their core technology focus, they are targeting passenger and commercial fuels and engine technologies. From descriptions of some of their research efforts, it seems they are focused on autonomous vehicle development, although that term was never used. Mr. Al-Tahini said that the over-arching research goal is to produce the most fuel-efficient vehicle with the lowest emissions.

Our take-away from that part of the presentation was that at some point in the past, Saudi Arabian officials began considering the forces at work reshaping the transportation business, a market dominated by crude oil. One broad trend impacting that market is demographics, but there is little Saudi Arabia can do to change the impact. Understanding these trends and their impact on the market is critical for long-term planning.

In recent years, the environmental movement has aggressively targeted the fossil fuel industry, which has resulted in a tightening of fuel-efficiency and carbon emission standards, the elimination of fuel subsidies in a growing number of countries around the world, and a strong push to urbanize the population and increase transportation alternatives. All of these forces will impact the growth of the transportation fuels market.
Given those forces, we have concluded that Saudi Arabia believes that oil demand may be closer to a peak than previously thought. This does not mean that the oil industry is going out of business anytime soon, but rather that its growth will slow in the future. Market share growth for Saudi Arabia will need to come from someone else’s share, which means increased price competition. It also means trying to slow the development of alternative energy sources. Knocking out future oil sands and deepwater oil output as well as marginally shrinking shale oil opportunities will all benefit Saudi Arabia’s long-term market potential. Any negative impact on the oil output of other significant producers such as Russia, Iran and Iraq, coupled with boosting demand would all help Saudi Arabia. Lastly, technological developments that enable Saudi Arabia to reduce the cost and extend the life of its oil fields would also help the kingdom’s future. While none of this is new to our thinking, Mr. Al-Tahini’s presentation provided confirmation of what we think is motivating Saudi Arabia’s actions.

 

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How Saudi Arabia views the market for its products matters. If they truly believe that the peak in demand growth has been reached that would help to explain the beggar thy neighbour approach that has been adopted over the last year. Major oil companies have responded by shelving expansion plans, Alberta put off its desire for more royalties from its producers and we can expect to hear a lot more about refracking in the unconventional supply sector. 

Exchange-traded funds that hold U.S. junk bonds slid to their lowest levels in almost seven years. BlackRock’s iShares iBoxx High Yield Corporate Bond exchange-traded fund and SPDR Barclays High Yield Bond ETF both fell to the lowest levels since 2009.

Financials and energy were the two investment-grade sectors that added the most risk in the U.S., Markit CDX North American Indexes show. In high yield, energy, communications and health care fared the worst.

Chesapeake Energy Corp., the U.S. natural gas driller that’s been cutting jobs and investor payouts to conserve dwindling cash flows, lost more than half it stock market value Monday after a report that it hired a restructuring law firm.

The company’s bonds led losses among high-yield debt on Monday. Chesapeake’s notes due March 2016 tumbled to a record to 74.5 cents, from 95 cents last week, while its bonds maturing in 2017 fell to an all-time low at 34 cents.

“Broad oil weakness has now turned into distressed energy cases, which investors view as possibilities of higher risk of restructuring or debt exchanges," Ben Emons, a money manager at Leader Capital Corporation. “Nothing has been announced of that matter but markets move quicker ahead of such possibility happening."

 

Regardless of the answer, when someone asks whether a default is imminent one has to conclude that the situation is troubling. This is as true of Chesapeake today as it was of Greece, Portugal et al a few years ago. 

Chesapeake’s 2017 6.25% Senior UnSecured bullet bond now yields 150% suggesting very few people think it will make its last coupon payment due in July.   

There are signs that the strength in household goods expenditure is losing steam, possibly reflecting the recent cooling of the housing market spearheaded by Sydney. That said, the more recent data on retail spending continues to be relatively resilient, underpinned by improving trading conditions, while a lower AUD has encouraged tourism spending. ABS retail turnover growth for November (0.4%) was slightly below October (0.6%) to be 4.1% y/y, around the trend seen since late 2014. Meanwhile, NAB’s Online Retail Sales Index for November showed a 0.7% m/m rise in online spending. Despite soft wages growth, we expect a modest pick-up in consumer spending growth through to 2016, driven by a gradual reduction in households’ saving ratio and strong employment growth.

The Sydney housing market has clearly cooled, having recorded two consecutive months of price declines, while momentum in the Melbourne market has also slowed -but not as much as Sydney. Other capital cities experienced mixed outcomes in December. Recent property market outcomes are consistent with our view that prices growth will increasingly come under pressure as credit restrictions on investor lending bite, in combination with subdued incomes and slowing population growth/rising supply. We have maintained our previous forecast for much slower house price growth in 2016 (2%), although risks to the downside have escalated even more, especially in the apartment market.

Signs of stronger non-mining investment remain hard to find in the official data (especially the expectations data), while inevitable declines in mining capex continue – and could well become more pronounced given further falls in commodity prices. Despite significant signs of improvement in the business landscape, the NAB Business Survey reports that firms are still apparently gun-shy on investment. A fall in capacity utilisation in the December Monthly business survey has probably not helped, nor would recent financial market uncertainties. That said, we remain hopeful that AUD depreciation will eventually assist investment in trade exposed industries. Dwelling investment has been a little softer than expected in recent quarters, yet record high numbers of dwellings in the construction pipeline suggest the positive contribution to growth is likely to continue – although the cooling housing market will likely stem the flow of new projects.

 

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A firmer tone on energy markets represents a tailwind for Australia as LNG shipping capacity comes on line. In fact with the rationalisation of China’s steel industry Australia needs energy to play a significant role in exports to make up for the loss of revenue from coal and iron-ore. If we take that a step further it is reasonable to expect the Australian Dollar to be more heavily influenced by moves in the oil price than was previously the case. 

With oil prices dropping and E&P companies cutting their spending, the answer to our question of what is the sound of another shoe dropping is becoming clear. It is the sound of pink slips landing on employees’ desks. Living within one’s cash flow has taken on greater meaning for companies today. Unfortunately, the major operating costs are employees, especially when there isn’t much to do. Reducing costs to stay within cash flow means laying-off employees. Last Thursday afternoon, Houston and the oil patch were shocked by Southwestern Energy’s (SWN-NYSE) announcement that it was terminating 1,100 employees, or 44% of its labor force, as it deals with low oil and gas prices. The third largest natural gas producer indicated it had no drilling rigs operating and was reducing its capital spending plans for the year. 

The next day, leading oilfield service provider Schlumberger Ltd. (SLB-NYSE) announced plans to reduce its workforce by 10,000 in response to low commodity prices and low oilfield activity. Since the third quarter of 2014, Schlumberger has cut 34,000 employees, representing 26% of its workforce. The company also stated in its fourth quarter earnings release that it doesn’t see an increase in oilfield activity until 2017. This view is rapidly being embraced by the industry and shaping all staffing and capital spending decisions. 

Leading forecasting groups – the International Energy Agency, OPEC, IHS, Wood Mackenzie – are embracing the view that the current low oil prices will force the industry to further cut its activity during the first half of 2016 and that natural attrition in production will drop global oil supplies, despite the addition of possibly 300,000-500,000 barrels a day of oil exports from Iran this year. These groups also see demand continuing to grow, although uncertainty about the health of the Chinese economy is becoming a significant wildcard in the forecasts. On balance, these forecasters see the imbalance of global oil supply and demand, which has existed for the past two years, will return to a more balanced condition by the second half of 2016. A balanced market will allow bloated global petroleum inventories to start shrinking, which sets the stage for higher oil prices in the third and fourth quarters of 2016 and still higher prices in 2017. It will be the combination of continued oil demand growth, matched by a stable supply outlook and declining inventories, that drives an upturn in oilfield activity in the first half of 2017. The challenge for the energy industry will be getting back those employees receiving pink slips now.

A link to the full report is posted in the Subscriber's Area.

The same subscriber added the following anecdote: 

Interestingly enough, the massive layoffs of the 1980's have not YET repeated themselves in the Texas Panhandle, where vast numbers of conventional wells continue to pump. One specialist contractor in drilling supervision said (to my brother over the weekend) that he was still as busy as he could handle, and my nephew just hired on to a drilling company as a roustabout. Interesting anecdotal information - not perhaps strongly suggestive of anything in particular, of course.

We would be biased long gold into Chinese New Year but only up to around $1,140 We expect the current rally to fade after that the metal to post a new low for the current down-cycle in Q3, followed by a sluggish recovery into year end.

Silver remains a derivative of gold. Trading opportunities are tactical and technical, not fundamental. We recommend buying silver volatility when one-month implied dips below 23%. We would rather own puts than calls.

In the short-term we expect platinum to trade below $800 and potentially test the global financial crisis low of $744. The medium-term outlook is improving, however, and we think platinum’s long period of underperformance relative to both gold and palladium will begin to reverse during H2.

Relative to spot prices we are most bearish palladium. That’s counter to consensus and recent history. But the demand outlook has deteriorated, supply is inelastic, inventories are large, and investor conviction is shaky. Palladium is more likely to trade in the $300s than $600s this year

A link to the full report is posted in the Subscriber's Area.

This report is representative of a large number that have crossed our desks recently with the abiding message being that there are short-term risks but medium-term upside potential. In any other circumstances investors would pre-empt a medium-term bullish view by buying now and using further weakness as an opportunity to increase positions. One has to ask why this is not more evident within the commodity complex right now?

2016 will be 47th year of The Chart Seminar and it is still the longest running course on a behavioural approach to interpreting the market in the world. We will soon be announcing dates for when you can expect to attend both at a physical location and via webinar this year.

I was thinking about this earlier in the week and was ruminating on how we focused on p&f charts when we relied on chartbooks but on candlestick charts now that we have the online Chart Library. Both have their merits and candlesticks are certainly more expedient because you do not have to customise box sizes. However there is nothing quite like monitoring a persistent decline, or rally, on a p&f chart because the reversal when it comes is very clear. 

This article recently published by Bloomberg caught my eye.   Do you have any insight into the technology and its potential? 

I’ve been watching the Small Modular Reactors (SMR) sector for a number of years because it has the potential to drastically change the way the nuclear sector is perceived. With smaller designs and generation IV technology many of the issues associated with nuclear can be avoided. In additional the plan to build them in a factory in a process that can be repeated should help to control costs. 

“The likely increase of Iranian oil production could not have come at a more unfavorable point in time, with the oil market being oversupplied and renewed economic concerns,”

Giovanni Staunovo, an analyst at UBS Group AG in Zurich, said in a report. “It is not worth holding a direct exposure to crude oil at present, before more clarity sets in.”

Brent capped a third annual loss in 2015 as the Organization of Petroleum Exporting Countries effectively abandoned output limits. Iran, which was OPEC’s second-biggest producer before sanctions were intensified in 2012, is trying to regain its lost market share and doesn’t intend to pressure prices, officials from its petroleum ministry and national oil company said this month.

 

Iran has been stockpiling crude ahead of anticipated end of sanctions and this has been a factor in the swift decline of prices over the last month. If we put some numbers on that, it is now January 18th and Brent Crude has fallen 40% from peak to trough so far this year. That’s an accelerating downtrend by any definition one might choose to use. 

Iran’s newfound unrestricted ability to sell oil is a potential bonus for the oil services sector since it is going to have to spend billions on upgrading infrastructure atrophied by sanctions. However let’s not also forget that Iran has been selling oil to China for more than a decade and that aside from what it has in storage for sale, the country’s ability to rapidly increase supply is relatively low.  

We are convinced that the moment the oil market starts to shift the focus towards 2017 and stops worrying about brimming inventories in 2016; that is the moment the oil price starts to increase. We have seen time and time again that the change in the oil price happens before changes in the supply demand balance. It has to do with interpretations of the future more than current fundamentals. The oil market has become similar to the equity market where the players try to “see around the corner” in order to get a head start vs the rest of the market. Investors would want to be early movers in order not to “miss the train”. 

We believe that the moment for higher oil prices will be the moment the investors starts to rebuild their long positions and buy back the short positions they have put on during 2015.

And 

Other potential catalysts are already on the list (known, unknowns), like for example the write-downs of shale oil resources from shale oil producers which we believe will start to materialize by end February. There are also other factors to watch like potential unrest in Venezuela after the parliamentary elections, falling US oil production which will likely lead to crude oil stock draws from March and onwards, increased focus on lower production from non-OPEC as a result of spending cuts, etc, etc.

We believe that one of the key drivers for higher oil prices through the second quarter will be a strong gasoline market, similar to what happened in 2015. The NYMEX gasoline crack spread increased significantly from late February last year and this was one of the key drivers behind the increase in oil prices during the second quarter last year. WTI increased from about 44 USD/b in March to 61 USD/b in June. Brent increased even more and reached almost 70 USD/b in May before it started to drift lower again. It was demand for gasoline which was the key driver on the demand side for refined products in 2015 and we believe the gasoline market will be strong also in 2016. This is due to the fact that gasoline is a consumer product and not an industrial product like diesel.

 

A link to the full report is posted in the Subscriber's Area. 

Oil prices are accelerating lower and we know for a fact that they will not go to zero. The counter argument is that the definition of an instrument that is down 90% is one that was down 80% and halved. Nevertheless the pace of the decline is picking up suggesting shorts are being increased and holders are panicking. 

Some encouraging news from the advanced nuclear sector. I am pleased to see that Terrestrial Energy (disclosure: I own shares) has successfully raised the equivalent of USD 7m in equity. Albeit modest, it is an important step forward. The company is making steady progress in its task to finalize its Molten Salt Reactor design, while the next step is to work with Canadian authorities with the aim to license the technology. Commercialization in the first part of the 2020’ies is still some years ahead, but this technology should, as I hope and believe, prove to be an important tool to reduce carbon emissions in the future.

Thank you for this update and the MIT review articles which gives additional insights on the development of new nuclear. Perhaps the greatest challenge facing the nuclear industry is that despite the fact technology continues to improve quickly, regulatory change is moving at a glacial pace. With sufficient government backing there is credible scope for new nuclear to flourish but it is dependent on political will to make it happen.

The creator of the “lower for longer” scenario, BP plc’s (BP-NYSE) CEO Robert Dudley was interviewed at year-end by a reporter with the BBC during which he began to qualify his view. “A low point could be in the first quarter [of 2016].” Given developments in the global oil market during the first few days of 2016, this looks like a good call. Mr. Dudley went on to say, “But 2016’s third and fourth quarters could witness a more natural balance between supply and demand, after which stock levels could start to wear off.” If that proves to be the case, it implies that oil prices should begin rising during the second half of 2016. However, there remains the overhang of global oil inventories that continue to swell due to the global overproduction. According to the International Energy Agency’s (IEA) latest total (crude oil plus refined products) inventory figures for the OECD countries as of October 2015, there were 2,971 million barrels in storage. Crude oil inventory totaled 1,181 million barrels. As shown in Exhibit 14, the amount of crude oil in storage grew dramatically last year.

A different way of looking at the crude oil inventory situation is to measure it on the basis of days of inventory in storage. Exhibit 15 (next page) shows this data for 2012 through August 2015. While one might think that 30-31 days of forward inventory cover is not meaningful, if we compared the July data when 2015 was at 30 days and the prior three years that were at 27 days, those three additional days represent nearly 300 million extra barrels of oil. To eliminate that additional supply, global oil demand needs to increase by nearly one million barrels a day, or 1% growth in existing oil demand, which just happens to be the long-term average increase in global oil consumption experienced since the 1980s. While consistent with the oil market’s long-term growth rate, reducing the oversupply assumes that supply stops growing, which we know may not happen due to the return of Iranian production plus efforts of other producing countries to boost output to offset lower oil prices.

 

A link to the full report is posted in the Subscriber's Area. 

With deteriorating geopolitical considerations and no sign yet that supply has peaked, the futures market for Brent Crude is in contango right across the curve. For prices to rise a catalyst will be required. That may take the form of a major bankruptcy in the highly leveraged unconventional oil and gas sector or a marked deterioration on the geopolitical front. Both are possible and this is particularly poignant considering the fact that oil prices are accelerating lower and have already had a large decline. 

Following yesterday’s disappointing start to the year and against a background of heightened geopolitical tension, weakening performance in emerging markets and fears about a paucity of earnings growth I thought it would be an interesting time to look at the performance of what have traditionally been viewed as safe haven assets. 

The Nevada Public Utility Commission voted unanimously in favor of a new solar tariff structure on Tuesday that industry groups say will destroy the Nevada solar market, one of the fastest-growing markets in the country.

The decision increases the fixed service charge for net-metered solar customers, and gradually lowers compensation for net excess solar generation from the retail rate to the wholesale rate for electricity, over the next four years. The changes will take effect on January 1 and will apply retroactively to all net-metered solar customers.

The broad application of the policy sets a precedent for future net-metering and rate-design debates. To date, no other state considering net-metering reforms has proposed to implement changes on pre-existing customers that would take effect right away. Changes are typically grandfathered in over a decade or more.

 

Renewable energy and distributed generation are two of the greatest threats to established utilities in the sun-belt. If people can generate their own electricity at home, sell excess onto the grid at a favourable rate and only take from the base load provider when necessary, they are put in a highly advantageous position relative to the utility. On the other hand utilities are accustomed to a highly regulated market but not to competition. 

“A quick shot of cold air will lead to the first widespread ice and snow event of the season across the northeast into Tuesday night,” AccuWeather forecaster Kristina Pydynowski said.

“As quick as the fresh cold and winter storm arrives, milder air will return to close out 2015. However, seasonably colder air should usher back in for the start of the new year.”

Futures for January delivery, which expire Tuesday, rose to $2.266 per million British thermal units, the highest price since Nov. 27, before trading at $2.263 by 6:57 a.m. New York time. The more active February contract gained 1.5 percent to $2.29 per million Btu.

Temperatures will likely drop below normal levels across most of the U.S. from Jan. 3 through Jan. 7, according to the National Weather Service. Temperatures in New York are forecast to fall as low as 22 degrees Fahrenheit (minus 6 Celsius), 5 below average, on Jan. 12, AccuWeather’s website showed.

 

Natural gas had fallen to such low levels by the middle of the month that even a modest change in the balmy weather that has been in evidence across much of Eastern USA and Canada would result in a bounce. 

According to the report, while Hon Hai — known as Foxconn Technology Group (???) outside Taiwan — has proposed acquiring Sharp at a high premium, it also wants Sharp’s current management team, including president and chief executive officer Kozo Takahashi, to step down.
Hon Hai would send a team to Sharp to manage the firm, the report said.

Hon Hai also plans to take over the debt shouldered by Sharp to help the firm address its financial problems, the report said.

However, the report also said that Hon Hai has yet to talk with Sharp’s bank creditors.

The report said that Sharp was shouldering about ?760 billion in debt as of the end of September.
Hon Hai is not the only potential suitor seeking to buy Sharp, the report said, adding that the Innovation Network Corp of Japan (INCJ), which is sponsored by the Japanese government, is studying a buyout of Sharp.

The report said that the INCJ still needs some time to map out a concrete acquisition deal, and the proposal is unlikely to come out until next year, so Hon Hai is taking advantage of the vacuum created to make a deal.

 

Hon Hai Precision is best known for assembling Apple’s iPhone as well as being one of the world’s largest employers. As a fabless manufacturer it generally does not promote its own brands so the potential acquisition of a manufacturer with global brand recognition such as Sharp is an interesting development. 

Over the period between Christmas Eve and New Year a lot of people take some time off with the result there are fewer traders around to execute orders. Market liquidity tends to dry up. We occasionally see enterprising traders take this as an opportunity to pressure stops in an attempt to reverse short-term overbought or oversold conditions. 

With the exception of a small number of outliers the worst performing shares this year have been in the energy sector. This is particularly true of the S&P 500 where 11 of the 15 shares down more than 50% are energy related. Those are pretty scary declines and sentiment is about as bearish as I have seen with news flow compounding that view as one would expect. 

Mergers haven't taken off in the oil patch this year largely because potential targets have been banking on a rebound and potential buyers have been expecting further falls. The spike in yields for borrowers in the energy sector, along with the growing acceptance that oil and gas prices likely face another year on their back, should mean those opposing views finally converge in 2016, prompting some deals.

What's more, this chart suggests the advantage should lie with large, strategic buyers like the oil majors for two reasons.

First, one way potential targets have been shoring up balance sheets is to sell assets rather than the entire company.

But a thriving asset market requires buyers being able to raise capital at reasonable rates, be they other E&P companies or private equity firms looking to snap up bargains. Asset sales have slowed already this year, with just $29 billion worth in North America, compared with $107 billion in 2014, according to data compiled by Bloomberg.

Second, with the cost of capital rising and cash harder to come by, any deals struck will require at least the promise of synergies and will favor those buyers able to use their own stock as a credible acquisition currency. One reason Anadarko's approach to Apache met with such scorn was that it scattered rather than tightened the company's focus. The majors, diversified anyway, bring the benefit of bigger balance sheets, which both alleviate any credit pressures weighing on the target and provide a clearer path to developing a smaller E&P company's reserves. Paying with shares also means that selling shareholders get to participate to some degree in the eventual recovery in oil and gas prices.

 

Major oil companies have slashed exploration budgets with the result they have more capital to pick up promising assets as prices decline. Private Equity firms have amassed sizable war chests to invest in troubled energy companies but have so far been slow to make large purchases. Meanwhile sellers are hoping for a rebound so they can get a better price. With everyone appearing to bide their time a catalyst is required to encourage deal making. 

U.S. shale drillers will soon be able to sell their oil all over the world. Too bad no one needs it right now.

A congressional deal to lift the 1970s-era prohibition on shipping crude overseas has the potential to unleash a flood of oil from Texas and North Dakota shale fields into markets already flush with cheap supplies from the Persian Gulf, Russia and Africa.

The arrival of U.S. barrels in trading hubs from Rotterdam to Singapore will intensify competition for market share between oil-rich nations, publicly traded producers and trading houses, adding pressure to prices that have tumbled 67 percent in the past 18 months. In the longer term, it may also extend a lifeline to shale drillers strapped for cash after amassing huge debt loads during the boom years.

“The winners in all of this are the U.S. oil producers who now have a bigger market for their shale” output, said Gianna Bern, founder of Brookshire Advisory and Research Inc. in Chicago and a former BP Plc oil trader. “Unfortunately, it’s coming at a time when there’s already way too much crude on the global market.”

U.S. oil explorers from Exxon Mobil Corp. to Continental Resources Inc. have been agitating for an end to the export ban for most of this decade as technological advances in drilling and fracking opened up vast, untapped reserves of crude. The so- called shale revolution has lifted U.S. oil output for seven straight years, making the nation the world’s third-biggest producer behind Russia and Saudi Arabia. 

 

2016 is going to be an important year for US energy producers. One way to look at it is that they are going to be running slimmer operations since they had to cancel so much spending amid a collapse in prices. Another way to look at it is they will have the ability to export both crude oil and natural gas for the first time in decades and that will contribute to increasing fungibility between international contracts. 

Natural gas output is on course to reach a fifth straight annual record this year, even as prices decline, government data show. Production will rise 6.3 percent to 79.58 billion cubic feet a day as output from the Marcellus and Utica shale formations expands, according to the U.S. Energy Information Administration.

Gas inventories totaled 3.88 trillion cubic feet as of Dec. 4, 6.5 percent above the five-year average. Withdrawals from storage will be smaller than average as warm weather curtails demand, Dominick Chirichella, senior partner at the Energy Management Institute in New York, said in a note to clients.

“With mild temperatures still looming through the end of December (and possibly beyond) weekly withdrawals are likely to underperform versus history for several weeks to come,” Chirichella said.

 

Natural gas is a big beneficiary of the climate agreement announced over the weekend not least because coal power is likely to face increasingly stringent environment regulation on top of that already in place. Gas more than any other fuel source will replace coal not least because energy storage solutions are not yet ready to ensure solar and wind can meet base load requirements. 

When interest rates are low there is an incentive to issue debt over equity. The low interest rate environment also contributes to spreads tightening as yield hungry investors move further out the risk curve to capture the return they require. The unexpectedly long length of time that interest rates have been low has created a situation where business models were framed around the situation continuing and now that the Fed is set to change tack an adjustment is underway. 

“Post Lehman there was too much to do and now there is again,” Marks said Tuesday, referring to the financial crisis that followed the collapse of the investment bank in September 2008. “For the credit investor we have our first opportunities in several years. It’s been a long, long time."

After Lehman’s bankruptcy, Oaktree deployed billions of dollars in distressed debt, reaping a handy profit. Its Opportunities Fund VII, which did the bulk of the investing, has so far distributed $22 billion to clients on $13.5 billion of drawn capital, according to its recent third-quarter earnings statement.

Oaktree’s top executives, including Marks and co-Chairman Bruce Karsh, had bemoaned a dearth of distressed-investment opportunities since at least 2013, when the Standard & Poor’s 500 index was still in the middle of a four-year run-up. That changed in August, when investor concern that China’s economic growth was slowing quicker than expected sparked a selloff in stocks and high-yield bonds. Energy companies have been hit particularly hard as oil prices continue to slide.

“What you saw in the third quarter of this year could well be a harbinger of things to come in the next year or two,” Karsh said in October. “We’re in the later stages of this credit cycle. We saw the psychology beginning to really roll over and change and people starting to get fearful. We started to see a lot of cracks.”

 

Private equity firms have had little trouble raising capital for energy sector acquisitions not least because it represents one of the few sectors trading at depressed valuations. With a dearth of truly high yield opportunities, investors have little choice but to look at energy and this is exacerbated by the availability of liquidity in an ultra-low interest rate environment. 

Statoil is flooded w/ offers of assets for sale from rivals squeezed by drop in crude prices, CFO Hans Jakob Hegge says in interview in Paris.

Co. not biting yet because valuations still too high; there are “a lot of unrealistic price assumptions from the sellers”

Statoil is cutting capex, opex, but not planning large-scale asset sales

 

Statoil is not the only company cutting capex. However it is one of the first to throw some light on just how many companies are seeking to dispose of assets in order to reduce debt burdens, in realisation they are no longer in a position to develop them and/or because they are in financially unsound condition following the collapse in oil prices. 

The creation of a new energy ministry speaks of the increasing importance of Argentina’s burgeoning oil industry.

Aranguren, former CEO of Shell Argentina, will be in charge of attracting investment to the Vaca Muerta formation, the world’s second-largest shale gas deposit and fourth-largest shale oil reservoir. He’ll also head up attempts to unravel the current government’s system of utility bill subsidies that contributed to an estimated budget deficit of 7.2 percent of gross domestic product this year.

An outspoken critic of the current government who frequently sparred with some of its officials, Aranguren has already made clear his different outlook, saying he would prefer to import energy while prices are low rather than maintain subsidies on oil. His double role as mining minister suggests Macri’s government may be more proactive in developing that sector after years of stagnation.

 

Argentina is not Iran but they both share the ignominy of having been locked out of the international markets for a long time. Argentina is blessed with abundant natural resources and an educated workforce. A trend of improving standards of governance has been lacking for decades but, with expectations so low, the potential for a positive reaction from investors from even a modest uptick has to be the base case. 

A final batch of questions focused on how important major oil company dividends were to holding up their share prices? We believe it is an important consideration, but the question of dividends and the major oil companies may actually foreshadow a discussion of their future business models. If a company is stuck in a low-growth industry, which oil certainly is, then spending inordinate sums of money to lift the growth rate may not be worth it. For oil companies, the cost for finding and developing new oil production to boost a company’s output growth rate from 2% to 3% to say 5% to 6%, without the company having any control over the price it receives for the product, should raise questions about their long-term business strategy. Maybe it is better to develop a steady, albeit low, production growth profile while using the surplus cash flow to maintain, and potentially increase, the dividend to shareholders. That might be a way to sustain a company’s stock market valuation and secure stable shareholder support. This strategy implies that capital spending would always be at risk in low commodity price environments, but the strategy could lead to stable employment, which is critical for securing and sustaining the technical talent required in the petroleum business. This strategy, however, wouldn’t work for smaller E&P companies needing capital to grow as their ability to tap the capital markets likely requires that they demonstrate rapid production growth. As we are learning, that strategy can be deadly in a period of low commodity prices. So if major oil companies were to adopt slow-growth production goals while defending and increasing their dividends, their share prices might not decline.

A link to the full report is posted in the Subscriber's Area. 

Capital Expenditure budgets have evaporated as companies deal with the revised economics of oil and gas development. On the plus side they have already taken significant write downs so any production that comes online as a result of previous investment can be considered already funded. Companies like Exxon Mobil, at a rating of AAA, are considered better credits than many sovereigns and the removal of the burden of capital expenditure leaves them in a better position to sustain their businesses into the medium term.

SolarCity took the leasing model that SunEdison Inc. first developed for the solar industry by a graduate student named Jigar Shah. He founded the company and sold its first power purchase agreement with Whole Foods Market Inc. in 2003, according to his book, Creating Climate Wealth.
SolarCity adapted that model for residential consumers in 2008 and many more offered similar arrangements including Sunrun Inc., which developed the first one in September 2007, and Vivint Solar Inc. In August, SolarCity bought a developer in Mexico that was offering the first leases to businesses in that country and plans to expand it to homes there.

And now the idea is spreading to other industries trying to sell expensive capital equipment that reduce pollution and fossil fuel consumption. Cambrian Innovation, a startup out of Massachusetts Institute of Technology, has developed onsite wastewater treatment plants. While the high cost make them difficult to sell, when they combine all the benefits to a consumer like a brewery -- lower disposal fees, water use, energy use and carbon emissions -- they can finance leases and offer savings at no cost to the consumer.

“SunEdison developed the solar power-as-a-service that helped the industry take off,” Matthew Silver, chief executive officer of Boston-based Cambrian, said in an interview. “Now we’re offering clean water as a service that municipal utilities can or won’t do.”

 

With the COP21 conference beginning in Paris today, there are a large number of articles circulating on the advances already seen in the development of renewable sources of energy. Lease back agreements that have increased access to these solutions is certainly important, but I am curious how these will be structured when interest rates rise and the cost of funding such largesse rises. 

Renewable intermittency means industrial scale storage solutions need to get substantially cheaper and battery technology needs to improve. Progress has been made on both fronts but we are still a long way from replacing fossil fuels. 

Geopolitical risk just escalated dramatically - and the American public seems to still be mainly concerned about the lack of decorations on their Starbucks cups.

The Turks shot down a Russian SU-24 Fighter this morning. Think this will improve Russia-Turkish relations? 

The US-sponsored rebels in Northern Syria shot down a Russian Search and Rescue helicopter using a US-provided missile, murdered the crew as they parachuted to the ground, and kindly provided video of the shoot-down. 

Al-Qaeda (Nusra) kindly provided a video showing they are using US-provided TOW missiles. 

The US warned the oil tanker drivers that they were going to attack their trucks, 45 minutes before the attack. The US proudly stated they destroyed 156 trucks. The Russians claimed to have destroyed 1,000 (even if they only destroyed 500, it seems the US is being pretty hesitant to seriously harm ISIS). Why?

No one has yet identified the oil trading company that is helping ISIS - yet the authorities in Europe and the US must know who it is that is buying this much oil... it just can't be that hard to find out. 3 
This is dangerous and feels... like the West is playing a really scary game, while a lot of people die.

 

Thank you for this summary of some of the main news items making headlines in the unfolding story of how a considerable number of countries are supporting competing factions,  ethnic and religious groups within Syria. Quite apart from the USA and Russia’s activities within the region, Turkey, Iraq, Saudi Arabia, Iran as well as a host of different tribes all have a vested interest in how the political situation in Syria is eventually resolved. Despite the fact John Kerry was quoted only last week as saying a ceasefire could be only a few weeks away, that now has to be questioned. 

After years of efforts, China achieved breakthroughs in nuclear export this year with two mega-size contracts signed with Britain and Argentina, respectively. In October 2015, China General Nuclear Corporation (CGN) reached an agreement with state-owned EDF Energy to co-invest in a Hinkley Point C nuclear project in England with respective 33.5% and 66.5% stakes in a deal worth GBP18bn. It is also worth mentioning that China will be able to bring its own Generation III nuclear technology of Hualong One to a subsequent project Bradwell B.

In November 2015, China National Nuclear Corporation (CNNC) sealed a USD6bn deal with Argentina to build the country’s fourth nuclear plant. According to media reports, CNNC also reached a framework agreement with Argentina on a fifth plant, which will use Hualong One technology if the deal is finalized. 

China’s first nuclear project based on Hualong One, Fuqing 5, achieved FCD in May. Its construction and operation, together with the recognition of developed countries with advanced nuclear tech and experience such as Britain, will help open doors to more markets for Hualong One. However, all these projects will take at least seven to eight years to complete, which suggests limited near-term upside potential for nuclear equipment exports. 

 

A link to the full report is posted in the Subscriber's Area. 

The current low price of oil is a benefit to China. However the fact it has to import such large quantities of energy means building domestic capacity that does not depend on fossil fuel will remain a priority for the foreseeable future regardless of slowing infrastructure investment in other sectors. 

Such concerted investment in nuclear technology has also enhanced China’s ability to compete internationally in what is among the most complex technology fields. This is even more important for the future because so few countries are willing to commit the capital necessary to fund development of new nuclear. 

In addition to a still over supplied global liquids balance it is of course bearish that OPEC does not look set to change their output policy in the December 4 meeting. The change in Saudi policy was one of the key reasons why we held the most bearish view to oil prices in the surveys one year ago. We were early to identify 1986 as the relevant comparison since this downturn is a supply led downturn and not a demand led downturn. Hence it made no sense to us that Saudi would defend oil prices this time, since the kingdom always has seen the 1980-86 cut period as a mistake. We do not foresee a change in the Saudi tactics in the December 4 OPEC meeting since there are very visible signs that the policy is working, first and foremost through the large global CAPEX cuts hitting shale, deepwater and Canadian oil sands.

It is also important to emphasize that we are still in a situation where there will be no contributions to a potential OPEC production cut from other than Saudi/UAE/Kuwait. Iran, Iraq and Libya is of course totally out of the picture to contribute, and how can Venezuela, Nigeria and the other OPEC countries cut back output voluntarily when their domestic economies needs the exports revenues? Since there is no sanctions on any OPEC country that does not follow the potential new quota, how can Venezuela trust that Nigeria is cutting any output?? The risk would be that Venezuela cuts and it is too small to affect the price and then revenues are falling as the exports volume is reduced. OPEC behaviour is still a lot of game theory… To us this means that the only way we could see an OPEC cut in the December meeting would be that Russia contributes to cutting production. We do not see this as very likely, noting the statements from for example the Russian Deputy Energy Minister in October where he said that Russian oil wells are mostly located in harsh climate in Siberia which means the wells will not be easy to restart after having been shut down and there is no storage capacity for the crude Russia would otherwise have exported.

On October 21 OPEC and some non-OPEC countries held a meeting with technical experts to discuss the oil market but the meeting gathered no interest from non-OPEC countries to contribute to any production cuts. Venezuela has proposed to reapply a new price band for OPEC where production should be reduced when the price is below a 70 $/b threshold but has seen little traction so far on this idea. The response from the Saudi “pump-king” Al-Naimi was that “only the market can decide on prices, no one else”, so it does not look promising for Venezuela which will just have to tighten their belts.

For OPEC it just makes it even more difficult that Iran is set to return to the market in 2016. IAEA must verify that Iran has implemented the nuclear agreement before sanctions can be removed. Iran must reduce the number of centrifuges from 9.500 to 5.060, move installed non-operating centrifuges into storage, dilute stock pile of low-enriched uranium from 10.000 kg to 300 kg, remove the core Arak heavy water reactor and establish verification systems across the supply chain. Iran’s supreme leader has stated that the process at Arak will not begin until the IAEA completes its investigation on past nuclear weapons work and that report is not due until December 15. We have hence factored in that the sanctions are not removed until the second quarter of 2016 in our global supply/demand balance.

 

A link to the full report is posted in the Subscriber's Area. 

There are large number of moving parts in the global energy sector and the number of potential wild cards that could have a major influence on prices has increased. At this stage it is a philosophical question whether the low price environment has led to increased risk but there is no denying that wars on the periphery of some of the world’s biggest oil producing areas is a risk. The piece in the above report focusing on the palace politics of Saudi Arabia is also worth keeping an eye on because of the influence regime change could have on energy policy. 

Considering the weather patterns that will dominate the 2015-2016 winter, Ms. Garriss writes,” Strong El Niños normally bring warm, dry winters to the northern tier of states and Southern Canada. Meanwhile the Southern US has cool, wet winters. Large Icelandic eruptions typically bring warm winters to the Midwest, Northeast and Canada from the Great Lakes to the Atlantic Provinces. If history repeats itself, expect lower heating demands.” That is not good news for the domestic energy business, but certainly good news for homeowners. It may also be good news for underlying economic growth as the combination of lower heating bills and reduced gasoline pump prices may result in more money being spent on other products and services. 

During the past four weeks of the natural gas storage injection season, weekly volumes have averaged 100 billion cubic feet (Bcf). As of the week ending October 9, there was 3,733 Bcf of gas in storage, which puts current storage up at the top of the five-year average weekly storage volume peak. Forecasters have been anticipating that total gas storage will end the injection season somewhere close to, or possibly slightly in excess of 4,000 Bcf. If we do exceed 4,000 Bcf, it would mark the first time in history that the industry began the heating season with that much natural gas in storage. During 2009-2013, with the exception of 2012, the industry ended the injection seasons with slightly over 3,800 Bcf of gas in storage. In 2012, the industry was able to slightly exceed 3,900 Bcf of gas in storage. Last year, the industry began the heating season with only 3,571 Bcf of gas in storage, which was due to the injection season beginning with the second lowest storage volume since 1994 - only 822 Bcf.

A link to the full report is posted in the Subscriber's Area.

The record hurricane currently moving towards Mexico’s Pacific coast near Puerto Vallarta and the speed with which it formed may have been influenced by the strength of El Nino in warming the normally cool Pacific. It is going to dump a lot of rain on Mexico and is expected to move into the Caribbean and potentially strengthen again to become a tropical storm that hits parts of Texas.  

The lower price of crude -- it’s fallen by about half in the past 12 months -- coupled with the kingdom’s spending plans, will leave Saudi Arabia with a budget deficit exceeding 400 billion riyals this year, according to the International Monetary Fund. The aggregate deficit for 2015 to 2017 is likely to exceed $300 billion, according to a report by HSBC. The government has ordered a series of cost-cutting measures, including a freeze on new construction contracts and bans on buying new vehicles or furniture, two people with knowledge of the matter told Bloomberg earlier this month.

“We have already seen a pick-up in loan growth at some of the Saudi banks in Q2 as contractors borrow to fund their cash flows as a result of a slowdown in payments,” Aqib Mehboob, a senior analyst at Saudi Fransi Capital, said by phone from Riyadh Monday.

Still, Saudi Arabia’s public debt is among the world’s lowest, with a gross debt-to-GDP ratio of less than 2 percent in 2014. Real estate stocks have also outperformed the Tadawul All Share Index. The Tadawul All Share Real Estate Development Industries Index advanced 7.5 percent in 2015 through Sunday, compared with a 6.5 percent decline in the benchmark stock gauge.

Saudi Arabia, the world’s largest oil exporter, has led the Organization of Petroleum Exporting Countries in boosting production to defend market share, abandoning its previous role of cutting output to boost prices. The country is now storing record amounts of crude amid a decline in shipments. Exports dropped to 7 million barrels a day in August from 7.28 million in July, while commercial crude stockpiles rose to 326.6 million barrels, the highest since at least 2002, according to data posted on the website of the Riyadh-based Joint Organisations Data Initiative.

Approximately 140 billion riyals of construction contracts were awarded in Saudi Arabia in the first half, a 12.4 percent increase compared with the first six months of 2014, according to a report by Jeddah-based National Commercial Bank.

 

In addition to the relatively low price of oil, Saudi Arabia is fighting wars on a number of fronts. With Russia now joining the fray the cost of its Syria/Iraq rebel support is only going to get more expensive. That suggests it has more incentive than ever to pump to capacity. 

To think of Saudi Arabia as having to go to the market for money is a misrepresentation of just how much capital the kingdom has. Let’s think of the country more as a feudal kingdom than the democracies we are accustomed to. It is not beyond the realm of possibility that the various princes who have accumulated impressive wealth based on the largesse of the crown could be called upon to supply the state with arms, capital or soldiers in just the same way that dukes and earls would have done in feudal Europe. There is no possibility, at the current time, the state will not make good on its obligations. In fact it may end up spending more to insulate the country from such strife on its borders. 

“Everyone is fighting over the same drivers,” said Dan Pallme, director of the Intermodal Freight Transportation Institute at the University of Memphis. “Eventually, what has to happen is salary has to rise, and the only way motor carriers can do that is by increasing the costs to their customers.”

The long-haul trucking industry, which employs about 800,000 people today, needs an additional 48,000 drivers, according to the American Trucking Associations, a trade group. That is a tall order at a time when unemployment is falling. Many who might have considered trucking are opting for construction work, a job that doesn’t involve long stretches away from home and pays competitive wages.

 

There is little commonality in the performance of trucking shares as they grapple with attracting more workers while also being required to carry lower cost items and facing competition from railroads. It’s still a number of years away but haulage is a prime target for autonomous vehicle manufacturers and the incentive to come up with a workable solution is all the more compelling with wage hikes such as those detailed in the above article. 

Yet for now, Toyota is still highly reliant on gasoline- and diesel-powered cars. Last year, around 14% of Toyota’s global sales were hybrid vehicles, including plug-ins. Most of the remaining sales were vehicles powered by gasoline and some diesel, though a detailed breakdown wasn’t available.

Toyota has posted record profits in recent years, partly thanks to growing sales of profitable but gas-guzzling sport-utility vehicles and pickup trucks in the U.S., backed by lower fuel prices.

The vision to eliminate gasoline- and diesel-powered cars was a part of Toyota’s wider green car strategy unveiled Wednesday.

By 2020, Toyota aims to cut carbon-dioxide emissions from new vehicles by more than 22% compared with its 2010 global average. It ultimately hopes to take that to a 90% reduction by 2050, the auto maker said.

To do so, Toyota plans to sell roughly 7 million gas-electric hybrid vehicles world-wide over the next five years, it said. Toyota has sold around 8 million hybrids since it started selling them 18 years ago.

Toyota also plans to sell at least 30,000 fuel-cell vehicles a year world-wide by around 2020, it said.

 

The fallout from Volkswagen’s diesel emissions scandal means other manufacturers, that had not focused on a “clean diesel” marketing campaign, are capitalising on the story by promoting their own innovations.  Toyota has made some big bets on hybrid and fuel cell cars and the debacle of Volkswagen’s fraud enhances the potential that these decisions will succeed in enticing consumers to try a new solution over the medium term. 

SolarCity will begin producing the first modules in small quantities this month at its 100 MW pilot facility, but the majority of the new solar panels will ultimately be produced at SolarCity’s 1 GW facility in Buffalo, New York. SolarCity expects to be producing between 9,000 - 10,000 solar panels each day with similar efficiency when the Buffalo facility reaches full capacity.

SolarCity’s panel was measured with 22.04 percent module-level efficiency by Renewable Energy Test Center, a third-party certification testing provider for photovoltaic and renewable energy products. SolarCity’s new panel—created via a proprietary process that significantly reduces the manufacturing cost relative to other high-efficiency technologies—is the same size as standard efficiency solar panels, but produces 30-40 percent more power. SolarCity’s panel also performs better than other modules in high temperatures, which allows it to produce even more energy on an annual basis than other solar panels of comparable size.

SolarCity initially expects to install the new, record-setting solar panel on rooftops and carports for homes, businesses, schools and other organizations, but it will also be excellent for utility-scale solar fields and other large-scale, ground level installations.

 

The low price of oil and other energy commodities has taken a toll on the moveable feast of solar power breakeven calculations. The sector simply has to continually introduce more efficient products and there is good reason to expect it will. Solarcity’s announcement of a production-ready panel sporting 22% efficiency is great news provided the final announced price is competitive. In the lab efficiency rates of over 40% are achievable but it’s a big leap from a sterile environment to rooftops. This is the primary reason SolarCity’s announcement is important. 

DuPont shares surged Tuesday by the most in six years in anticipation that more value will be unlocked. The Wilmington, Delaware-based company said Kullman will be replaced later this month as both CEO and chairman on an interim basis by board member Edward Breen, who oversaw the dismantlement of Tyco International Plc.

Earlier on Monday, Trian Fund Management, the activist investor that argues DuPont would be worth more as two companies, announced it had added to its stake in the company.

In May, Trian co-founder Nelson Peltz led the firm in its proxy fight in a doomed attempt to get three board seats.

"It’s kind of bittersweet, because Trian is vindicated in some respects," said Hank Smith, who helps manage $6.5 billion as chief investment officer at Haverford Financial Services Inc.

in Radnor, Pennsylvania. "If DuPont had embraced Trian earlier on and welcomed Peltz on the board, Ellen Kullman would still be CEO."

 

Speciality chemicals is an amorphous terms used to describe businesses leveraged to everything from agriculture, energy, healthcare, home improvement and anything in between. The drawdown in commodity prices affected at least two of those segments and the difficulties experienced by Latin American countries has been an additional headwind particularly for DuPont. 

One of the original reports on the potential of unconventional gas was written by analysts at Citigroup and titled “Shale Gas: a gamechanger for the chemical sector”. The boom in unconventional oil and gas drilling was a major benefit for chemical companies supplying the “mud” that lubricated the drill bit and keeps the fractures open so oil and gas can flow. The reduction in drilling activity has been an additional headwind and contributed to the relative underperformance of chemical companies. 

The new Imperial Oil technology involves adding a solvent to improve the flow of oil to the surface as well as generators that burn less natural gas to supply the steam. What we understand about Imperial Oil’s new technology is that currently proposed oil sands projects could produce 55,000 to 75,000 barrels a day in oil output compared to their presently planned output of 30,000-40,000 barrels a day according to Mr. Krüger. As he was quoted during the presentation,

“This is bigger on a per phase basis than we’ve talked about in the past.” From Mr. Krüger’s viewpoint, this technology represents “a very large, long-term growth opportunity.” Even though the company seems satisfied with the new technology, it is not ready to move forward with some of these planned oil sands projects while management assesses their cost, possible changes to Alberta’s regulatory policies and the outlook for global oil prices.

Citi Research has prepared a chart showing its assessment of the impact of technological and economic cost reductions of various oil outputs between 2014 and 2015, based on assumed 2020 output contribution, due to the industry downturn. Most of the decline since 2014 is about $5 per barrel, although Gulf of Mexico costs may have declined by $7 a barrel and the shale formations by $10 a barrel. If Mr. Krüger’s assessment of the impact on output from Imperial Oil’s new technology is correct, then there would likely be a significant reduction in the cost of new oil sands output. According to the Citi Research chart, they estimate that oil sands currently cost between $80 and $100 a barrel. However, if the Imperial Oil claims are correct and can be implemented commercially, then a 30% output improvement might translate into $25-$30 per barrel cost reductions.

Obviously there are a number of assumptions that must be made in reaching this conclusion, including that the solvent-added SAGD process is not more costly than what is being done now and that additional output volumes require extensively larger facilities in order to handle them.
If you are Saudi Arabia and you have targeted new, large and long-term output sources such as oil sands and deep water oil in your price war, the prospect of their costs declining materially has to be unnerving. It has been our contention that Saudi Arabia’s target was these deposits, including Arctic output, and less about the domestic shale business. Why? The shale revolution is a “real-time” output, meaning that if producers are forced by economics to stop drilling, eventually oil prices will rise, drilling will resume, as will shale output, and the price cycle will start all over again.

 

A link to the full report is posted in the Subscriber's Area. 

Technological innovation continues apace and lower energy prices only increase the incentive to develop solutions in order to ensure survival. North America represents an exciting energy geography and the relatively low price of oil does not change that. On the other hand the continued development of new extraction methods may keep a lid on prices but will increase volumes. 

The overwhelming consensus view is that “deepwater is dead” or structurally impaired. We strongly disagree. The tried and true path to long-term success in energy investing is to “go where the oil is” and that is in deepwater where reserve additions have outpaced shallow water by 3.2x and onshore by 45% (1.3x excluding oil sands). Our field by field analysis suggests long-term (10 year) demand for 320 floating rigs (vs. 225 currently active and a total fleet – including expected newbuild deliveries - of about 385 today). The bad news is that near-term demand remains weak with a rig-by-rig analysis suggesting demand will bottom at 194 rigs in 2H ‘16. A similar analysis of the jackup market implies trough demand of 328 by YE ‘16 (vs. a fleet of about 570 rigs).

Reality bites: Industry to tackle structural supply issues
Rig attrition has begun to take hold with 43 floaters retired in the current cycle to date and an additional 28 floating units cold-stacked with most of those unlikely to return to the market. Although a significant increase relative to the last several years, these actions have only removed 14% of deepwater capacity (23% including stacked units) even as roughly 75 newbuilds remain on order so the fleet will still see net growth absent more aggressive action. The news is worse on the shallow water front, where only 52 units have been retired and 57 stacked (10% and 20% of the global fleet, respectively). With the oil price testing new lows again recently, backlog dwindling and hopes for a near-term demand recovery fading rapidly, the industry now seems more realistic about the need to take more decisive action on capacity reduction. We see scope for as many as 70 floaters and 110 additional jackups to exit the fleet over the next 12-18 months, although we believe the floater market will come into balance sooner given its better secular demand outlook, higher degree of consolidation and greater differentiation between newbuild and older units.

 

A link to the full report is posted in the Subscriber's Area.

The decline in oil prices continues to take a toll on the drilling and services sector with a large number of consistent downtrends in evidence. Inevitably this is putting the most strain on the most highly leveraged operations and rationalisation is a virtual certainty the longer prices remains close to current levels. 

Other than public debt and equity, the E&P industry has also been seeking other sources of capital. Drawing down bank credit lines has been one avenue, but lower oil prices will mean reduced asset values, especially as some of the assets will be redlined because they have been in the undeveloped category for too long so will be considered uneconomic. With the upcoming bank loan redeterminations, we expect to see increased E&P sector financial stress. In March, the last time loan redeterminations were conducted, oil averaged $71 per barrel. Now, the average is $57 a barrel; helped by the spring run-up in oil prices. By the fourth quarter, it is possible the average oil price will be in the $40s. A 40% haircut in the borrowing base will impact 2016 E&P spending.

The E&P industry has also lived off its earlier production hedges. As a result, some companies were being paid in the $90s a barrel for their output, but most of those high-priced hedges are running out. An analysis by investment banker Simmons & Company International and quoted by The Wall Street Journal, cited 36 U.S. oil producers with hedges covering 33% of their 2015 output at an average of $80 a barrel. Next year, those companies only have 18% of their output hedged, and at an average price of only $67 per barrel. Those high-valued hedges during the first half of this year was a reason why layoffs and G&A cuts were not severe, if at all. Management teams’ days of living in a world of unreality is rapidly coming to an end, and the pain will be severe.

Another source of capital for the energy business has been private equity - pools of capital that can be used to start new companies, buy companies on which to build much larger companies, and to provide capital for companies to grow. Data for the past three years (Exhibit 10) shows that private equity invested $43 billion in 2012, $36 billion in 2013, but only $11 billion in 2014. Private equity deals this year have been sparse as fund managers struggle to find attractive deals in an environment in which it is difficult to assess what companies are worth. That also explains why deal-making in 2014 was down sharply from the prior two years. 

As a result of the 2010-2014 period of high oil prices and expectations that these prices would only go higher in the future, private equity targeted the energy business due to its large capital needs. Virtually every major private equity firm raised one or more energy-focused funds. Those private equity firms who have ploughed the oil patch for years were easily able to raise large new funds off their successful track records. With billions of dollars sitting in these energy-focused private equity funds, finding and executing deals has become a high-pressure effort. 

Increasingly, private equity managers are recognizing that this potential avalanche of capital seeking energy deals is their biggest problem. It has, and is, leading to overvalued deals. As long as this money has to be put to work due to the mandates of the funds, the pain in the industry is likely to continue. The energy business truly needs to have the capital flow turned off, not merely turned down. Only then can the industry washout occur and the healing begin. 

A link to the full report is posted in the Subscriber's Area. 

The energy sector remains in a state of flux and the stress some of the more overleveraged companies are coming under has seen yields almost double in the last two years. BBB Energy 5-year yields are not at high absolute levels relative to history but the trend remains clear. 

Stepping back for a moment, on September 3rd, Tesla’s Founder Elon Musk reiterated his commitment to source materials from Nevada. However, that pledge did not necessarily mean another sourcing deal, announced so soon, or that it would be for lithium. Other materials besides lithium will be required. Cobalt and graphite, (among others), will also be needed to feed Tesla’s massive giga-factory in Nevada. I find this agreement to be highly noteworthy in the sense that Tesla’s growing need for lithium, perhaps more so than that for cobalt and graphite, represents the single most important raw material need. I imagine that other lithium agreements will be signed in coming months. Without question, Nevada wants further lithium deals to come from Nevada.

The fall in oil prices has had a knock-on effect on most energy related sectors as the relative economics of various alternatives have changed. Lithium miners have been no exception and this has been despite the fact lithium prices have not fallen. Demand for lithium-ion batteries in everything from consumer goods to cars and planes has helped fuel major investment and a large number of explorers are now listed. However securing an agreement to supply Tesla’s factory is a major coup for Pure Energy.

My hunch - but I may be wrong - is that electric cars are relatively easy to build... there is not much technology in an electric engine, no complexity; as for the batteries (which I understand are Panasonic's in the case of Tesla, which assembles them together in very large modules) I understand that the know how is not really in the hands of Tesla or any other producer (even Renault/Nissan stopped developing in house technology) and therefore someone else did the clever job. 

As a first mover Tesla has very competently built a good product, taking risk only where strictly necessary: luxury brand (low risk) with traditional, long bonnet, probably off the shelf design (low risk), an old chassis for the roadster, well tested batteries. Also, the complexity of electric power train - compared even with a small 1ltr engine - is little: there are fewer (almost none in fact) moving parts, no gear box. No way a new producer could enter the industry with its own internal combustion engines, but the electric car gives this opportunity.  A good demonstration of this is that Tesla's provisions for warranties are in line with those of a mature manufacturer with a well-tested line up of cars... probably Tesla know that there is so little in an electric car that can actually go wrong.

Traditional producers have held off from making a proper move into the sector not to cannibalize their current products and make all R&D and Capex in a probably obsolete technology completely worthless. After all they can catch up quickly: the difference between a Tesla, and a BMW or Nissan Leaf or 500e is purely the size of the battery, whose development risk is not theirs... On paper, a Leaf may have the range of a Tesla simply by doubling the size of the battery. In the meanwhile, no necessity of taking the risk of killing their current baroque business model, made of V12, V6, boxer, in line 4 or 3 or 2 cylinder hyper complex engines that you have to service all the time and last 300k when of exceptional quality.

Traditional car manufacturers will "tolerate" Tesla as far as it does not build a too strong brand (ludicrous speed is genius by the way: intrinsic of electric engine, easy to do, but presented as cool high tech stuff), then move in and with their economies of scale and less vertically integrated structure quickly catch up... it will be dear, but unavoidable as Tesla made clear it is possible to achieve a usable and fun product with no petrol engine.? VW making its move,? but I guess everyone if working on something. 

What I think could get ugly in this story - from the point of view of Tesla shareholders - is the excessive use of dodgy accounting (there are examples), the glorification of the CEO and its ideas (never good in a plc), just to get hold of capital for a venture that is extraordinarily risky and liable to competitive pressures from corporations much larger and much more sophisticated. How far will the individual Musk go to keep the business going? He is very successful, people love him, Tesla S has been voted best car ever. Difficult to give that up, right?

Did not look at the other businesses of his, with Space X he is against defence and/or state run companies... difficult.

Anyway, just a thought, I may be completely wrong...

 

Thank you for this detailed email and I agree that with valuations as they currently stand Tesla does not have a great deal of margin for error. The company has lost money in every quarter since 2013 but less than analysts estimated which has helped support the massive run-up in prices. 

It’s possible that if China’s coal consumption dramatically declines, India will be there to fill the hole. Macquarie estimates that by 2025, India’s energy demand will rise 71 percent, with coal taking the lead among oil, gas, hydro, nuclear and others. The south Asian country is already the second-largest importer of thermal coal, and it might very well surpass China in the coming years. Macquarie writes:

Although all energy use will rise [in India], coal is the major theme as consumption and local production are both set to almost double by 2025 on the back of large-scale coal power plant construction plans.

The group adds that, unlike China, India has no present interest in reigning in its use of coal. Most emerging markets, India included, recognize that coal is an extremely affordable and reliable source of energy, necessary to drive economic growth.

Even if these predictions don’t come to fruition, the consensus is that we haven’t yet seen peak coal use in Asia. Estimates vary depending on the agency, but everyone seems to agree that demand in the medium-term will rise before it retreats. A 2014 MIT study even suggests that Chinese coal consumption could rise more than 70 percent between 2012 and 2040.

 

North America and Europe engage in a great deal of navel gazing when it comes to climate change and yet US emissions have been falling because of natural gas boom and the EU has seen aggregate emissions decline not least because of its sluggish economic recovery. The main future contributors to carbon emissions are the up and coming developing economies. If governments are truly interested in tackling the issue, doing everything possible to help China and India migrate from coal is in everyone’s interest. This is no small task because above all else coal is cheaper now than it has been in a decade. 

In an attempt to improve manoeuvrability, the e-tron quattro is fitted with all-wheel steering similar to the system offered on Porsche's 911 GT3 RS, the rear wheels turning in the opposite direction to the front wheels at low speeds for a smaller turning circle and working in the same direction as the fronts at high speed for a sense of stability.

Audi has given its latest SUV concept a sleek and coupe-like sloping roofline and tapered glasshouse. At 4.88 m (16 ft) long and 1.93 m (6.3 ft) wide, the e-tron isn't a small car, but it looks far sharper than the bigger, more traditional Q7. With a drag coefficient of 0.25, it's also very aerodynamic for an SUV.

This is partially thanks to the sleek shape of the body and partly thanks to electronically-actuated aerodynamic elements in the bonnet, the side of the car and at the rear that activate at 80 km/h (50 mph). Just as it has done with the new A4, Audi has also worked hard on the underbody to cut down on drag. The e-tron has a fully enclosed floorpan.

 

Tesla was first to market with an attractive luxury electric car and continues to reap the benefits of being the best in class. However that success encourages competition and the company’s ability to be also the first to deliver an electric SUV will a major milestone. 

Brazilian companies that piled on $270 billion in international debt during the boom years are seeing their funding costs rise after the nation’s credit rating was cut to junk.
     
The spread for five-year credit-default swaps to protect against a government default, one benchmark for setting what Brazilian companies must pay for external funding, has jumped 7.5 percent to 400 basis points since the downgrade, the highest since 2009. Adding to the pain, the dollar surged to a 13-year high, making principal and interest on international borrowing more costly for local firms.

“Even very small, unknown companies issued international bonds when Brazil was considered one of the most promising economies after the 2008 financial crisis,” Salvatore Milanese, a partner at debt-restructuring adviser firm Pantalica Partners, said in an interview in Sao Paulo. “Now many of them are facing the consequences.”

Standard & Poor’s last week lowered Brazil’s sovereign credit rating one level to BB+ and said it might cut it further in response to the administration’s inability to shore up fiscal accounts as the economy falters. President Dilma Rousseff has failed to win support for her initiatives amid an investigation into corruption at the state-controlled oil company, some of which allegedly occurred while she was its chairwoman, sending her popularity to a record low and generating calls for her impeachment.

Dilma Rousseff rode to power on the coattails of President Lula’s endorsement but she was never the best candidate from a governance perspective and the currency has collapsed under her watch. An ability to ignore contradiction is characteristic of every crowd. It is not until the cohesion of the crowd deteriorates that these contradictions regain their importance for participants. 

The press has been touting the "sharp drop in rig counts" as evidence of an imminent slowdown in oil production, headlining off the drop of 18 rigs in the week ending 9/11. Now if we look at the facts, we are at 652 oil rigs versus 635 2 months ago. Last I checked, 652 is more than 635. Oil rigs dropped 10 in the past week. Gas rigs have been in a pretty clear, slow downtrend for most of this year.

Now of course a drop of 10 oil rigs in a week may sound like a lot to the untrained ear (which most journalists appear to have), but 10/662 = 1.51%, which is not exactly a blow-off-the-socks change. In fact, it is within the normal ebb and flow of wells being taken down to move to the next location, rigs offline for maintenance, etc.

I think the IEA's prediction of "slamming the brakes" on the production of shale oil (see http://www.ft.com/intl/cms/s/0/15e4dc9a-585e-11e5-9846-de406ccb37f2.html ) needs to be taken with a somewhat wait-and-see attitude. Low prices will ultimately bring down high-cost production, but economists' predictions about oil production costs just might have included too much sunk cost and not factored in enough efficiency gains in the oil patch. This just could further reinforce the notion that oil prices will stay lower for longer than most in the financial media expect.

Thank you for this informative email and chart contributed in the spirit of Empowerment Through Knowledge. Technological innovation is enhancing just about every area of our lives but its’ influence on the energy sector is particularly poignant. 

I have just read that China is apparently planning to launch its own oil benchmark in October, thus competing with the Brent & WTO oil future markets! (See attached)

Would it be possible for China to succeed?  … Should they really do, that could create unwanted volatility in these markets!

As usual, your view would be appreciated.

Thank you for this article which may be of interest to other subscribers. Major oil producing countries tend to have oil benchmarks. Brent crude for the North Sea and Nigeria, West Texas Intermediate for the USA, Dubai Select for the Middle East and Western Canada Select for Alberta. China’s plan to create a benchmark represents an effort to pay for more imports in its own currency rather than any serious threat to upsetting the global pricing mechanism for the commodity. 

The Bernstein report contained a chart showing LNG terminals in existence, under construction and planned globally as of late 2011. The chart actually understates the number of LNG export terminals in the United States.

One area of concentration is Australia where huge offshore gas reserves and gas from coal fields are feeding into new LNG export terminals that when all are completed will position the country as the world’s largest gas exporter, surpassing Qatar. Virtually all of this gas has been targeting Asian markets, but with the slowing economies there and now the resumption of nuclear power plants in Japan, that may be smaller than previously anticipated. A report from consultant EY shows projected global LNG demand beginning in 2012 through 2030. While the demand from Japan and Korea was projected to grow, it rose very slowly. The more dramatic growth was projected to come from other Asian countries including China. Since this forecast, China and Russia have agreed to a deal to ship Siberian natural gas into the Chinese pipeline system reducing the need for China to buy as much LNG as originally planned

Even with the projected demand growth, the EY report shows that the planned construction of LNG export terminals globally would exceed demand beginning as early as 2015 but certainly by the end of the forecast period in 2025. At that point, all the speculative liquefaction capacity as of 2011 would be surplus for meeting the world’s gas needs. 

A link to the full report is posted in the Subscriber's Area. 

Natural gas is becoming an increasingly globally fungible commodity just like crude oil. With a more efficient global market it is reasonable to expect arbitrages to narrow. This is a significant consideration when long voyages are planned to the destination market not least when such a huge amount of capital has been invested in building export capacity in the USA and Australia. For the USA at least the opening up of the expanded Panama Canal early next year is good news. For Australia relatively close proximity to its destination markets is a positive.

Onshore/Offshore Renminbi – Today’s announcement that the Chinese government is going to permit foreign central banks greater access to the Yuan market, so they can hold the Chinese currency as part of their reserves had a marked effect on the offshore renminbi. The ratio between the onshore and offshore versions of the currency compressed sharply and helps put a lid on fears that capital flight was fuelling the arbitrage. 

One of those investments was the 2009 purchase of Cyber Power Group Ltd. for $77.6 million, a company that makes polysilicon, the main raw material in solar cells. Yingli’s founder and Chief Executive Officer Miao Liansheng invested another $270 million to upgrade the plant. The project made more sense then, when the material sold for $400 a kilogram; today, it can be bought for less than $20, said Angelo Zino, an S&P Capital IQ analyst in New York.

Yingli spent aggressively on marketing as well, including sponsoring the World Cup. Its logo was prominent during matches in Brazil last year. “They spent on capacity, they spent quite a bit on marketing,” Sanganeria said. “They took everything to the extreme.”

Suntech and Q-Cells faced similar issues, borrowing to expand capacity and then finding themselves constrained by debt, said Raymond James’ Molchanov. Both struggled to cut manufacturing costs fast enough to keep up with the market. The challenge was exacerbated starting in 2011 when slowing demand in Europe led to a global oversupply of panels and falling prices.

The problem for solar cell manufacturers is that the primary bullish case for solar is that Moore’s law can now be applied because it is a technology rather than an extractive resource. This means companies relying on producing legacy products, when technology is advancing rapidly are being left behind and often with high debt loads. 

Northern Alberta’s oil-sands companies have been the single most affected region in the world since the global retreat on investment began last year, according to various analysts. All told, about 800,000 barrels a day of oil sands projects have been delayed or canceled, according to Wood Mackenzie Ltd., a research consultant.

After the last prolonged price downturn in 1986, no new major oil sands plants were started well into the next decade. The projects caught in midstream today may again be the last ones built for the foreseeable future, experts say.

“The economics have changed and there’s no promise things will come back to the way they were,” said Bob Schulz, a professor at the University of Calgary’s Haskayne School of Business. Once the current round of projects is finished, the planning boards are empty, he said.

It’s going to be hard for exploration and development companies to raise capital for increasingly supply over the next decade considering the extent to which oil prices have fallen without the catalyst of demand destruction. The wild card will be private equity interest which has been raising money for acquisitions. In the event this goes ahead, and there is no reason to suspect it won’t, it could delay the bottoming process for oil by prolonging the time required for higher cost suppliers to exit the market. 

“The market turned around on two pieces of news,” Phil Flynn, senior market analyst for Price Futures Group Inc. in Chicago, said by phone. "The EIA cut its U.S. output estimates and OPEC says its ready to talk to others about cutting output."

$40 represents an important psychological Rubicon for crude oil prices. Last week’s upside weekly key reversal and upside follow through this week suggest a low of at least near-term significant. A clear downward dynamic would now be required to question current scope for additional mean reversion. 

Hope isn’t a strategy – but what can you tell me about this chart?   It’s the Canadian energy index.  What signs should I be looking for?

This has been a very active week in just about all markets but the only emails from subscribers I received in the last two days were focused on the energy market. I chose to publish this one because it’s from a normally very calm person but the stress he is feeling is evident in the wording. 

Hi Eoin, I love my daily read of your great service.

What is your opinion on Royal Dutch Shell, I am under water by about 30% not counting dividends.

Thank you for this question which is sure to be of interest to other subscribers and I’m delighted you’re enjoying the service. The steep decline in a large number of sectors, particularly energy has left a lot of people in a similar dilemma. My first thought is that with a share yielding 7.71% today it would be rash to ignore the dividend even if the yield was lower when you purchased it. 

This analyst made a couple of other interesting observations. He said he questioned E&P management teams about their view of the level for oil prices that would generate returns similar to those earned when crude oil was at $90 a barrel and finding and development costs were much higher than today’s. In his view, the consensus was that $60-$70 a barrel is the “new $90 a barrel” oil given lower well costs and improved corporate efficiencies. He also said that producers acknowledged that returns were “skinny” with crude oil in the low $40s a barrel. We aren’t sure what “skinny” equates to, but we suspect not much profit, if any at all.

We were interested in his other observation, which dealt with how producers are coping with the current environment. He said that producers seemed to be reverting to the “1980’s playbook.” What does that mean? How about drilling within cash flow and attempting to hold production flat. What novel concepts! What someone who didn’t live through the ‘80’s and ‘90’s might not understand is that the playbook resulted from there not being cheap capital and private equity money available then. In fact, following the demise of Continental Illinois Bank in Chicago and Penn Square Bank in Oklahoma City, commercial banks almost outlawed energy lending in the 1980’s as it was considered too speculative, so there was virtually no new capital available. Today, we live in a world driven by easy money policies globally, meaning zero interest rates, which contributed to the high oil prices of 2009-2014 and the surge in capital flowing into private equity funds. A recent quote from economist and money manager Gary Shilling highlights this phenomenon and its damage to the energy industry. He said:

“The oil optimists noted that earlier high oil prices, aided by low financing costs, had pushed up production, especially among U.S. frackers. Low prices, they reasoned, would curb production, especially since fracked wells tend to be short-lived and the cost of drilling new ones exceeded the depressed prices. But a funny thing happened on the way to $80 oil: The rally stopped dead in its tracks at about $60 in May and June, then slid to the current $42, a new low. “Me? I'm sticking with my forecast of $10 to $20 a barrel.”      

 

A link to the full report is posted in the Subscriber's Area.

This Service is not bullish of oil prices over the medium-term and we have been vocally proclaiming how much of gamechanger shale oil and gas are for years. However $10 - $20 is an aggressive forecast even in an environment where major producers such as Saudi Arabia and Iran are competing for market share and prices are working on a ninth consecutive week to the downside. 

Today, Audi revealed that the 2018 production model will reach the 310-mile goal using a battery pack developed from high-performance cell modules from LG Chem and Samsung SDI. The companies will supply Audi from their European production plants.

"With our first battery-electric Audi-SUV, we are combining an emission-free drive system with driving pleasure," Hackenberg says. "We will optimally integrate the innovative cell modules developed with LG Chem and Samsung SDI into our vehicle architecture, thus achieving an attractive overall package of sportiness and range." 

 

Tesla has raised the stakes by developing new uses for batteries while simultaneously introducing innovations in manufacturing. Other companies are racing to catch up. Tesla in a many respects a battery company that also makes cars while companies like Volkswagen, and its subsidiary Audi, will need to generate cost efficiencies in the manufacturing process if they are to be competitive with the expected release of Tesla’s SUV. 

We are not convinced that the stock market needs higher commodity and oil prices in order to continue to rise. In our view, the shift in the direction of commodity prices since 2010 reflects a transfer of the benefits of higher commodity production from producers to consumers. That means basic industries and consumers should be the beneficiaries of falling commodity prices. Long-term, commodity prices should climb in response to increased consumption, which will drive up corporate earnings that are necessary to support higher share prices. A higher stock market can come without oil prices reaching new all-time highs, but they need to be higher than current levels for energy company earnings to rebound, that is unless substantial operating costs can be removed from the energy business. The energy business may get both, and investors will benefit from increased share prices. Unfortunately, this isn’t likely until sometime in 2016.

A link to the full report is posted in the Subscriber's Area. 

It strikes me as odd that anyone thinks you need a high oil price to support a bull market in equities outside the energy sector. The stock market does not need high oil prices to rally but it does need the perception that the future will be better than the past to justify progressively higher prices. Admittedly this is often associated with higher energy demand.

The concentration of revenues in the energy sector that occurred as a result of the high energy price environment is over. This has acted as an incentive for mergers. Consumers will be medium-term beneficiaries as energy savings accrue and spending power improves. But what about the short term?

Hello, that article on gold by Ambrose-Pritchard for The Daily Telegraph also refers to the $4.5 trillion in US dollars borrowed by emerging countries. With today's devaluation of the Yuan this Bloomberg article identifies the Chinese airline companies that got hammered because of the significant debt they hold in US$ terms. As the trend for rolling over US$ debt plays out in a couple of years perhaps we should trim some of our EM holdings ahead of the curve. If so, what to trim. It may be useful to know which EM sectors/companies hold significant US$ debt.

Thank you for the above article and this question which is sure to be of interest to subscribers. I would welcome some detailed research on emerging market issuers and their US Dollar exposure. Hopefully someone in the Collective has access to this information. 

At The Chart Seminar in Chicago last year a Peruvian delegate highlighted the risk of Dollar strength to the domestic market and the impact it was having on demand for consumer goods. He postulated that it was going to represent a problem for a number of Latin American issuers. This was a common sense point. 

Iran’s oil minister Bijan Namdar Zanganeh recently stated that Iran wants to pump almost 4 million b/d within seven months after sanctions are lifted and 4.7 million b/d as soon as possible after that. 

Zanganeh also stated that “such an increase may cause oil prices to fall, but that does not mean we won’t enter our oil into the market”. Other highly interesting statements from Zanganeh are the following: “Countries that sold more oil and took market share from sanctions-bound Iran will have to adjust as the country restores its output and exports to historical levels. Those who are responsible for protecting prices are those who have filled our share before and used it. Our only responsibility here is attaining our lost share of the market, not protecting prices.” 

We think that sanctions will be lifted by yearend and that Iran should be able to reach back to about 3.5 million b/d by 1H-2016 from the current level of 2.8 million b/d in output. These extra barrels should be going to exports, which should hence increase exports from today’s 1.3 million b/d to about 2 million b/d by next summer. In order to take the next step and reach back to 4 million b/d in production and 2.5 million b/d in exports we believe it will be necessary to invest heavily in the Iranian oil industry. Those investments will most likely be coming in our view.

 

A link to the full report is posted in the Subscriber's Area.

There has been a great deal of debate on the merits of the deal to remove sanctions on Iran in exchange for access to its nuclear program. However the most likely scenario is that the deal will be ratified and that Iran will ramp up oil exports. That policy will achieve a number of goals, not least recapture lost market share, discomfit its regional competitors and improve the country’s balance sheet. 

After reporting its lowest profit since 2009 and cutting in half its plans for buybacks this quarter, Exxon Mobil’s vice president of investor relations Jeffrey J. Woodbury told analysts on a conference call: ‘‘Fundamentally, we’re committed to our shareholders to continue to provide a reliable and growing dividend.”

Said Chevron Corp. chief financial officer Patricia E. Yarrington on her company’s earnings call: “We said we would cover the dividend from free cash flow in 2017. We stand by that commitment.”

Chevron is paying almost 5 percent of its share price in dividends, the most since 1992 and near the highest above 10- year Treasury yields in data going back to 1991. It’s one of 19 energy companies in the S&P 500 with dividend yields above 10- year notes, and in recent weeks it exceeded Verizon Communications Inc. as the highest yielding blue chip in the Dow Jones Industrial Average.

Can’t you almost taste the salt-water taffy, kids? Like others who have addressed the “are we there yet” question in recent months, Martin Adams at Wells Fargo offers a less-than-satisfying answer: not quite yet, kids.

 

The energy sector offers an interesting perspective on the motivations of investors in purchasing shares over the last number of years. Often the size of the buyback program has been a more alluring factor than the dividend. The low interest rate environment has played a role in this preference and helps to throw light on why the security of energy companies’ dividends are receiving less attention than the fact that they will be buying less of their shares. 

All that being said, it is somewhat surprising that the wholesale-related MLP stock prices are soft, despite decent margins and overall stable fuel demand and strong profitability.  For example, CrossAmerica Partners LP (linked with CST) is down 29% from last year's high, strong Global Partners LP is down 26%, and Sunoco LP is down 38%.

Granted, equity supply continues, as indicated by the initial public offerings of GPM Investments and Empire Petroleum Partners. However, these are relatively small equity offerings of $100 million apiece, not normally enough to kill the overall equity side, unless the demand for these equities has tapered off considerably. What might be wrong with this seemingly good picture for downstream MLPs? Let me offer some possibilities:

Oil prices. Should oil prices drop much further than now assumed by the marketplace, all downstream petroleum margins could suffer over time. Most vulnerable might be U.S. refiner margins, which are currently “to the moon,” because of the wide WTI-Brent crude-oil spread and the lunacy that U.S. producers cannot export their crude oil, yet U.S. refiners can export products at world-market prices--ah, heaven! Lower oil prices could impact margins in general as working capital requirements decline, and, more importantly, the 1% discount for prompt pay offered by branded refiners becomes worth less to middleman distributors. Perhaps Wall Street simply feels the “bloom is off the rose” for anything oil related for now.

Are purchase multiples too high? There has been spirited competition for M&A deals from MLPs, but equally from refiner-marketers such as Marathon/Speedway and Shell, as well as from many solid retail oriented players who want to use their strong cash flows and credit lines to expand, yet find organic growth too slow. Thus, there is a huge urge to merge by many players, as on Wall Street in general these days. MLPs have the absolute need to grow their dividends but, depending on their complicated structures, have quantifiable EBITDA multiple limits as to what they can pay and still have the acquisitions be accretive to earnings. And, as we all know, not all acquisitions work as planned, so the need can increase to acquire more to stay ahead of earnings. Many are fortunate because the interesting web of MLPs, general partners, sponsors, long-term financing vs. short-term financing, and lines of credit give them a smorgasbord of financing options while most interest rates are at historic lows. It’s a chief financial officer's best dream--or nightmare.

Interest rates. For whatever reason, unforeseen right now, might interest rates go higher than anticipated?

 

Selling pressure in the energy sector has been indiscriminate with major producers, service companies and pipelines deteriorating. A great deal of bad news is being priced in, not least since oil prices have so far failed to recover. An additional question on many minds will be whether Saudi Arabia will be more or less likely to continue to pump record volumes with the removal of sanctions on Iran. 

While there really was nothing unique in the observations they shared about the investment process or the desirable criteria, the scary fact was (is) the volume of private equity money seeking a home in the energy industry. According to Mr. Ryder, energy private equity investing as a percentage of total energy sector merger and acquisition activity had climbed from under 2% in 2000 to over 20% in 2014. During the first quarter of 2015, the energy private equity funds were investing at that slightly greater than 20% rate until the announcement of the $70 billion BG Group (BG-NYSE) and Royal Dutch Shell (RDS.A-NYSE) deal. We have not yet seen updated figures so we don’t know how the current state of the industry may have changed in the second quarter.

As the First Reserve article pointed out, the increased size of the investment pools forced the group to abandon its proven strategy of making smaller investments in smaller enterprises. First Reserve was forced to increase the size of its investments, meaning it needed to invest in larger deals. This investment shift is an economy of scale issue. To hold to its original investment philosophy, First Reserve would have had to make many more investments in each fund stretching the human resources of its investment team. It would have also potentially diluted the potential investment returns anticipated when putting the fund together, although given the performance of those funds a broader pool of investments might have provided them with better results. At the same time it was being forced to alter its investment strategy, First Reserve may also have been a victim of the “feeding frenzy” among energy private equity funds and non-energy new entrant private equity funds that could have inflated deal valuations. That feeding frenzy may have been the biggest problem if one believes that since the financial crisis in 2008-2009, the energy industry has been in a long-term downturn, just as happened during the 1980’s. We remain concerned about the magnitude of private equity money seeking investment opportunities in the energy business. We concluded our prior article on energy private equity funds with the following observations, which we still believe are correct.

“The uniformity of thinking among private equity players is a bit scary. Group-thought is usually not a successful strategy. The volume of public capital is not only surprising, but discouraging if one believes the industry needs to experience pain before a true recovery can begin. Lastly, in looking at the presenters and the audience, there were very few present that experienced the 1980’s forced re-structuring of the energy business following the bullish experience of the 1970’s. In our discussions that day, we encountered another old-timer who referenced the 1980’s downturn starting in 1982, three years before when most who look at the industry’s history think it began. We were there then, and this guy had it exactly right. This industry is headed for significant change.” In our view, the industry’s changes are just now beginning to emerge. 

 

A link to the full report is posted in the Subscriber's Area. 

The energy sector has gone through a decade long investment cycle predicated on developing previously uneconomic resources that were justifiable at a price structure above $40 and more often above $60. It is reasonable to expect that more than a little of that investment capital was used to bring resources into production with a considerably higher price point. As a result the natural progression for a sector going through a consolidation is rationalisation. 

Mexico waited 77 years to invite foreign oil producers back into its borders. That was one year too many.

The move to lure tens of billions of dollars from the likes of Exxon Mobil Corp. will be put to the test for the first time at an oilfield auction on Wednesday. With oil prices down by about half since last year, five of 38 potential bidders including Glencore Plc, Noble Energy Inc. and even Mexico’s state-owned oil producer have pulled out.

President Enrique Pena Nieto moved to end the state monopoly after poor drilling infrastructure and technology failed to reverse a decade-long production decline that reduced government revenue. To lure investments now, Mexico will probably get a much smaller share of profits than it would have a year ago.

“They shaped expectations at a $100-per-barrel market and we are way off that now,” Wilbur Matthews, chief executive officer of San Antonio-based Vaquero Global Investment, which oversees more than $100 million of assets including oil-producer bonds, said by phone July 10.

 

Favourable geology doesn’t just stop at the border between Texas and Mexico. Officials must have been looking on with envy as the shale boom took off in the US south west. Mexico’s state owned oil company dealt with declining output. Today’s news of Iran reaching an agreement to end sanctions and increase oil exports is another reason for Mexico to ramp production. The country will not get the same price they were hoping for from producing unconventional supplies and boosting offshore but it has little choice but to develop these reserves if the hole in its budget is to be repaired. 

I'm looking for your view again on the Canadian energy sector.  I obviously am aware of the effect technology has had on the shale boom etc...I do disagree with most assertions that there is a flood of supply in oil at these price levels.  Anyway, aside from that- how do we go into this massive global GDP growth phase and not require an abundance of resources of all kinds?  Technology has brought on supply but they require much higher prices to break even.  Help me reconcile how we have this huge growth backdrop and yet the market is pricing in disaster levels in Canada?  Is the energy sector forever dead or is this a tremendous buying opportunity?   Thanks as always. Hope you and your family are well.

Thank you for a question sure to be of interest to the Collective. My family are all in rude health thank you. The oil sector has a lot of moving parts so let’s try to pick it apart. 

Saudi Arabia is pumping oil like it is going out of fashion and in a sense it is. The evolution of solar in particular, but also other renewables, batteries, electric cars, hydrogen fuel cells and the migration of work onto the cloud mean that oil now has challengers both as a transport fuel and for heating. 

U.S. airline shares tumbled, erasing an earlier gain, after the initial Associated Press report on the inquiry. Citing a document, the AP said the department was investigating whether carriers were colluding to help prop up airfares.

The Bloomberg U.S. Airlines Index slid 4.7 percent, the biggest intraday drop since June 8, at 2:03 p.m. in New York. The gauge rose as much as 1.7 percent earlier.

Messages left with the four largest U.S. carriers -- American Airlines Group Inc., United Continental Holdings Inc., Delta Air Lines Inc. and Southwest Airlines Co. -- weren’t immediately returned.

Airlines have benefitted enormously from the fall in oil prices, the recovering economy and consolidation in the aftermath of the credit crisis. If you have booked a summer holiday in the last month you will have noticed that the price of airline tickets has not come down and differences in pricing between airlines is almost non-existent. Little wonder then that the Justice Department is asking why?

The significance of the oil sands on global oil supply cannot be ignored. Over the past five years, oil sands output has grown by 1.1 mmb/d, fully one-fifth of the total oil production growth for North America. The impact of lower oil prices on the oil sands cannot be missed. Early in 2014, Western Canada Select, a heavy oil price market, was selling at $86 a barrel. By the end of March, that marker was trading below $30 a barrel. This is when, according to oil industry consultant Rystad Energy, new oil sands projects require a price of $100 a barrel in order to breakeven. What’s been the impact of the price decline on the Canadian oil industry?

In February, Royal Dutch Shell (RDS.A-NYSE) withdrew its application to build a new 200,000 barrels per day (b/d) mine at Pierre River, north of Fort McMurray. In May, the company announced it would delay for several years a new 80,000 b/d in situ oil sands project at Carmon Creek near Peace River. The significance of these projects is highlighted when one realizes that Shell currently operates 225,000 b/d of oil sands production. Other projects are being delayed as companies plan to bring much smaller in situ projects into production at a delayed pace in order to manage their cash flow and capital investment requirements.

A June 16th report from Ernst & Young LLP projects a 30% decline in Canadian oil sands spending, bringing this year’s investment to $23 billion, down from an expected $33 billion. The result of this spending decline and the announcements by several producers to stop or delay new oil sands mines and in situ projects means total oil production will be 17% lower by 2030 compared to the target output in the 2014 forecast provided by the Canadian Association of Petroleum Producers (CAPP).

In addition to cutting new investment, oil sands producers are looking at ways to cut their operating costs to help improve their breakeven prices. Suncor Energy (SU-NYSE), a significant oil sands producer, has said it plans to replace 800 dump truck drivers with automated trucks at its oil sands mines. That move, which is a huge boost for autonomous vehicle technology, is projected to save the company C$200,000 per driver.

 

A link to the full report is posted in the Subscriber's Area.

Decisions to postpone or cancel spending on new projects has long-term consequences for oil supply growth forecasts not least when this situation is not limited to Alberta. Oil and gas companies are cutting expenditure wherever they can in order to remain profitable in what could be a persistently low price environment, at least relative to the levels that prevailed until a year ago. 

U.S. coal shares jumped after the Supreme Court struck down the Obama administration’s mercury and acid gases power plant rule, saying it hadn’t considered the billions of dollars in costs before issuing the rule.

Arch Coal Inc. jumped as much as 19 percent, Peabody Energy Corp. climbed 15 percent and Alpha Natural Resources Inc. was up 14 percent in intraday trading after the ruling was announced Monday.

The court’s decision calls into question an Environmental Protection Agency rule that targets mercury and acid gases. The rule has led to the closing of dozens of coal-fired power plants over the last two years.

 

It’s been a long time since coal caught a break and a great deal of bad news is already in the price. Coal is dirty, antiquarian, low tech and contributes to pollution but is cheap and abundant.  Over the last few years investors and regulators have concentrated on the former points and forgot the latter ones. Coal is the feed stock for a substantial portion of electricity production and today’s decision will mean that fewer power stations in the USA will need to be closed as a result of stringent regulations. 

Isolated solutions are often only implemented in a fragmented fashion from division to division. Innovation processes are still being driven forward laboriously using an outdated silo approach. Furthermore, many banks' command of the global “language of the internet” is still deficient. The banks will not achieve resounding success using such methods. Digital change requires far-reaching structural reforms that extend beyond all internal and external bank processes and systems.

The new market players from the non-bank sector, by contrast, have an almost perfect understanding of the language of the internet. First and foremost it is the scarcely regulated digital ecosystems, but there are also many fintechs that are using their platforms and ingenious “walled garden” strategies to dominate markets across a range of sectors. Their recipe for success is based on the harmonious interplay between implemented hardware and software. Via the optimum interlinking and utilisation of compatible and interoperable standards/technologies we – the platform-spoiled consumers – are courted with attractive products and services conveniently, globally and from a single source. 

Traditional banks could do this, too, however. This now provides the opportunity to swiftly learn and adopt the strengths and particularly the monetarisation strategies (walled gardens) of the successful digital ecosystems.

There are many benefits to be gained by banks that transform themselves into platform-based, digital banking ecosystems. Apart from easy access to numerous personalised products and services, including those of external providers, as well as a more secure IT environment, the customer can also make interactive contributions on the financial platform in a variety of useful networks. Furthermore, the banking ecosystem offers a flexible corporate architecture that will in future enable as-yet-unimagined technologies to be docked onto one's own infrastructure in a timely fashion and at an acceptable cost.

 

A link to the full report is posted in the Subscriber's Area.

Fintech (finance technology) is rapidly advancing as the evolution of the block chain, demand for enhanced online services and the economies of scale represented by services delivered online coalesce to drive the sector’s growth.  

The price of solar power will continue to fall, until it becomes the cheapest form of power in a rapidly expanding number of national markets. By 2026, utility-scale solar will be competitive for the majority of the world, according to BNEF. The lifetime cost of a photovoltaic solar-power plant will drop by almost half over the next 25 years, even as the prices of fossil fuels creep higher.

Solar power will eventually get so cheap that it will outcompete new fossil-fuel plants and even start to supplant some existing coal and gas plants, potentially stranding billions in fossil-fuel infrastructure. The industrial age was built on coal. The next 25 years will be the end of its dominance.  

2. Solar Billions Become Solar Trillions
With solar power so cheap, investments will surge. Expect $3.7 trillion in solar investments between now and 2040, according to BNEF. Solar alone will account for more than a third of new power capacity worldwide. Here's how that looks on a chart, with solar appropriately dressed in yellow and fossil fuels in pernicious gray:  

3. The Revolution Will Be Decentralized 
The biggest solar revolution will take place on rooftops. High electricity prices and cheap residential battery storage will make small-scale rooftop solar ever more attractive, driving a 17-fold increase in installations. By 2040, rooftop solar will be cheaper than electricity from the grid in every major economy, and almost 13 percent of electricity worldwide will be generated from small-scale solar systems.

 

The pace of technological innovation in solar is rapid and the argument that Moore’s law is applicable is gaining ground as the sector attached increasing research and development spending. The difficulties reported in getting the Ivanpah concentrated solar facility, in the Mojave Desert, up to peak performance is a setback suggesting the time required to deliver new technologies might be longer than some are currently envisaging. Here is a section from a Huffington Post piece dated November 17th: 

"During startup we have experienced ... equipment challenges, typical with any new technology, combined with irregular weather patterns," NRG spokesman Jeff Holland said in a statement. "We are confident that Ivanpah's long-term generation projections will meet expectations."

The technology used at Ivanpah is different than the familiar photovoltaic panels commonly used for rooftop solar installations. The plant's solar-thermal system — sometimes called concentrated-solar thermal — relies on nearly 350,000 computer-controlled mirrors at the site, each the size of a garage door. 

One trader told Reuters that by entering bids on screen that no seller is in a position meet, a bidder could artificially push up prices.

"The way you do that is by the timing and size of those parcels," the trader said.

As the market is not particularly liquid, bids and offers help inform pricing on the API 4 index, which is calculated using data gathered by Argus and IHS McCloskey.

Traders said that the concerns over artificially high bids pushing up coal prices on the API 4 index had cut the volumes traded.

API 4 trade volumes between January and May fell by almost a third from a year earlier, data published by the CME and ICE exchanges showed.

The index is the world's third largest behind the API 2 benchmark for northern European coal markets and globalCOAL's Newcastle benchmark index for thermal coal in the Asia-Pacific.

 

Coal has been a benighted sector as energy prices have declined and regulations tightened in an effort to reduce emissions. The possibility that HFT type trading practices have extended to the illiquid commodity markets is not a welcome development and suggests short-term volatility may increase. 

US Coal prices remain in an accelerating downtrend and a clear upward dynamic will be required to pressure shorts. The activism of the Environmental Protection Agency (EPA) and low cost of natural gas are at least partly responsible for the underperformance of US prices relative to global benchmarks.