Category Archives: On the cover

On the cover

Russia may remain cheap for a while

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The geopolitical landscape created by the Ukraine crisis and the ongoing sanctions against Russian interests from both the EU and US have made the MICEX Index fall 4% YTD.

For investors, the main things to consider:

– Russian stocks are cheap and they have always been. Headline multiples disguise a market where the semi-state owned companies tend to pursue a strategy that is less focused on total-shareholder-return than on maximizing capex. State intervention and value destructing investments have been some of the factors behind the de-rating of Russian stocks.

On the flipside, Russian independent companies have been following a very shareholder oriented policy (think Novatek, for example), reacting inmediately to rumours and creating value by being focused. So the index large weights cloud a market where some companies do shine and develop solid strategies.

Therefore, for investors, the key is stock picking, not index buying… and focusing on clear strategy independent companies, not necessarily on the “headline cheap” multi-megacap conglomerates. These are OK for a short term technical trade driven more by oil price momentum and geopolitical risks easing.

– Ruble strength is likely as oil prices remain high, and with low debt and little financial dependence on foreign entities, Russia can sustain the economic slowdown created by sanctions better than the EU debt-ridden countries with strong commercial ties with Russia. The current oil price-ruble combination prevents any risk of economic collapse in Russia and, to a limited extent, the state can substitute for foreign lenders in strategic sectors. However, without a big pick-up in inward investment and domestic confidence, the economy will not be able to move from near stagnation to the sustainable 3-4% annualized growth it needs, according to Chris Weafer. Russia’s balance sheet and budget are solid and the government can afford to provide domestic funding to banks or to raise public investments.

– Besides the human tragedy, the consequences of the MH17 crash may also be less lending from European banks to Russian companies, which could make the Russian economy even more isolated on markets. The direct impact on European credit is likely to be contained however, as exposure to Russia is already limited (with the exception of Austrian banks), according to RBS. But in a worst-case scenario, Europe remains dependent on Russian gas. Today there is no risk as gas inventories are at five year highs (83%) but any cuts to supply could make several countries vulnerable during the winter.

– The US is imposing sanctions with the EU’s pocket. The US has very limited exposure to Russia, while the EU -and countries such as Italy or France in particular- are heavily exposed.

 

Additional read: Check Chris Weafer, one of the top experts on Russia, from Macro Advisory.

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in this blog are strictly personal and should not be taken as buy or sell recommendations.

Sitting in a weak energy commodity environment

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As I predicted, Brent lost all the geopolitical premium of the Iraq crisis to trade at $110.46/bbl as Libya exports rise to new highs offsetting the Iraq concerns, and showing how well supplied the market is. WTI moves to $103.77/bbl driven by increased US production, now at 11.7 mbpd.

Fighting between the Iraqi army & ISIS continues but with few developments over the weekend – the conflict remains well away from the main Iraqi oilfields in the south of the country. At the same time, Saudi Arabia is believed to have deployed 30,000 troops to its borders with Iraq. Furthermore, Jihadists of the Islamic State took control on Thursday 3 July of the Al Omar oil field in the east of Syria.Libyan production is currently 325,000 b/d.

Libya’s NOC officials said that they were considering lifting the force majeure on the Es Sider and Ras Lanuf terminals, which has been in place since August 2013. The Es Sider terminal holds between 3.5-5.5Mbbls of oil in storage, meaning new production is not needed to resume oil loadings. Es Sider and Ras Lanuf terminals accounts for 50% of Libya’s export capacity (or 500kbpd).

Coal loses ground at $77.70/mt and is below the key support of $78/mt. Highly unlikely to see it strengthen as summer sees more exports from Australia and South Africa.  Coal weakness shows the oversupply in the market, close to 20%.

Chinese thermal coal imports fell sharply in May, down -19% month-on-month seasonally adjusted and -20% y-o-y. The fall has been driven by declining thermal power generation due to broadly flat overall demand and improved hydro and renewables generation.

CO2 at €5.55/mt… The moment that backloading buying is reduced, it collapses…. Down 6% MTD.

US gas at $4.27/mmbtu as milder weather affects slightly the supply-demand balance. However, inventories are at 666 Bcf below last year’s 2,595 Bcf and 790 Bcf below the 5-year average. Still supportive.

The EIA reported an injection of 100 Bcf, matching forecasts of a 100 Bcf. U.S. working gas in storage is now at 1,929 Bcf, 29% below the five-year average of 2,719 Bcf and 26% below last year’s level of 2,595 Bcf. Weather forecasts for the U.S. over the next six to 10 days call for above-average temperatures on the West Coast and East Coast.

UK gas lost all the premium from the Ukraine crisis and more, down at 35.40p/th (-46% YTD) as inventories rise above 4,250mcm and demand weakens…. The contango is at 26p/th.

The EU levels of gas storage are truly high at this point. UK is at 83.28%, Germany at 76.80%, Netherlands at 98.7%, Spain at 94.5%, Italy at 76.80%… Only France remains oddly low at 54.75%.  These high levels of storage explain the weak gas prices despite Ukraine and the lack of concern from countries about security of supply.

Power prices continue to fall in Europe. German power is down at€34.20/mwh (-7.1% YTD), French power at €41.55/mwh (-6.4% YTD) and Nordpool at €31.20/mwh (-2.7% YTD)

Dr. Fatih Birol, IEA’s Chief Economist just gave some of the key conclusions from IEA’s World Energy Investment Outlook which was published last week.

Main conclusions:

1)            Over $22 trillion forecasted oil and gas capex over the next 20 years. Need for investment in Middle East oil production: Dr. Birol expressed concern over the current lack of appetite to invest in new oil and gas projects across the Middle East, despite oil prices at $110/bbl. If oil prices were to fall, the level of investment from both Middle East NOCs and global IOCs would be even lower. Over the next 20 years, the IEA estimates the Middle East will account for almost a third of global new oil production.

2)            LNG prices likely to remain high: There is now more than $700bn invested in LNG infrastructure, but the cost of shipping LNG around the world remains high. Dr. Birol highlighted that the cost of transporting gas via LNG is 10x that of crude. Despite low US gas prices, the additional liquefaction and transportation costs mean gas price differentials between the US and Europe/Asia are likely to persist for some time.

3)            In Europe, wholesale electricity prices are at least 20% too low: Over the next two decades, Europe needs $2.2 trillion to replace ageing electricity infrastructure and meet carbon targets. However, these investments will not happen under current market conditions, according to Dr. Birol. He highlighted that power prices are about 20% too low to recover costs on new investments. Weak power prices are the result of lacklustre demand and heavily subsidised renewables along with cheap coal imports from the US. Dr. Birol pointed out that total investments in European renewables so far have been three times the size of total investment in US shale gas production. With some overcapacity in the European system, there is some breathing space, but 100GW of thermal capacity is needed over the next decade to safeguard reliability.

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in this blog are strictly personal and should not be taken as buy or sell recommendations.

China Energy Demand Stalls

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China oil demand growth disappointed in May, with apparent demand contracting 1% year-on-year.

Consensus estimates +3-4% year-on-year oil demand growth forecast this year, which now needs to average c6% y/y growth from June onwards to be reached.

Natural gas supply growth recovered in May to +15% y-o-y after a disappointing 3% y-o-y growth in April. Imported gas remains c33% of China’s total supply

Thermal coal imports fell sharply in May, down -19% month-on-month seasonally adjusted and -20% y-o-y. The decline has been driven by declining thermal power generation due to broadly flat overall demand and improved hydro and renewables generation.

Fuel oil net imports (graph attached) fell to the second lowest on record for May and kerosene net exports reached a new high for the year. Apparent demand for fuel oil was extremely weak in May, down -32% y-o-y as industrial demand remains weak.

Agricultural imports fell steeply in May, most notably wheat and sugar – each down nearly 40% month-on-month seasonally adjusted. Better rainfall early in the year may lead to improved domestic harvests for a number of crops, reducing appetite for imports later in the year.

In aluminum I still see accelerating capacity addition.

At the higher end of the cost curve, Chalco Guizhou, Zhunyi, Yulong plan to restart 330kt old capacity after the local government granted a RMB12cent/kwh tariff subsidy. Gansu Hualu will restart 50kt old capacity. Baotou aluminum will start 150kt new capacity with captive power plant. Zhongfu has been granted RMB4cent/kwh on the power grid pass-through fee.

At the lower end of the cost curve, Shenhuo will complete the second 400kt capacity in Xinjiang. East Hope, Tianshan and Xinfa will complete 350kt, 500kt and 550kt additional capacity in 2H14.

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations.

Myths and Mistakes of the Iraq crisis

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

This article was published in El Confidencial on 22/6/2014

“There is no military solution for Iraq” Barack Obama

“Rarely has a U.S. president been so wrong about so much at the expense of so many” Dick Cheney

Getting it wrong is dangerous. Worsening things is lethal. In the case of Iraq , the United States, after spending a billion dollars to remove the regime of Saddam Hussein, has left a global security problem which may be greater than imagined when Obama decided to withdraw the troops . It’s not just about oil. Anyone who lived the Baghdad of Saddam Hussein understood that the regime was a global danger. Similarly, it is essential to understand that the threat was not only Saddam, but the many factions that existed well before the Baath dictatorship, which remained in conflict during the regime and still do so today. Leaving Iraq can become a decision that Obama will regret for a long time.

Why did the U.S. leave Iraq? 

For love and peace? No. Because in 2016 the US will be energy independent -including Canada. The need to defend its interests in the area is today infinitely smaller.

America is already independent in gas and produces 11.3 million barrels a day of oil thanks to the fracking revolution, becoming the largest producer over Saudi Arabia and surpassing the country’s own 1970’s peak.

However, removing the troops leaving behind a timebomb of sunni and shiite factions could end up turning against the United States and the OECD, as it generates an enormous risk of multiple terrorist threats. Energy is not the problem. It is a cultural problem. It is naive to say the least to think that everything will go smoothly leaving Iraq on its own when the country is decimated by clashes of tribes with invasive ambitions. it is the same mistake we have seen in Libya or Egypt after removing a dictatorship regime. The Pandora box of multiple threats opens. I recommend you read ” The Clash of Civilizations “ by Samuel Huntington and “The Lesser Evil”  by Michael Ignatieff. In the West we do not want to understand the culture and customs of these countries, which are very far away from our idea of democracy. Accepting the lesser evil of maintaining a military presence is much more logical than closing our eyes in the hope that the world will move according to our wishes.

Does the Iraq crisis affect its oil exports?

The OECD placed too much trust on the unstable government of al-Maliki. US troops were disappearing and the industry seemed to be recovering. It looked as if everything was on track, but the risk had not gone away, in fact it had increased with the wrong strategic decision to pull U.S. troops from the country without a security contingent.

This week the Iraqi risk rose dramatically after terrorist attacks in the northern part from ISIS (Islamic State Of Iraq and Syria), a jihadist group that even has an annual report of its sinister achievements. See it here (http://azelin.files.wordpress.com/2014/04/al-binc481-magazine-1.pdf ) courtesy of the Financial Times .

When I traveled to Iraq people used to say: “Baghdad is a city covered in gold, but in the south is where the real gold is” (oil).

This map, courtesy of IHS Energy ( press@ihs.com ), shows the location of the main fields and refineries.

Terrorists have taken Mosul, the second largest city in Iraq, Tikrit, Tal Afar, and Dhiluiya Yathrib. However, they have not taken any of the large fields north of the country, especially the giant Kirkuk oil field in the Kurdistan region. the people I knew in the area called this field “the passport of Kurdish independence”. Today it produces 260,000 barrels a day. ISIS terrorists have no ability or desire to attack the Kurdish region.

Most of Iraq’s production, 80%, is exported and more than 77% comes from fields in the South, where terrorist ISIS militants cannot be measured with local forces and private security contingents. There has been no impact as of today in exports, which are made mostly through tankers from the South.

Is it a crisis to regain control of oil from the hands of the multinationals?

Contrary to what has been said in some press, oil in Iraq does not belong to international companies, much less American . All is state-owned fields where international, American, Russian, Italian, Chinese or British companies work with contracts for service , and they are paid to maintain or increase production. That is, the State benefits from international companies’ experience in improving productivity, and therefore has no interest in seeing these companies leaving. This type of productivity contract is what has led to Iraq recovering its pre-war peak production so quickly.

Is it all the fault of Obama or Bush?

The fights and attacks between Sunnis and Shiites are not new. It’s a conflict that has been ongoing for hundreds of years. In the era of Saddam Hussein it was already a challenge to organize security to travel from Baghdad to the border with Kurdistan. In fact, access was banned even for many potential contractors due to constant attacks.

George W. Bush made a mistake thinking that the US would be received as heroes after the invasion, as Wolfowitz expected. The moment that the regime’s repression ceased, the various factions began fighting bitterly. A weak government only reduced the perceived risk. The same mistake has been committed by the OECD in Libya and Egypt.

The Obama administration made a huge mistake by reducing up to three times the number of contingency troops that would support the weak government of al-Maliki. By reducing the promised figure of 50,000 soldiers to 25,000 and then to 3,000, aid became irrelevant, and therefore rejected by the local government.

The lack of involvement of NATO countries in the Middle East problem is part of the disaster. Not only Libya and Egypt have spiralled out of control, but Al-Assad in Syria is now more powerful than ever due to the inaction of the OECD, and Syria has become the launchpad of a strengthened ISIS in North Iraq. Thus, the risk that the area controlled by ISIS becomes a huge camp of international terrorists is not small.

Proposals to divide Iraq into three (Kurdistan, a Sunni North and a Shiite South) would increase the risk of allowing to build a huge training center for global jihadists.

Is the crisis due to peak oil?

Sunnis and Shiites have been fighting for hundreds of years. The problem is not oil … Because in the oil market there is no great risk.

On 11 June, OPEC met in Vienna. Independent analysis (BP Statistical Review) confirmed that there is plenty of oil for decades. Global proven oil reserves have increased to 1,687.9 billion barrels in 2013, sufficient to meet 53.3 years of global production.

Messages from the major oil exporters focused on some aspects that I think are extremely important when assessing the geopolitical risk and not overdo it:

  • The market is adequately supplied and OECD inventories in terms of demand cover are at “comfortable” levels (2,548 million barrels, 55 days, similar to the 55-60 day average level of the past ten years).
  • Spare capacity, ie what OPEC can produce above the established quota of 30 million barrels per day, is today 3.5 million barrels a day.
  • Iraq has reached a production of 3.3 million barrels a day, reaching record highs.

Will Iraq take oil to $ 200 a barrel?

Not likely. The OPEC spare capacity is equal to 100% of total production in Iraq.With the US producing at record levels and non-OPEC production growing by 1.2 million barrels a day in 2014, the market would be adequately supplied even if Iraq fails to export.

Libya, for example, has dropped to almost zero exports from one million barrels per day after the fall of Gaddafi and the oil price has not moved aggressively. The analysis is not “oil has risen to $ 115 per barrel,” but “even after the crisis in Libya, Ukraine and Iraq, oil has only risen to $115 per barrel …” And oil remains in backwardation (the future price is much lower than the spot).

Will the price of oil it create an economic crisis?

Oil does not create crisis. Excess credit and money supply that shoots commodity prices well above the fundamental levels are the ones that create crisis. The price of oil is a consequence, not a cause. In any case, the oil burden of the OECD has not reached 5.5% of GDP, far from levels that are supposed “to trigger a crisis”. The oversupply also helps to mitigate it.

The world has been operating with such crises in producing countries for decades. And the market is always adapting. But linking the Arab problem only with oil is a grave error on the part of all governments.

In the end, as Ignatieff said there is never an ideal solution. To think that the OECD will solve conflicts between Sunnis and Shiites that have been going on for centuries only with military domain is optimistic. Believing that NATO and the United States will be able to opt out of supporting Middle East security without dire consequences for the Western world is suicidal.

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations.