- January 6, 2012
- Chart of the Week—Banning Iranian Oil Imports
It appears that the Iranian government is being offered a choice: give up its quest to build nuclear weapons or risk losing some of the country’s most important oil customers.
The New York Times reports that the European Union (EU) will agree to ban Iranian oil imports by the end of January. Iran is OPEC’s second-largest oil producer behind Saudi Arabia, according to the U.S. Energy Information Administration (EIA), and the third-largest crude oil exporter in the world. Iran is estimated to hold 137 billion barrels of proven oil reserves, nearly 10 percent of the world’s total.
Revenue from oil exports is a key pillar of Iran’s economy. The EIA says the country’s net oil export revenues totaled $73 billion in 2010 and accounted for 80 percent of the country’s total exports.
Europe is one of the main destinations for those imports. This visual from Reuters shows Italy, Spain, Greece and France were top-10 importers of crude oil during the second quarter of 2011.
The EIA says sanctions recently adopted by the EU have already decreased export volumes to Italy and the U.K.
Diplomatic relations between Iran and the West regarding the country’s determination to enrich uranium have been contentious for some time. However, the current rhetoric and new policies such as the banning of Iranian oil imports have upped the ante.
This intense political chess match is one development that could significantly drive oil prices higher in 2012.
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- January 5, 2012
- Burgers or Barrels—What’s Your Power Play?
In a recent blog post, the Wall Street Journal asked its MarketBeat readers if a share of McDonald’s stock or a barrel of oil made a better $100 investment. The share price of the fast-food restaurant topped $100 for the first time ever in late December and rose 30 percent over 2011, substantially beating the overall market. Crude oil prices had less sizzle, only moderately increasing over the year.
The three-year picture is a little different, with crude oil more than tripling since its bottom in late 2008. Over the same time, McDonald’s increased about 66 percent, says the Journal.
This is an interesting question because it pits a classic U.S. company that has expanded from one drive-in restaurant in 1940 to the world’s largest restaurant chain today against a commodity in limited supply but growing demand from emerging markets.
McDonald’s embodies many of the qualities we like in a company. During a challenging global environment during the third quarter of this year, the company reported higher revenues, operating income and earnings per share compared with the prior year. Global comparable sales grew a modest 5 percent, diluted earnings per share increased 6 percent in constant currencies, and $1.5 billion was returned to shareholders through share repurchases and dividends.
The company also boasts the fact that it has been able to increase its dividend since the program began in 1976. The latest quarterly dividend rose to $0.70 per share—nearly a 3 percent yield on an annualized basis at the January 4 closing price.
And even with 33,000 restaurants in 119 countries today, McDonald’s is expected to continue growing, especially in emerging markets such as China.
A survey of farmers in rural villages across China by CLSA Asia-Pacific Markets found half of rural families expect their meat and meat product consumption growth to outpace vegetables, dairy and fruit over the next 5-10 years. With its established footprint in the country, McDonald’s is positioned to feed these rising rural carnivores. According to a Bloomberg article last summer, the restaurant chain expects to open a store in China “every day in the next three to four years.”
However, I recently highlighted that China also has an insatiable appetite for oil. In addition, oil has been a victim of declining supply in major oil fields in the Persian Gulf. Oil prices were also affected by civil war and turmoil in the Middle East throughout 2011, and we don’t see this ending soon.
There’s also a developing demand story for oil. In its World Energy Outlook, the Paris-based International Energy Agency says crude oil consumption will be driven by developing countries over the next 20 years. These countries will account for 90 percent of the world’s population growth, 70 percent of the increase in economic output and 90 percent of global energy demand growth over the period from 2010 to 2035.Each power play has its strengths, but both, to a certain degree, depend on the growth of emerging markets.
So, how would you invest that $100 bill? Let me know at editor@usfunds.com.
Recent Oil Posts:
Case for Sustained $100 Oil
Things Get “Heavy” for Saudi ArabiaNone of U.S. Global Investors Funds held any of the securities mentioned in this article as of September 30, 2011. By clicking the links above, you will be directed to a third-party website. U.S. Global Investors does not endorse all information supplied by this website and is not responsible for its content.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
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- January 3, 2012
- Case for Sustained $100 Oil
In 2011, oil was one of the top performing commodities among those we track, with Brent rising more than 13 percent. Geopolitical risk and unexpected non-OPEC supply losses caused oil to rise significantly in early 2011. By October, we saw the black gold sink to a low of $96 per barrel before rising to its current level of nearly $108 a barrel.
Last year’s unrest demonstrated how major oil-producing regions can significantly affect oil prices. As I’ve previously stated, according to PIRA, the Middle East accounts for over 70 percent of OPEC oil production and, along with North Africa, more than 95 percent of the cartel’s capacity growth.
A disruption of the supply chain can also influence oil prices. One of the largest chokepoints along the global oil supply chain is the Strait of Hormuz, which roughly 90 percent of all Persian Gulf oil tankers—some 18 million barrels per day—pass through, according to Barclays. With Iran controlling the entire northern border of the strait, there is a significant chance for disruptions should the country fall into conflict or war.
The story will likely continue into the new year, as “sanctions against Iran, including a possible European Union oil embargo, and fear of an Israeli attack on Iran’s nuclear facilities led 2011 to close on a bullish note” for oil, said PIRA Energy Group in their new report today. Additionally, there’s new political uncertainty in Iraq that may keep oil elevated.
The chart below sums it up: With more than 40 percent of the world’s oil controlled under autocratic rule, oil supply in democratic nations likely depends on the state of autocratic nations.
Read The Many Factors Fueling a Return to $100 OilChina Rises to Top of Energy Pyramid
Another significant development in 2011 was that China surpassed the U.S. to become the world’s largest energy consumer. BP’s Statistical Review of World Energy report calculated that China’s energy consumption rate grew 11 percent over the previous year, with the country consuming 20 percent of global energy.
Read China is World’s Largest Energy Consumer
While coal accounts for a significant portion of China’s total energy use, the country’s need for oil should continue to rise. Its rising income levels, the government’s social housing plan, and an aggressive transportation effort to link 700 million people across more than 250 cities should continue drive this growth. Bank of America-Merrill Lynch agrees, suggesting that “China’s oil dependency will rise as U.S. imports fall.” In the chart below, it’s projected that China’s imports of crude oil and petroleum products will surpass the U.S. in 2014. BofA-ML thinks that on a volume basis, China oil imports “will grow quite rapidly on the back of rapid per capita income growth.”
China’s demand is what makes today’s oil situation different from the end of 2007. At that time, a lack of supply increased oil prices even though the U.S. was in a recession. What’s different is that “China is likely to re-accelerate” in 2012, according to Goldman Sachs.
China, along with other emerging markets, and the European Central Bank are in the early stages of a global easing cycle, primarily by cutting interest rates to spur growth. Also, the Federal Reserve should remain stimulative. These government actions set the stage for sustained, or perhaps higher, demand for oil. As stated earlier, geopolitical threats remain on the horizon, and could also be a positive catalyst for oil.
As always, our team will closely follow these events, as well as the monetary and fiscal policies, to find global investment opportunities in 2012.
We wish you and your family a very happy and prosperous new year!
John Derrick contributed to this commentary.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
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- December 22, 2011
- Chart of the Week - Struggling Copper Supply
As China’s appetite for commodities slowed this year, much of the world’s copper demand went with it. Despite this softening in demand, Macquarie Research thinks the red metal could see a rebound in 2012 because copper mines are struggling to supply the marketplace with adequate reserves.
Macquarie says, “Global copper mine output has continually disappointed forecasts and, more importantly, market needs over a number of years now, despite the strong financial incentive not only from high copper prices but also high by-product prices.”
Chile, the world’s largest copper-producing country, has had a series of struggles that has curtailed production gains. Macquarie says the country’s output has fallen by 730,000 tons over the last decade and a lack of new mining investment has been insufficient to offset fledgling production. Furthermore, a three-month strike at the world’s second-largest copper mine, Freeport MacMoRan’s Grasberg mine in Indonesia, has also limited copper production.
The first chart illustrates how correlated copper mine production has been with the operational cash flows of mining companies over the past 10 years. Escalating costs to develop and operate new mines are one of the main constraints to copper supply. HSBC estimates investing in new copper mines is 50 percent more expensive today than it was in 1985 due to higher energy costs, better wages and equipment shortages.
To reach untapped deposits, companies must finance new technologies and equipment to develop deeper mines with often lower ore deposits in sometimes politically unstable parts of the world, research firm Credit Agricole says. This is why copper supply has remained relatively flat despite companies’ willingness to spend near record amounts of money to find additional ore deposits.
Despite bullish sentiment heading into 2011, copper’s price has largely underperformed this year as China scaled back on large purchases. However, recent trade data suggests the world’s largest consumer of natural resources is restocking its depleted inventories.
Chinese copper imports totaled nearly 452,000 tons in November, the highest monthly total in nearly 20 months, according to data from Macquarie. By 2012, Bank of America-Merrill Lynch analysts suggest China will continue its copper shopping spree. BofA-ML is predicting a 6 percent year-over-year increase in Chinese copper imports next year.
Sluggish copper mine production and increasing demand from China should help boost copper’s price moving forward. BofA-ML says, “Supply problems will remain a constituent part of the copper market” before additional copper supplies become available in 2013.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
The following securities mentioned in the article were held by one or more of U.S. Global Investors Fund as of 09/3011: Freeport-McMoRan Copper & Gold Inc.
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- December 21, 2011
- Calculating the Impact of the Keystone Pipeline
Global markets have been tough in 2011 but I look forward to a strong 2012. To kick the year off, we’ve scheduled a special webcast with John Mauldin and our investment team to discuss our outlook for the coming year.
Make sure to register and add it to your calendar.
Mauldin is a wizard when it comes to markets and his annual outlook pieces are a perennial “must read” for global investors. His Thoughts from the Frontline e-newsletter is also distributed weekly to more than 1 million readers.
In this week’s edition, Mauldin shared his thoughts regarding the Keystone Pipeline that I thought you might find interesting. He begins with a short discussion from his book, Endgame, on the budget balance struggle that countries face when the private sector is deleveraging, and continues with a candid commentary on America’s dependence on energy and the impact of the proposed pipeline:
The desire of every country is to somehow grow its way out of the current mess. And indeed that is the time-honored way for a country to heal itself. But let’s look at yet another equation to show why that might not be possible this time. It is yet another case of people wanting to believe six impossible things before breakfast.
Let’s divide a country’s economy into three sections: private, government, and exports. If you play with the variables a little bit you find that you get the following equation. Keep in mind that this is an accounting identity, not a theory. If it is wrong, then five centuries of double-entry bookkeeping must also be wrong.
Domestic Private Sector Financial Balance + Governmental Fiscal Balance - the Current Account Balance (or Trade Deficit/Surplus) = 0
(By Domestic Private Sector Financial Balance we mean the net balance of businesses and consumers. Are they borrowing money or paying down debt? Government Fiscal Balance is the same: is the government borrowing or paying down debt? And the Current Account Balance is the trade deficit or surplus.)
The implications are simple. The three items have to add up to zero. That means you cannot have surpluses in both the private and government sectors and run a trade deficit. You have to have a trade surplus.
Thus the problem of Greece, with its massive trade deficit and huge fiscal deficit. They have no choices but default or depression.
The U.S. has two main sources of its trade deficit: energy and China, in roughly equal proportions. If we reduce our energy dependence, we can get the trade deficit below 2% of GDP.
The China problem is not simply one of reducing our trade deficit with China, as much of what China makes and sells to the U.S. is sourced in countries outside of China. While the final manufacture is perhaps in China, the bits and pieces come from other parts of Asia. The true cost of a product from China is less than 20% actual Chinese value added. An example is the Apple iPhone, which is assembled in China but whose most costly components come from elsewhere in Asia. Direct Chinese costs are less than 4%, but the entire amount is “attributed” to China in calculating the trade deficit.
The real problem is the demand in the U.S. for cheaper goods. If the U.S. were to pass a tariff on Chinese-manufactured goods, then production and buying would shift to other countries without the tariffs. Markets look for the lowest-price source. For a tariff to be truly effective, it would have to be on the product and not the source country. And the only way to do that is to start a trade war. That is typically not a good way to promote free markets and general prosperity. Think Smoot-Hawley in the 1930s.
On the other hand, the U.S. can do something about its energy dependence. We are blessed with abundant energy, if we simply exploit it in a responsible manner. And doing so would directly create hundreds of thousands of jobs, many of them quite high-paying, and many more hundreds of thousands of jobs servicing those employed and their companies.
Which brings us to the rather strange case of the Keystone XL Pipeline project. For non-U.S. readers, this is to be a 1,700-mile pipeline designed to connect Canada’s oil production in the province of Alberta with the U.S. Gulf Coast. The various government agencies of the current U.S. administration approved the project, after exhaustive environmental impact analyses. President Obama overruled his subordinates, postponing a decision until 2013, after the next election. Even though labor unions (normally thought of as Democratic and Obama allies) actively supported the project (as it means lots of jobs), various environmental lobbies were against it, and Obama apparently gave into them. (That is not just my opinion, but widely assumed, even by Democratic supporters.)
This issue has raised a few questions from international readers, wanting to know why so many people (the large majority of US voters, if polls are right) are seemingly willing to hurt the environment simply for the purpose of transporting oil. Wouldn’t a new pipeline create a whole new host of environmental dangers? What were we thinking?
As it turns out, a new pipeline is not all that radical. If you drive in the U.S., you cannot go ANYWHERE for any length to time without crossing dozens of pipelines that already exist, especially in the corridor where they want to build the Keystone XL pipeline.
Let’s look at two maps. The first is a map of natural gas pipelines in the U.S. To say it looks worse than your grandmother’s varicose veins is no exaggeration. It is hard to find a state that does not have a natural gas pipeline. Without them the U.S. would simply come to a grinding halt. (The source for this map is a governmental agency, the U.S. Energy Information Administration.)
The next map is just the major oil pipelines. If you were to add in all the small (8-inch or less) lines connecting minor oil fields, you could not distinguish between the lines in certain areas, as we will see in the third chart.
This next chart I throw in because it also shows the rather extensive pipeline system in Canada. This chart combines commodity pipelines of all kinds. The point is that we have the technology to build pipelines safely and in an environmentally reasonable way. When was the last time you heard of a serious pipeline disaster, or even a small one? Yes, the BP oil rig certainly comes to mind, but that was human error and not the fault of technology. Just as the large majority of airplane accidents are pilot error, you do everything you can to minimize the impact, and require safety procedures. But people screw up every now and then.
This is not to dismiss the problems and environmental concerns of drilling for petroleum products, or mining for various minerals. There needs to be strict controls on all such activities, with real penalties. You can see from the maps that my home state of Texas has a lot of pipelines and wells. The problems with pollution in the early development phase here in Texas were well-known. Now there is a very aggressive and popular regimen of control of drilling and transportation of oil and gas. We have to live next to the wells and pipelines. No one wants their water or land destroyed.
Now, let’s circle back to the Keystone Pipeline. We started this section with a reference to trade deficits. And this is Canadian oil, not U.S. oil. So it does not help our trade deficit directly, although a large portion of U.S. dollars that go to Canada come back to the U.S. Canada is far and away our largest trading partner and major energy supplier.
The problem is that the opposition is mainly of the “I don’t like any carbon-based energy” variety. Whether it is coal or oil or natural gas, it is not as “clean” as solar or wind.
The problem is that solar and wind simply cannot produce enough energy without huge government subsidies, at least with current technology (although that will change over time). In the meantime, if we want to balance our budget in the U.S. (and we must!), we are going to have to become energy independent as one part of the solution. In the short term (10-15-20 years), that means carbon-based energy. If we can produce our energy in the U.S., and we can, then why not create the jobs here rather than elsewhere, if jobs are our #1 political concern, as they seem to be, according to the polls? Further, in the short term, as Mexican production is falling rather fast, we are going to need that Canadian oil if prices are not going to rise.
(Note: in my book, I actually call for a slowly rising energy tax on gasoline usage, to be solely used for rebuilding our decaying infrastructure, so I am not against higher prices per se. I just want the reason for higher energy costs not to be shortages. But that’s another story for another day.)
In the “payroll tax cut” bill that will be passed in a few days here in the U.S., Congress will require the President to make a decision by the end of February on whether to allow the Keystone project. I hope they do pass it, and I hope he does decide to allow it.
But let’s not think that this one more pipeline is going to destroy the environment of the U.S. It might create competition for some U.S. producers, but if you can’t live with competition then you’re in the wrong country.
The U.S. is in a very deep hole. We need to stop digging and start figuring out a way to climb out. The world is sadly going to see what happens when Europe has to resolve its current crisis, one way or another, and what that will mean for world GDP growth. Then, I am afraid, Japan will be the next crisis in waiting.
The world can ill afford for the U.S. to be the third major economy to implode. The world is far too connected to shrug off such problems.
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All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The following securities mentioned in the article were held by one or more of U.S. Global Investors Fund as of September 30, 2011: Apple.
By clicking the links above, you will be directed to a third-party website. U.S. Global Investors does not endorse all information supplied by this website and is not responsible for its content.
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