Wednesday, 12/11, Market WrapUp (A Year of Things)

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Oil is the lifeblood of western economies. Everything in our western lifestyle is based on oil. We use oil for transportation in the form of gasoline, diesel and jet fuel. We use oil to heat homes and businesses. We use oil to generate electricity and power for manufacturing. Oil is also the base for a myriad of other products that are manufactured from petrochemicals. Products such as drugs, fertilizers, pesticides, plastics, synthetic fibers, and detergents are made from a petrochemical base. Think of everything you buy at a store, whether it is food or clothing that got there by rail or truck that run on oil. Like it or not, we live in an oil-based economy and there is nothing on the horizon in the next decade that is going to replace it. What happens to the price of oil is of concern to all that live in western society.

The developing world is also increasingly becoming the source of the greatest demand for oil over the next two decades. What happens in China may become more relevant to what happens to oil, than what happens here in the U.S. China’s consumption of oil will double over the next ten years and then triple in the decade that follows.

One of the big stories this year that has been ignored by the financial markets, shown in these graphs below, is the jump in energy prices for heating oil, oil, and especially natural gas. Since the beginning of the year, oil prices have risen over 27 percent, heating oil is up 24 percent, and natural gas prices have jumped over 46 percent. The picture for natural gas is now a matter of becoming a supply problem; while oil has become a political problem.

Geopolitical Aspects of Oil Looking Serious Latin America - Venezula In the case of oil, much depends on what is going to happen in the coming war against Iraq. There is also the issue of political instability in Venezuela where Marxist President Hugo Chavez is waging war against his own people. The President has been trying through his own will to move the country towards communism. The people are revolting and have taken to the streets. As the confrontation heats up, people are taking their money out of banks and stocking up on food supplies and gasoline. Citizens in Venezuela rushed and stood in lines to withdraw money out of banks when they weren’t rioting in the streets. The country’s citizens are calling for the resignation of their President. The President has called in outside help from Cuba in his determination to fight the popular will of the people. The result is that Venezuela is now in a state of chaos and political upheaval. The country’s main source of income is oil. The strikes and riots have virtually shut down the crippled oil industry. It is also carrying over into other industries. Their oil refineries have cut their throughput rates by 20 percent. This could drop by 60 percent once the on-site stocks of existing state oil run down. Up until the strikes began on December 2, Venezuela was exporting 2.6 million barrels of oil a day. The majority of that oil, 1.5 million barrels, went to the U.S. Venezuela has been one the major suppliers of imported oil into the U.S. This shortfall in imported oil has yet to be factored into existing inventory supplies in the U.S. The latest reports out at the end of the day indicate that strikers in the oil industry are prepared to shut down the state-owned oil company Petroleos de Venezuela completely. This would remove 2.5 million barrels of oil from the market and deprive the U.S. markets of 1.5 million barrels a day.

Prelude to War With Iraq In addition to political unrest in Venezuela, a major OPEC producer, we have the upcoming war with Iraq. The U.S. and the U.K. have now set up command and control facilities in Qatar, carrier battle groups loaded with troops are heading for the region, and reserves in all major branches of the military have been called. War games take place each week; while command and control facilities within Iraq’s outer regions are being neutralized by ever increasing bombing missions. These are all preliminary steps to a lead up to war. Today the Bush Administration informed Congress that the U.S. will use overwhelming force, including nuclear weapons, if chemical and biological weapons are used against this country or its military forces. The policy is part of a doctrine of “preemptory self defense.” It basically states that if terrorists use these weapons, the U.S. will respond in kind. The announcement by the Bush Administration that it will not tolerate groups using weapons of mass destruction is aimed at dissuading nations and groups from using them. The document given to Congress today is the strongest policy statement to date of possible nuclear retaliation if attacked by WMD.

The increasing likelihood of war in the next couple of weeks or at the beginning of the New Year is putting the energy markets on edge. Oil prices have been steadily rising towards $28 a barrel and may surpass that level and go on to $30, if war rhetoric heats up and the situation in Venezuela continues to deteriorate. In addition to rising oil, natural gas prices are starting to go parabolic. In the case of natural gas, demand continues to increase, inventories are being worked down and supply is expected to decline this year and next. Supply levels will be down by 3 percent this year and are expected to decline by 2 percent next year. Industry experts are forecasting tight supply conditions for the remainder of this year and all of 2003. The amount of working rigs remains low and is not expected to increase significantly unless prices rise and remain high. Drillers are reluctant to increase drilling activity unless they can be assured prices will remain high. Industry analysts are already raising their overall price estimates for 2003 to an average price of $3.80 from $3.30. This has yet to be reflected in the price of energy shares given the potential increase for profits this quarter and for all of next year. Graphs of the OSX, XNG, and the XOI show recent strength, especially the oil service sector and the natural gas index.

Iraq & The Aftermath of War At the moment, there is a lot of uncertainty in the energy sector. Wall Street is forecasting a benign outcome for the upcoming war. Wall Street believes the U.S. will experience a quick victory, and once it does, the price of oil will flow in large quantities out of Iraq. However, even under this best-case scenario, governing Iraq until a stable government is put in place to replace the Iraqi dictator will not be that easy. This morning’s WSJ featured a front-page story describing the ethnic, religious and political rifts that exists inside the country. The U.S. will need to maintain thousands of troops inside the country until a stable government could be put in place. The history of the region is one of violent power transitions and bloody internal wars.

In northern Iraq, the Kurds want political autonomy and a share of Iraqi oil wealth. This is opposed by the U.S.’s ally, Turkey. The diplomats hope the spoils of Iraq’s oil fields, the second largest in the Middle East, would be spread amongst the disparate groups within Iraq to keep most groups mollified. The southern part of Iraq is populated by Shiites who are opposed to mostly Sunni Moslems that make up most of the area around central Iraq. It is this Sunni population around Baghdad that would feel itself most threatened by a U.S.-led coalition. The WSJ believes it is this group that has dominated Iraqi politics for centuries. In summary, even if the U.S. was to win a quick military victory, the real problems may come after the war is over. The present assumptions of a quick victory and free flowing oil may be a bit premature. Got to own oil and natural gas.

Today's Market Back at the casino, today the markets plunged at the opening bell, then made their 10:00 AM traditional, miraculous recovery before diving again, only to be followed by another last hour miracle. This has been a pattern that can be recognized consistently over the last month. The impetus for the rally was new Wall Street projections that Oracle will beat lower estimates. Software companies led the NASDAQ rally; while insurance companies led Blue Chips after MetLife forecasted higher profits. It was a tug-of-war that lasted the entire session, with heavy futures buying necessary to keep the markets in positive territory. Tomorrow will be a big day on the economic front after the government reports retail sales for November. The consensus is that they rose by 0.02 percent. Consumer spending may be weakening now as result of a major drop in mortgage refi’s. In fact, a Bloomberg report out today shows that debt-weary consumers may be tiring of threatening spending plans. Consumer debt-induced spending on consumption and on real estate have been one of the three props holding up the U.S. economy. The other, at the moment, is government spending.

There seems to be a widening disparity between what Wall Street is telling investors and what companies are saying. Wall Street is forecasting a big rebound in capital spending next year. However, companies like Intel see things differently. Today, Intel’s Andy Grove said there is very little growth in the chip industry sales. He said he has no idea when that will change. Chip sales posted their biggest decline last year and are expected to grow by only 1.8 percent this year. It is this 1.8 percent growth that has been spun way out of proportion by Wall Street to what it signifies. An immediate turn- around isn’t one of them. Intel’s revenues fell 21 percent in 2001 and are expected to decline this year despite an increase for flash memory. Grove said it is impossible to predict when demand will return. Intel’s Grove is less bullish than Wall Street analysts who believe in a turn around next year.

Nevertheless, the markets managed to squeeze by with minor gains overcoming corporate earnings warnings, a plethora of new job cuts, declining industry conditions for technology, and mounting geopolitical risks. The fact that stocks go up miraculously at the end of the day is cited as new evidence that we are in a new bull market. Analysts are pitching the story that you should own stocks now so that when the economy recovers you will benefit by owning stocks early. The only problem is that there has been no fundamental change since this bear market rally began. The major indexes were stopped right at their technical resistance lines. Momentum indicators continue to decline, indicating that this bear market is tiring and has now been confined to a narrow trading range.

Trading was light again with only 1.25 billion shares exchanging hands on the NYSE and 1.39 billion on the Nasdaq. Breadth was positive by 9-8. The VIX fell .27 to 31.40 and the VXN slipped .13 to 51.62.

Overseas Markets European stocks rose, led by Aegon NV, after Capital Group International Inc. increased its stake in the Dutch insurer. Allianz AG gained as takeover speculation boosted the value of its stakes in Beiersdorf AG and Credit Lyonnais SA. The Dow Jones Stoxx 50 Index climbed 1.2 percent to 2524.56, paring this month's drop to 5.2 percent.

Japanese stocks fell, led by companies that rely on domestic sales such as Seven-Eleven Japan Co., on concern a central bank survey will show that businesses were pessimistic about the economy for an eighth quarter. The Nikkei 225 Stock Average declined 0.9 percent to 8727.66.

"Back at the casino, today the markets plunged at the opening bell, then made their 10:00 AM traditional, miraculous recovery before diving again, only to be followed by another last hour miracle. This has been a pattern that can be recognized consistently over the last month. The impetus for the rally was new Wall Street projections that Oracle will beat lower estimates."

Being in Fairbanks, I watch the price of natural gas. It has been trending up gradually. Last winter it didn't. But it's nowhere near the run-up of 2 years ago.

You are kind of in an isolated market where there is more supply than consumption and no where to export it to.

Here in So. Calif. it's a totally different story, most of our gas in imported and the enviros have shut down almost all the oil fields and forced the electric generation to natural gas (really stupid) and look forward to another energy crisis this winter here.

There is more oil and natural gas here than we can consume if the enviros would only allow it to be drilled and used.

That says it all.

there is more supply than consumption and no where to export it to.

The market for natural gas is tiny in Fairbanks, even if they hook up everyone. We watch the natural gas price because if it gets high enough the Alaska Natural Gas Pipeline will be built and that represents a bonanza of jobs for Fairbanks. Break-even is $2.70 and now it is $4.70 or so, but they won't build until it gets above $9.00 and stays there a while.

Today the Bush Administration informed Congress that the U.S. will use overwhelming force, including nuclear weapons, if chemical and biological weapons are used against this country or its military forces.

Just where exactly would be drop a nuclear bomb? So much huffing and puffing going on you'd think this was about the three pigs and the big bad wolf.

Richard W.

Thought you all might enjoy this nightly gathering of market commentators, economic junkies, and various other misfits.

We also have some serious thinkers who lurk and post here. If you are interested in getting an opposing and more realistic view of the economy that you won't hear on pump and dump media outlets like CNBC, this is the place to be.

I came across the Lawrence Parks interview again and thought that it was worth a repost. The audio runs about an hour but it is extremely enlightening. Here's the link:

Lawrence Parks Interview

Richard W.

Considering the coming war with Iraq, the strains with Saudi Arabia, and the general restlessness in the Muslim world, it's remarkable that oil prices aren't a lot higher.

Er, that we'd use nukes to even the score in the event of a chem/bio attack has been a poorly-hidden secret ever since we stopped producing chemical and biologial weapons. Personally, I'd drop bomb #1 on the cultural center of whoever sent over the chemicals or biologicals (read, Mecca).

You forgot about the near-chaos in Venezuela. It is quite surprising that I still see gas for around $1.30/gallon up here in high-price central (suburban Milwaukee).

near-chaos in Venezuela. It is quite surprising that I still see gas for around $1.30/gallon up here in high-price central... .

Yep, they used to bump it up a nickel for a little refinery fire. Now, a major source is shut down and nothing. Guess it just shows how controlled and manipulated the market really is. They price it where they want it.

Richard W.

The former is a "final product" shortage that can't be solved by simply getting the gas from someplace else (US refineries are at essentially 100% capacity and have been for some time). Venezuelian oil can, at least theoretically, be replaced at virtually no cost.

Still, it is another commodities game.

If it has really been that consistent, I guess Puplava must be a billionaire by now from daytrading. NOT!

And I just paid $1.28 for gas, the cheapest I've seen in months. The spot markets aren't too worried about Iraq or Venezuela. Maybe they should be. As always we'll see...

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