Tag Archives: Macro

Thoughts On The European Crisis

Global Economy, On the cover, Sin categoría
EUROSTOXX (1)

(Extract from an interview with me published in the Spanish press on June 20th, 2011)

How do you see the situation in Europe?

Complicated. On the one hand, Europe has a powerful engine, Germany and the Nordic countries, and sometimes we forget that this engine has the same GDP as China.However, industrial demand from the rest of Europe is deteriorating, and countries have not used the crisis to reduce debt dramatically.

A strong euro, driven by the European engine does not help, and differences between countries have increased. A strong euro means that the over-indebted economies, which are also big exporters, become less competitive.

In my opinion, the estimates of GDP, especially for 2012, are still very high and the estimated deficit levels are relatively optimistic in the peripheral countries. Italy could be a negative surprise, but this crisis can also be a great opportunity to eliminate the weight of the low productivity and high debt  sectors (construction, civil works) and support high-productivity sectors (technology, energy, services) that have been behaving really well under the circumstances.

What can happen if finally Greece has to restructure its debt?

So far the European crisis has been suffered by citizens, equity investors and businesses, but not by the bondholders. This paradox is curious. Europe has an entire economic and financial system that is supported by the fallacy that sovereign debt has no risk. This affects everyone from private investors to governments (local and state) to banks, their investment criteria and their perception of risk, and has generated a disproportionate percentage of sovereign bonds in portfolios. The CDS widening has been perceived as an opportunity to buy “no-risk assets but with high return”, not as a warning sign.

Going back to the Greek debt, to keep bonds as if nothing was happening, when these are already discounting a “default”, only prolongs the agony of a story whose end can only be to restructure. Once the debt is restructured in a proper way, it will be the time to see the beginning of the recovery in Europe and the peripheral countries. It will likely be a tough process and austerity plans will be much more demanding than current estimates, but it will also be the beginning of the solution, because the new governments that will manage Europe between 2013-2015 will no longer have the same vision of the problem of debt which so far has been to “hold on and wait for the issue to solve itself.”.

If it were in your hand … bail-out or restructuring?

Restructuring always, in an orderly manner and agreed with the financial institutions. Bailouts only encourage bad government behaviour , because there is no penalty for poor managers. Citizens end up paying anyway through higher taxes and worse working conditions because, as we have seen with Greece, that received a massive bailout already two years ago, a few months later the economy is in the same same poor situation, if not worse.

And Spain, is it better than the market thinks or, as some say, the situation is worse?

The big question is the debt of the regional communities and the State’s ability to join community after community to solve the debt problem and tackle unnecessary spending. Investors do not know exactly what the real indebtedness of the state is, and how much of all the enormous “receivable” items are simply bad debt and will never be paid.

Spain today is a bit better than the market thinks, and has positively surprised, because high productivity sectors of the economy have pushed in a very difficult environment, but that process can slow down or stop short if the real debt of the country is much higher, and deeper and more drastic reforms are not implemented because of a period of prolonged political uncertainty, because investment will stop.

What will we see in the markets short term?

The market discounts a very optimistic scenario for corporate earnings in Europe for the following two years, and especially a scenario of extremely optimistic cash-flow generation. EPS momentum is very weak. Consensus should review not only their earnings estimates, but target prices, because in some cases the latter ones are simply amazing.

A market correction that lowers the real PE (the revised one, not the current one) of the market to more reasonable levels will be a very attractive opportunity to buy, considering that the next cycle will probably be longer in duration (if countries do the right thing about debt) and less aggressive than the 2009-2010 one. The mistake, in my opinion is to seek refuge in index heavy weights or betting on companies that pay optical high dividends, when those are financed with debt.

Given that interest rates will not be low forever, it still makes sense to stick to well-capitalized stocks, growth companies that generate superior returns in the bottom of the cycle, and focus on high-productivity sectors.

External link: http://www.cotizalia.com/galeria/daniel-lacalle-20110620.html

Brent-WTI Spread…. More Fundamental than Market Perceives

Global Economy, On the cover, Sin categoría,
brent wti
(This article was published in Cotizalia on Feb 17th 2011)

I write to you this week from Oman. Impressive country, producing 900 thousand barrels of oil a day, and 9% of GDP from oil revenues, which finances amazing investments in infrastructure and civil works from Musqat to Salalah and other cities that are downright impressive.

As a country, it’s an example of how different the countries of the area are, despite the Western media efforts to put them all in the same basket of so-called risk of Egyptian contagion.

Another week and now that the Egyptian crisis has been solved, the market continues to focus on that country and the risk involved in the Suez Canal for crude supplies. And there is no real risk. The importance of the Suez Canal for the transportation of crude oil has fallen sharply in recent decades. During the 60s and 70s, almost 10% of global oil traffic passed through the canal. Today, it’s less than 1%. Moreover, as the three largest companies working in the channel say, the traffic is roughly balanced, with 55% of oil on ships heading north (992 thousand barrels/day) and 45% (about 850 thousand barrels/day) due south. Any problem in the Canal is, first, negligible for the transit of oil and, second, very easy to re-route around the Horn of Africa, an increase of transit time of less than 15 days.

For those who care about Egypt and the Sumed pipeline, just remind them that it only moves 1.1 million barrels per day despite having a capacity of 2.4 million barrels per day. And as a good friend of EGPC told me, there are few safer places than this pipeline, where the army has more troops than any city in the country except Cairo.

And in this environment we find the Brent and WTI spread at historical highs. Two clear effects: first the inflationary impact on Brent added to the deflationary impact on WTI to create the largest differential between the two ever seen: $14.5/bbl. Also very wide differential relative to other crude, Bonny Light (Nigeria), in particular, and Asian Tapis.

Let’s start by explaining what justifies the weakness of WTI:

Inventories at Cushing (at Oklahoma) are at historically high levels. 50% higher than the average for the past five years (25022). The problem is that the WTI weakness shows the growing isolation of the North American market and infrastructure problems to evacuate excess oil.

WTI crude trades on the basis of inventories at Cushing, in the middle of the American continent, and it is hard to move oil out of the area (called PAD II) or the large refineries on the Gulf.

1) There is enough transport capacity to carry crude from the Gulf to the center of the continent, but not vice versa. The fact that the Enbridge pipeline has had problems has increased the glut of crude in Cushing.

2) There has been an increase in exports of crude oil (oil sands) from Canada to the U.S., which increases the overcapacity in Cushing. Transcanada launched the second phase of its Keystone pipeline, which attracts even more crude to Cushing bottleneck.

3) The increase in U.S. domestic production, including Bakken, is also filling the stores in Cushing. The over-production in the U.S. is partly because the gas companies take advantage of high oil prices to produce more natural gas liquids, whose price is close to oil, in order to fund production of natural gas which today at $4/mmbtu, is not giving the best economics, actually very poor returns. Therefore they compensate for the low profitability of the gas with the price of associated liquids.

Add the fact that three refineries have been closed for maintenance, and we have the perfect storm. Excess production of high oil prices, withdrawal of the American system because of lack of infrastructure, and reduced refinery demand .

Meanwhile, Brent is affected some powerful inflationary forces:

1) The decline of production from Norway and North Sea, that previously functioned as a cushion against price increases, and does not produce that effect anymore.

2) The increase in OPEC oil transit to Asia, and rising domestic demand in exporting countries have reduced the oil for export. Saudi Arabia expects to increase its exports by 1 million barrels per day, but, for now, demand does not justify it.

3) The perception of geopolitical risk and the effect that we mentioned of transport cost increase. The market assumes that the cost of transport must rise. We are already seeing freight day rates recover, particularly in the VLCC segment, as I commented with Oman Oil. Having seen the Baltic Dry Index tumble to record lows due to excess spare capacity of ships, we could start to envision a horizon of recovery. Very gradual, and certainly not to be bullish, because overcapacity still exists (especially in the Capesize and Panamax segments.) And if freight costs rise, the chance to evacuate American crude to Europe is reduced.

As I mentioned two years ago on the differential between gas (Henry Hub) and oil, it is very dangerous to play against a very clear structural effect of isolation of a market, the American, in which the administration has no intention of promoting improvements in the system, and as a result, crude oil and domestic gas (WTI and Henry Hub) at lows is a clear boost from the country’s competitiveness.

Further read:

http://energyandmoney.blogspot.com/2010/01/revolution-of-shale-gas.html

http://energyandmoney.blogspot.com/2011/06/iea-releasing-strategic-reserves.html

Salamander, a case of de-rating through exploration

Energy, Global Economy, On the cover, Sin categoría,

Being an E&P the main catalyst for the company’s stock is its exploration campaign. However, when it comes to this, Salamander Energy has not had the greatest run.Out of 3 exploration wells dug by Salamander Energy in 2010, none were successful in finding commercial hydrocarbon flows.

Bang Nouan 1 well was spudded in April 2010 in Lao PDR. However, in May the company reported that the zones of permeability encountered in the primary objective were water bearing. All hopes were turned to the gas shows encountered in the secondary objective, which upon a well test, failed to be of commercial level. Thus, the well was plugged and abandoned in early August.

The next blow came from the high-risk Tom Su Lua prospect, Vietnam, where TSL-1X well was drilled. However, in late June the company announced that the well has been plugged and abandoned having failed to encounter any commercial hydrocarbon levels. It had been drilled to a total vertical depth sub-sea of 1,380mt and encountered both, potential seals and high quality reservoir sandstones, which were water-wet in the Tertiary clastic section.

The company then focused on drilling the THX-1X well on the Tom Hum Xanh prospect in Vietnam, 250km south of the TSL-1X well. Similar to its neighbour, THX-1X was announced a dry hole in late July and subsequently was plugged and abandoned as it failed to encounter significant hydrocarbons in the target reservoir sections. It is important to note that the acreage in Vietnam was previously unexplored and therefore was high risk.

The key risk to the share price is the company’s drilling results. Since the start of the year the company has drilled 3 wells, all of which have been subsequently plugged and abandoned as dry holes. Thus, the results of its next planned wells, Angklung and Dambus in Indonesia’s Kutai basin, are the key risks to the stock performance. Serica Energy, operator of Dambus, has assigned a 40% chance of success for the well, while Salamander Energy has estimated the geological risk for the Angklung at 24%. However, both wells are located in a heavily explored acreage, which already contains several producing wells.

Unsuccessful drilling campaign has cost the company in the loss of 40% of its stock value since the beginning of the year. However, although the stock is in a downward trend, it has not reacted greatly to the drilling updates.

The market’s reactions to the updates were positive. Thus, the stock rose on average by 2.00% on the day Salamander Energy plugged and abandoned its wells. Moreover, it seems that the market was reacting to the negative news a day before the announcement was made public. The company is currently trading at 34% above its core NAV (164p/sh) while E&A risked upside is at 116p/sh (632p/sh unrisked).

Overall, the Dambus well looks low-risk, while although the company claims the same about the Angklung, the failure of Unicol as well as the delay in project have put an increased risk on the prospect. Thus, the results of these 2 wells will be crucial to the future position of the company.

What the Dry Bulk tells us that markets might be ignoring

Energy, Global Economy, On the cover, Sin categoría

bdiy index

Dry Bulk is back to almost January levels. We have seen a consistent and improving number of datapoints pointing to a more bullish environment for exporting companies-countries and commodities. This is driven predominantly by movements ion oil and grain. Interesting that we have a combination of strength in dayrates (as pointed out below) and volumes (as Frontline mentioned yesterday, picking up 12% MTD). Mostly driven by Asia, as usual

In the Cape market the Pacific basin is particularly strong with some vessels being contracted at USD 12.25/ton for West Australia to China vs index of USD 11.8/ton. Data is from Pareto.

In the Atlantic charterers are bidding USD 28.5/ton and owners asking USD 29.5/ton for a Brazil to China trip vs index of USD 28.8/ton.

Brokers report of owners asking USD 60,000/day for a Fronthaul trip (Atlantic to the Far East).

In the Panamax market the Atlantic is the driving force with US Gulf grain drawing the most tonnage. Average Pmax TC rates gained 11.1% to USD 25,100/day in three weeks.

In general very positive for inflation (food in particular) and a pick up in exports in the year of the highest increase of new vessel availability since 1998.