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For Frack’s Sake

April 25, 2012 by SteveT   Comments (0)

And relax. BBVA results not the shocker disasternistas were hoping for, the cult of AAPL continues to fleece its disciples and it is looking more as though that was NOT the big one re Europe. TMM can’t help but think this has got a july 2009 feeling about it. We had the QE sugar rush from mar09 to jun09, then the market sold off because no-one believed it. But then the earnings season was good and the market ripped higher, never looking back. OK it may be a bit premature, but with all the noise subsiding and the market blaming the quiet on “waiting for the FOMC” which to be frank no one really cares about, TMM are more inclined to believe that the markets are “shagged out after a long squawk”. Whatever the reason, we will be invoking the “do not short a quiet market” rule and expecting more up drift.

Whilst it is quiet we will have a look at something we believe is about to change the world much more than any Apple iteration – the changing shape of energy supply.

TMM would like to start today’s post with an interesting chart showing energy costs per Gigajoule for major fossil fuel sources in the US. White is Power River Basin coal, orange is henry hub gas, yellow is oil and pink is international coal (Newcastle spot).

As you can see, the big story of energy prices going to the moon over the last decade remains very much intact but gas has been doing something very unusual – after spiking hard it has gone into a massive decline and is almost as cheap as powder river basin coal on a per GJ basis. The cause of this is the fracking revolution in gas production which has massively increased the US’ fossil fuel reserves. It is already being keenly felt in power markets where US coal companies are being killed by the increased competitiveness of gas fired power generation as the portion of the day in which it makes sense to burn gas is longer and more profitable, reducing those peak time margins that coal fired power plants make much of their profits from. For coal equities this is hardly news – Cliffs Natural Resources, Alphadyne and Arch Coal have not been feeling the vim and vigor of a resurgent US economy.
Similarly the US’ strategic exposure via oil imports to the Middle East and less than friendly regimes like Venezuela is waning judging by the chart below. Crude import percentage from Saudi in white, Canada in orange and Venezuela in yellow (Note the post Libya ramp in Saudi imports – that won’t be around for long).

TMM can’t help but feel that the money for the “war on terror” could have been better spent, but the US appears to have been a classic case of “better lucky than smart” in that regard since they have secured a reduced exposure to middle eastern madness through oil sands.
Now, not that oil is mattering as much as it used to – below are vehicle miles travelled in the US in orange, inferred gasoline demand in green and average MPG of sales in white.

Not hard to see what is going on here: a period of high oil
prices has pushed consumers into buying much more efficient vehicles and
vehicular travel has peaked. Much like any business if unit sales and prices
are down revenues are down a lot. TMM are wary of hockey sticks though so we
thought we would do the comparison of a new efficient hybrid, say a Prius C and
a Corolla. In summary – it’s ugly, and the google docs link is here. You need
gasoline to even think twice about not buying the hybrid. In addition,
companies like Ford are offering vehicles in gasoline, electric and LPG
versions. No points for guessing how gasoline stacks up in the lifetime cost
analysis there. Simply put, the vehicle mileage hockey stick is going further,
a lot further unless WTI halves. It would be particularly disturbing if people
widely moved to plug in electric cars which essentially allow you to do what
the power grid does – determine which fuel is cheapest to burn then burn that.
In that case you would expect oil and gas to converge on a per GJ basis which
would be a catastrophe for WTI.
In summary a few very important things are happening in
energy, but particularly so in the US:

  • Energy prices are falling for gas, with knock on
    effects for other markets in which it is substitutable. Similarly, vehicle
    fleets are becoming more efficient and gasoline demand in DM is probably in a
    structural bear market on that alone. This has major implications for US
    inflation most of which has been from food and energy in recent years despite
    motor fuel being only ~5% of CPI basket and heating and utilities being another
    5%. It may be the case that even if housing recovers and “rent equivalent cost
    of ownership” (~40% of the basket) stabilizes that the
    US has a very
    benign inflationary environment for structural reasons. Buy all the gold you
    want, but if people’s gas bills cease to exist or go into a nominal decline
    then that will take the bite out of a lot of quantitative easing in
    commodities.
  • The historic segmentation of the energy markets
    into transport fuels and utility fuels is starting to blur and is likely to
    continue to do so. For that reason, the pricing per GJ for each should converge
    over time. You may not be able to make everyone in the
    US buy an
    electric car tomorrow
    but the ability of
    WTI to command a big premium over henry hub will weaken over time
    .
  • US energy imports are falling fast and will
    continue to do so as the vehicle fleet turns over. This is going to have major
    implications for US defense spending – how much does the
    US care about the Middle
    East
    , ex oil? TMM would note that if the straits of Hormuz are
    closed,
    China has more to
    lose from it than the
    US.
    In addition, it has major implications for
    US tax receipts if people buy LPG
    cars or electric ones. US utilities pay cash taxes in the
    US, Saudi
    Aramco does not.
    The major problem of
    the US
    from a macro standpoint, its twin deficits and high debt may be reduced
    materially by these trends and the historically cheap USD may be the best buy
    in FX for the next decade.
  • Make it in America? The US and particularly
    the Democrats have developed some kind of romantic attachment to manufacturing
    and politically astute CEOs like Andrew Liveris of Dow have picked up on this
    theme and have called for the US to have an industrial policy, aka, handouts
    for corporate along the lines of China. TMM see this for what it is – getting
    something for nothing and think it is largely unnecessary for most businesses.
    It is highly unlikely the
    US
    is going back to making garments or in any way competing with the scale
    efficiencies of southern
    China
    when it comes to cheap labor, especially as
    China’s factories increasingly
    replace labor with capital
    . Where it can compete however is in areas that
    are skills or technology intensive (when in doubt, buy out
    Asia’s
    best and brightest with grants) and anything that is energy cost intensive.
    Liveris notes that labor is <12% of COGS at Dow and Energy is 25% or more.
    TMM think that gas makes a much bigger difference than looser labor laws or
    tax holidays.
     

The Downside….
There is another side to all this aside form extolling the
virtues or hope of a resurgent America,
and that is the effect it will have on those on the long side of the
commodities trade. For the likes of the Middle East
and Russia TMM have this to say:
Saudi and Russia
in particular have developed fiscal arrangements (Saudi’s covered well here) such
that their economies “don’t work” at much less than WTI. Russia is not that
much better and is more dependent upon gas, something that the European buyers
they have held to ransom for so long might not want to buy if they can frack
their own as Romania
is currently exploring
. For that reason TMM are hard pressed to think of currencies
they dislike more than the rouble – all the terms of trade frothiness of Australia with
a boatload of political risk and a much bigger credit bubble as can be seen
below. 




Even in the case of Australia all those lazy RBA terms of
trade and commodity price projections may go awry if China manages to produce a
lot of fracked gas – China SOEs have never been ones to shy away from
renegotiating off take of commodities if it suits them though that is likely a
late 2010s / early 2020s problem. Some countries have the political wherewithal
to take such a crunch in terms of trade (Brazil,
Australia)
others might not make it and require some institutional change when they can’t
deliver their side of the autocracy / milk-and-honey trade.

Of course the real crunch
comes against renewables. Whilst cost differentials have been narrowing between
traditional fossil fuels and solar and wind,.  will the energy addicts be able to resist dirt
cheap carbon emitting gas for the benefit of the environment? TMM think not as
austerity drives people to short term survivalist individualism rather than
long term community spirit though that is arguably in the price these days. The larger shock is that by the time we start running out of gas energy prices might be following solar’s quasi Moore’s law – which wouldn’t hurt any of TMM’s power bills.


Macro Man

For Frack’s Sake is a post from: The Forex Trading System Blog


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