Monday, March 16, 2009

4+1 Market Commentary

It has been a while since I last posted a 4+1 market commentary - a posting that is meant to tie together and make sense of the different postings on this site. Truth be told, it isn't because I didn't have stuff to write about. I can always come up with something to talk about (ask my wife).

Instead, I had a technology problem. At the end of the last 4+1 I mentioned that my next 4+1 post would be a video blog posting. That was the goal. But it was "all hat and no cattle." I didn't have my technology worked out, and trying to install the audio and video technology cause a devastating error on my computer. It was called a "kernel stack" error. Being a finance guy, I really don't know what a kernel stack is. Nor do I quite understand why kernels would need to be stacked. But I do know if your kernels are not stacked you won't be happy with the outcome.

I was minding my own business and stringing the USB cord one minute, and the next I was looking at the "blue screen of death" and contemplating the complete system restore. Wow, what a mess! I was out of commission for three days. If I could offer the readers of this site just one humble piece of advice, I would recommend you make sure all kernels are stacked appropriately at all times. The video post is coming...after I restack my kernels, and do whatever I need to do to make sure that what happened NEVER happens again.

Now...on to business. I will touch on 4 important market factors, as well as one thing that does not matter at all.

1) The Changing Face of OPEC
Russia is an observer, and Brazil was entreated to join but refused. Economies that rely on petrodollars as a significant economic driver are aligning together. OPEC becomes even more important in the future for these economies, because petrodollars lubricate the wheels of government. Petroeconomies are typically run by petro-dictators, and dictatorship (or autocracy) is easiest in a climate of economic plenty. The lower classes are happy with the government when there are petrodollars to go around - and they are more unsettled when they do not have jobs or when the economies have to cut back on building projects or social projects.

Compliance is a big thing, because OPEC saying it will cut and OPEC actually cutting production are really two different things. However, the most recent round of cuts has actually gone better (from a compliance standpoint) than I had expected. To put this in perspective, right now OPEC members are receiving about a quarter of the oil revenues that they received this summer, due to the falling price of crude and the production cuts that have been announced. When you think about it this way, it makes Oman and the UAE sound a bit like Las Vegas - having taken a massive cut in the revenue source that the economy was built upon.

OPEC's ability to constrain supply is bullish. Maybe not now - but when it begins to matter again.

2) Demand is Driving
Domestic gasoline demand is UP year over year. The mainstream media might want you hold yourself up in a tornado shelter because Armageddon is nigh...but it is not. Folks are driving more this year than they did last year. And we must remember that, due to EPA regulations, there have been no new refineries built in the US in 30 years. There is a supply/demand imbalance regarding domestic refining capacity - and that imbalance will show itself again this summer. Look for the crack spreads to widen, and potentially apply upward pressure to the crude complex, as the marketplace finds itself in the driving season.

Strong demand for finished products is bullish to the market.

3) The Least Worst Sovereign Currency
Democracy and Capitalism are the perfect parlay - I will bet on the resilience of both of them. When the government exercises restraint and does not attempt to meddle or socially engineer solutions, the independent American businessman solves problems. He/She allocates capital efficiently and grows his/her business. Growth in business means growth in economic value - and growth in economic value is the way we get out of the recessionary funk in which we currently find ourselves mired.

Other countries don't exactly work like that. Government tries, but one or one hundred bureaucrats cannot allocate capital as efficiently as businessmen like you and me. China is trying, of course. But this op-ed piece from the India Times eloquently states my point - when the world economy is stressed, look to America to lead the recovery - due to the resilience of the American businessperson.

Due to this resilience, the dollar index should maintain its strength against other currencies. A strong dollar makes crude and other commodities priced in dollars cheaper (because a dollar goes further when buying some). This is neutral to bearish for energy prices.

4) Oil on a Fulcrum
The incremental cost of production for the next barrel is somewhere above $60/bbl. So when the cash price is below $60, no new production cash flows. More importantly, plans get mothballed, exploration ships get dry docked, and crews get sent home. Major oil projects take years to plan and develop in good economies. But allowing all the assembled physical assets, inertia, and human capital to disburse back to their home bases mean that the supply will no be there when it is needed, and it will take years to bring these hydrocarbons to market. Therefore, the more time the market spends below the $60-$65 threshold, the more violent and pronounced the spike will be.

China knows. They are on a buying spree, grabbing commodity assets throughout eastern Asia and the Pacific rim. Billions are being spent so that China is secure and well positioned for further worldwide demand-based uncertainty.

Are we at peak oil? Personally, I don't think so. However, demand is increasing as economies modernize. And it takes a whole lot of infrastructure to slake the world's energy thirst. I my mind, the move to $147 can be repeated, and may just be an opening act for the volatility and price moves to come, as the new Asian middle class develops a liking for the hydrocarbon intensive goods and services (corn, cars, plastic stuff, etc.)

Crude oil being below the cost of production is bullish for energy prices.

+1) The one thing folks should be ignoring: Banks and Credit
The credit market is healing, and the Federal Reserve has demonstrated a willingness to print money to insure the solvency of the system. Markets are looking more positive in a number of ways. And each day that goes by gives the large financial institutions more time to de-leverage and heal themselves. Sure, there are pockets of the domestic market that will take a long time to heal (California, Phoenix, coastal Florida) but in a year, our market will be focusing on a new problem - it will most likely not be the credit markets.

Daily news headlines regarding banks and credit markets should not a reason for the energy markets to lose 10% or more in a day (like has happened in the last few months).
If you like or dislike this stuff - my analysis - feel free to leave an anonymous post comment.

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