The Daily Reckoning - The Quest For Oil

verfasst von Firmian, 28.08.2003, 10:32

-->The Quest For Oil

The Daily Reckoning

Paris, France

Wednesday, 27 August 2003

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*** No fear... the legacy of 9/11...

*** Plunge protection: good work if you can get it...
beware the 'stealth financials'... beware, too, the short
squeeze on Fannie Mae...

*** Housing's last hurrah... China sticking in the craw of
the heartland... Iraq and the quest for oil... and more...

---------------------

"The optimist," wrote the writer James Clabell in 1926,
"proclaims that we live in the best of all possible worlds;
and the pessimist fears this is true."

In our vain search for something profound to write about
the rising stock market this morning, we found only this:
fear is good.

Fear stops a child from sticking his hand in a strange
dog's mouth... or at least it ought to. Fear keeps a married
man from sleeping with a beautiful woman he meets on the
bus. Or, at least, it ought to...

Fear ought, too, to stop investors from buying overvalued
stocks during a grandiose 'secular' bear market.

It ought to. But it doesn't.

"Lack of fear is ill omen," confirms a headline from this
morning's Financial Times. Or, at least, lack of the right
kind of fear.

"Investors are [still] afraid of missing the boat," the FT
quotes Rich Bernstein, Merrill Lynch's chief investment
strategist."Portfolio managers are under such intense
pressure to perform minute-by-minute and fundamentals don't
change quickly enough to keep up. They need higher
frequency data and higher frequency data are called stock
prices. They follow technicals at the expense of
fundamentals."

"Despite our best efforts to explain to our clients what we
perceive to be a very, very high level of risk in the stock
market," explains a financial advisor from Denver,"we are
starting to meet with deaf ears."

Following technicals, traders tend to expect the market
will jump in the final hours of trading. Yesterday, the Dow
recovered from an 81-point deficit to finish 22 points in
positive territory. And the illusion of recovery continues.
(Strategic Investment's Dan Denning offers an entirely
different explanation for yesterday's late day boost in
today's market coverage, below.)

Portfolio managers may continue to ignore fundamentals...
but sooner or later, say your editors, they get what they
have coming. The New York Post's John Crudele predicts that
when 3rd quarter economic data is released, the economy is
going to look a whole lot worse than it does right now.

Why? Well, admittedly, for an entirely different reason
than the cranks who write the Daily Reckoning believe. We
actually think a job-less, profit-less recovery is a bad.
Crudele predicts the bad news will come as a result of a
wrinkle left in Government economic models due to the
effects of 9/11. Huh?

That's what we thought.

Crudele's theory is fairly intricate. We summarize: The
rapid downtick caused by 9/11 was statistically factored
into government economic predictions as"normal." Without
the same downtick in 2002, and goosed by zero-percent
financing of cars, the fall numbers of last year actually
exceeded expectations, and gave some credulity to last
year's round of"second-half recovery" shenanigans.

This year, however, just when higher interest rates and
skyrocketing energy prices will be slashing their way
through corporate balance sheets, the computer models will
be predicting an unusually strong second half. Which, of
course, won't be any truer than the excessively pessimistic
forecasts of the year before.

Okay... so what does it all mean? Well, more of the same, as
far as we can see."Interest rates should come down," says
Crudele,"but so will stock prices. Wall Street is once
again getting irrationally exuberant about the prospects
for corporate profits at a time when companies will be hurt
by the same things you and I are - the rise these past two
months in interest rates and the more recent jump in fuel
costs."

Gasoline prices jumped yesterday to their highest point
since the pre-Iraq run up in March. Natural gas is hovering
at a healthy $5.08 per BTU... oil is still a tough $31.
These are not helpful prices for those trying to stage the
recovery. (John Myers fills us on what to expect from the
quagmire in Iraq and the rising price of oil, in a guest
essay below... )

But first, Strategic Investment's Daniel Denning covers the
markets for us today. Dan?

-------------

Mr. Denning writing from the Paris HQ of the Daily
Reckoning...

- The mythical Plunge Protection Team is good work... if you
can get it. Lucky for them, we're in a bear market. There's
plenty of work. And they're pretty good at it.

- If you work for the PPT, you can reverse an entire day of
selling on the Dow by buying futures contracts on the big
indices during the last two trading hours of the day.
Suddenly, what looks like an 81-point loss for the Dow
becomes a modest 22-point gain - and within striking
distance of the 14-month high set last week. More on the
PPT below.

- GM and Ford - or the 'Stealth Financial' stocks, as your
vacationing New York editor calls them - did well for
themselves. GM was up 1.5% and Ford was up 3%. Mr. Fry
calls them 'Stealth Financials' because both stocks are
surprisingly sensitive to interest rates, due to either
excessive use of debt, or enormous exposure to the consumer
credit market.

- Yet Ford is up an astonishing 76% since March 11th. Since
May of 2002, Ford has been Wall Street's automotive
whipping boy. And even at yesterday's close over $11, it's
STILL down 36% from its May 2002 price of $18. But with a
debt to equity ratio of 20.96 (compared to an industry
average of 2.92), it's not exactly a buy - even with
yesterday's durable goods report, which revealed a 5.5%
rise in auto sales in July.

- Still, why worry about 'Stealth Financial' stocks when
there are so many more obvious stocks in
trouble... including Fannie Mae and Freddie Mac? But perhaps
these two have become TOO obvious to short profitably.

- Macro-data detective Greg Weldon reports that short
interest in Fannie Mae has nearly doubled from March to
August. Over 19 million shares - 2.3% of Fannie's float of
818 million shares - are sold short. With these kinds of
numbers, as things could get for Fannie Mae if rates keep
rising, you should also be wary of a short-squeeze - like
the kind that sent Fannie Mae up 5% on Monday.

- The key for the stealthy and the not-so-stealthy
financial stocks is interest rates. The ten-year Treasury
bond rose yesterday, driving rates down modestly to 4.47%.
The 30-year Treasury was also up. (The best way to directly
play any rise or fall in bond prices, in my Strategic
opinion, is through Lehman's 7-10 year Treasury index and
its 20-year Treasury index. In fact, I've recommended calls
on TLT to my readers in the last few weeks to play a
temporary rebound in what I think is an oversold bond
market.


- The rebound in bond prices will only be temporary though,
and that's because the dollar is still in trouble. Despite
gaining a little ground on the euro, the dollar can't shake
gold, which traded up to $361. COMEX traders are still net-
long gold. Either they are speculatively over-extended, or
they're waiting to hear the giant 'crackle' in the global
monetary system... the sound of trillions of dollars in
paper (debt and currency) going up in flames.

- Even the imperturbable IMF is concerned about the dollar.
Reuters reports that it obtained a draft of an IMF report
due next month, which states,"The IMF sees further
potential for a depreciation of the dollar given the high
current account deficit." Not quite panic mode for the
world's most serious lenders... but with U.S. deficits
(fiscal, current account, consumer) running at record
highs, it's only a matter of time before those holding
dollar-denominated debts realize they aren't worth the
paper they're printed on.

- So... is there REALLY a PPT run by a shadowy government
group that intervenes in the markets to keep stock prices
high and investors solvent? Alan Greenspan isn't saying.
But the maestro and his merry men COULD orchestrate a
reversal by buying an enormous amount of S&P or Dow futures
contracts late in the day. How would it work?

- The easiest way would be to buy front-month futures
contracts on the S&P and increase the 'spread' between the
futures market and the cash index. The 'spread' is the
difference between the fair value of the cash index and the
price at which the futures market calculates it to be. By
buying S&P futures, you increase the 'spread' between the
futures market and the actual cash index. And if the spread
gets big enough, program trading kicks in to buy the cash
index rather than the futures.

- Could you prove this is happening? Well... you could look
at prices for front-month futures contracts on the Dow and
S&P and see what kind of buying took place between, say,
1:52 and 2:18 yesterday.

- THEN, you could check to see what the program trading
statistics were for the day in question. The Wall Street
Journal publishes program trading stats on a weekly basis.
And according to the Journal, in the last four weeks
starting on July 25th, program trading has accounted for
38.5%, 42%, 45.5%, and 39.9% of the total trading volume
for the NYSE.

- The August 22nd Journal reports that for all the program
trades on the NYSE during the week ended August 15th,
"13.6% involved stock-index arbitrage" and that"Some 53.9%
of program trading was executed by firms for their
clients."

- Is Uncle Sam a client? And is he pumping money to
accounts set up with the big brokers on Wall Street to buy
futures and cause program trades to kick in and buy the
cash index? We report... you surmise.

-------------

Addison Wiggin, back in Paris...

***"Housing's last hurrah," reads a CNNMoney headline,
confirming our suspicion that the story has captured the
imaginations of mainstream financial writers. What's the
problem, according to this one?

"Though household income has been climbing slowly and
steadily," the staff writer writes,"despite the longest
stretch of labor-market weakness since World War II - it
can't compete with the abrupt jump in mortgage rates,
driven by a 42 percent surge in the 10-year Treasury yield
since mid-June. If wages can't keep up with rates, then
first-time buyers will simply be able to afford less house,
putting further downward pressure on demand..."

And pop goes the bubble."When that happens," we quote
ourselves from yesterday,"there are going to be a lot of
angry people."

*** The Chinese yuan is emerging as a"tough business
issue," another headline from the NYTimes tells us. Anger
is rising in America's heartland, claims the paper, which
also purports to publish all the news that's fit to print.

Since the yuan has been pegged to the dollar, the trade
deficit with China has exploded. While Chinese exports to
the United States doubled to $125 billion in the period
1995-1997, American exports to China inched up a mere $6
billion over the same period. Now, the deficit now stands
at over $100 billion a year.

"We can compete against China's low labor costs," a man who
makes plastic for a living in Pennsylvania told the Times.
"and we can compete with them if they play by the rules.
But we cannot compete with them if they have a 20 percent
to 40 percent currency advantage."

This is exactly the kind of garbage sentiment politicos
will feed on in the next election... and it can come to no
good. Expect an increase in protectionist proposals by
Congressman and state-level politicians, who more often
than not wouldn't stand a spin-the-bottle's player's chance
in the closet of finding China on a globe.

If the twentieth century serves as any model for the next,
first we'll see trade wars... then shooting ones. China
makes at least as healthy an adversary as al Qaeda, don't
you think?

In the meantime, friend and colleague Porter Stansberry
estimates the yuan is undervalued by 40% in the wake of the
dollar's drop against the world's free-floating currencies.
If John Snow's efforts to strong-arm the Chinese into
letting the yuan float are successful, there may be more
than one way to skin this cat for profits. Porter, trading
on his own brand of skeptical xenophobia, suggests a few,
in his special missive:

The China Strategy Report
http://www.agora-inc.com/reports/CSR/WCSRD835/

*** You'll be happy to note that Bill's project to get his
son Jules installed in the American school here in Paris is
complete."He's not exactly 'firmly' installed," Bill
reports,"but there it is..."

Finding one's way through the intricate web that is
France's education system - or even through the equally
complicated league of foreign schools that have set up shop
here - is just one of the many joys of family life in
Paris. We have come to know quite a few others, of varying
degrees of enchantment.

France is a good place to visit. But it is a better place
to live.

The City of Lights reveals its more obvious delights to
tourists... just as the French countryside embraces them
with its vineyards and chambres d'hôtes... but as those who
make their home here know, France's true beauty - and
imperfection - are found in the small things.

If you've ever thought of living in France, you might be
interested in an event our friends in the Paris office of
International Living are hosting this October. They promise
to provide attendees with a comprehensive guide to making
one's home in France (we sure wish there had been a
conference like this when we moved here!).

---------------------

The Daily Reckoning PRESENTS: As the disaster that Iraq has
become continues, the oil services industry looks elsewhere
to replenish dwindling supplies of crude. Just as it was in
software 20 years ago, opines John Myers, picking the
eventual winners will lead to incredible investment
fortunes.


THE QUEST FOR OIL
By John Myers

Oil is the largest single traded commodity in the world. It
supplies about 95% of all transportation fuels and 40% of
the world's commercial energy. It also provides feedstock
for thousands of manufactured products and is critical for
food production.

While global consumption has continued to rise steadily,
worldwide oil discoveries have declined progressively since
the 1960s. The challenge for oil producers is that each
year, the world consumes more than three times the amount
of oil that is discovered.

"The time has come for a rational response to the
inescapable reality that oil is finite and available
supplies will soon be insufficient to satisfy growing
demand," writes Dr. Colin J. Campbell, a petroleum
geologist at the London-based Oil Depletion Analysis
Centre.

A growing number of analysts predict that global oil
production will peak within the coming decade and then
start to decline, leading to higher energy prices with
major economic consequences.

Big Oil acknowledges the increasing difficulties of finding
new sources of petroleum to replenish reserves. In an
effort to reverse this trend, petroleum companies are
turning to technology. The oil service industry is
providing the instruments to locate previously undiscovered
reserves and the tools to glean existing reserves from
abandoned wells.

Since petroleum technology and service companies hold the
keys to the world's remaining oil reserves, that puts them at
the top of the investment chain, in my opinion. And just as it
was in software 20 years ago, picking the eventual winners
will lead to incredible investment fortunes.

Moreover, the petroleum industry, and the companies that
service it, have the full weight and support of the federal
government [for what it's worth... ]. Early in his
presidency, George W. Bush announced that one of his
administration's priorities was to provide the nation with
secure energy supplies. The president insisted that part of
his strategy was to maximize North American production.

Washington's Oil Doctrine was announced in a May 2001
National Energy Policy report. The report concluded:
"America must build strong relationships with energy-
producing nations in our own hemisphere, improving the
outlook for trade, investment, and reliable supplies... As
a result, the United States will rely increasingly on
imports of both natural gas and oil from Canada."

Big Oil has admitted that finding large oil pools has
become a major problem. One remedy that has worked at the
corporate level has been a rash of takeovers. In May 2001,
Conoco announced that its Canadian unit would buy Gulf
Canada Resources for $4.33 billion; in August of the same
year, El Paso Energy acquired Canadian-based Velvet
Exploration Ltd. for $228 million. These are just two
acquisitions in a string of Canadian petroleum companies
that fell into U.S. hands.

But although buying reserves might look good on a balance
sheet, it doesn't add a drop of new oil to the world's
reserve base. The only way to do that is through
exploration. After years of falling exploration budgets,
oil companies are once again aggressively searching out new
reserves.

According to a 2003 survey, Canada will set the global pace
for exploration and development spending this year. The
money will be fueled by U.S. majors and independents
shifting capital to Canadian activities, says investment
banker Friedman, Billings, Ramsey & Co. Inc. The Virginia-
based firm projects U.S. exploration and development
spending will edge up by a mere 0.2% to $32.08 billion,
while Canadian spending will race ahead by 12% to $11.9
billion.

Oil exploration companies are fulfilling Friedman & Co.'s
prediction. The total U.S. count of working rigs at the end
of June was 1,067 - up from 838 units that were working in
June 2002. Renewed exploration is even more remarkable in Canada,
where 337 rotary rigs were working at the end of June compared to
210 in June 2002.

The petroleum industry is more optimistic about its chances
of finding new oil and gas than Washington is. I will get
to why Big Oil has high hopes in a minute. But first let's
look at the energy quagmire that our federal government has
gotten us into.

In June, Energy Secretary Spencer Abraham called for more
conservation and fuel-switching by utilities. His concern
is over low gas inventories and high summer demand,
limiting storage injections ahead of next winter. In a
letter to 30 U.S. lawmakers, Abraham wrote that in the
Department of Energy's view, there are only 'limited
opportunities' to boost supplies over the next 12-18
months.

Of course, the federal government has good reason to fret
about oil. The Middle East, home to two-thirds of the
world's oil reserves, remains a tangled mess with America
taking pot shots from the world press while our GIs are
taking rifle fire from irate Iraqis.

Baghdad fell to U.S. forces in early April. Since then,
efforts to restart Iraq's oil industry have been delayed by
looting, sabotage and technical problems. According to The
Wall Street Journal,"Continued attacks threaten to set
back U.S. efforts to pacify Iraq's restive populace. Long
lines are again a common sight at Baghdad gas stations,
with drivers waiting hours to fill up at prices still
higher than before the war."

In June, two Iraqi oil pipelines exploded - merely the
latest violence that has occurred in an occupied, but not
yet conquered, country. The first explosion shut down a key
fuel pipeline 150 kilometers west of Baghdad. The second
pipeline carried crude oil to Syria.

Saudi Arabia, the world's oil kingpin, holding one-third of
the world's conventional reserves, has also been
experiencing unprecedented terrorism.

The Saudi Ras Tanura oil terminal, the largest in the
world, used to be a stop on sightseeing tours. But today,
the facility that processes 4.5 million barrels per day -
or half of the oil that the kingdom produces - is
surrounded by elite security troops. The tightened security
follows a string of attacks by extremists in the country,
including a June gun battle between al Qaeda and police in
the holy city of Mecca.

But blanket security may be an impossible proposition in
this desert nation where oil is almost as plentiful as
water. A retired oil engineer who spent 30 years working in
Saudi Arabia told me that there are many choke points
inside the country where a bomb could disrupt the flow of
Saudi oil.

Al Qaeda understands that petroleum is America's Achilles'
heel. In June U.S. intelligence warned that al Qaeda may be
targeting petroleum facilities and pipelines in Texas.
Ironically, an attack on Texas would do less strategic harm
to the United States than an attack on Saudi Arabia.

As of this past April, the United States imported a record
12.3 million barrels per day (mb/d), almost 6% more oil
than it was importing in April 2002. Meanwhile, U.S. oil
production continued to slide down the slippery slope of
decay. Our nation is producing 5.8 mb/d of oil, down from
the 1970 peak when America produced 11.3 mb/d. Over the
past few years, U.S. production has declined at a rate of
4% per year.

Yet new technologies promise not only the discovery of new oil
and gas fields but also the ability to extract new
hydrocarbons from abandoned oil fields. Just how important
is this endeavor? A study completed in 1995 showed that in
the United States from 1983 to 1992, about 85%, or 20
billion barrels, of proved oil reserves were from old fields.

To recover old oil and discover new oil, the petroleum
industry has armed itself with a bevy of new technologies.
The big oil companies are betting that they can reverse the
decline of America's petroleum production and boost
Canada's production. If they are successful, the companies
that deliver effective oil service technologies will
generate windfall profits.


Good investing,

John Myers
for The Daily Reckoning

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• The Daily Reckoning - The Quest For Oil - Firmian, 28.08.2003, 10:32