ExxonMobil (XOM) has been producing a little over 2.4 million barrels of oil a day for the last year and a half, its lowest rate of production over the last decade. The dark blue line in the figure below shows the company's production each year since 1999. Four years ago, Stuart Staniford noted that ExxonMobil's 2001 annual report predicted 3% annual growth in production between 2001 and 2007. That projection appears as the red line in the graph below; didn't quite come out as planned. Stuart's theory was that the company correctly predicted the contribution of its new discoveries, but underestimated the declining production rates from mature fields.

ExxonMobil again predicted in 2006 that it could achieve 3% annual growth over 2006-2011. I've shown that forecast as the lighter blue line in the figure. We still have two more years to make that one right, I suppose.

Dark blue: ExxonMobil's annual net production of crude oil and natural gas liquids in millions of barrels per day. 1999-2008 from company's annual reports. 2009 based on average of 2009:Q1 and 2009:Q2. Red: forecast from the company's 2001 annual report. Light blue: forecast from the company's statements in 2006.

The Wall Street Journal reported on Wednesday that ExxonMobil is prepared to spend $4 billion to buy 1/4 interest in the Jubilee oil field off the coast of Ghana, which would represent 15% of the oil giant's 2008 capital and exploration budget. Alan von Altendorf thinks they can't make a good return unless they sell the oil for $100/barrel. Presumably the company is reckoning on more oil in the field than current estimates suggest. But even if von Altendorf's calculations are off by a factor of two, it still seems to signal a change in philosophy for a company that has historically been extremely careful with its investments in order to maintain its position as a very low-cost producer.

But what else is the company to do? It's not like they haven't tried to take advantage of Russia's or Venezuela's strong commitment to protect foreign investors or the peaceful aspirations of Nigerian rebels.

Chevron (CVX) and many other companies are finding clever new ways to get more oil out of mature U.S. fields. That may well succeed in slowing the rate at which production from those fields declines over time. But to get the plot in the graph above to slope up you really need to develop new fields.

The New York Times is encouraged by the "brisk pace of new discoveries" which the paper reports "have totaled about 10 billion barrels in the first half of the year".

The Oil Drum, always a party pooper, notes that the world likely consumed that much in the first four months of the year.

Company Description

El Paso Corporation is a large independent natural gas producer and operates one of North America's largest interstate natural gas pipeline systems.

El Paso Surprised by 19.05% on the Second Quarter

On Aug 6, El Paso reported its second quarter results and beat the Zacks Consensus Estimate by 4 cents. Earnings per share were 25 cents which was lower than the 39 cents from a year ago. Lower natural gas and oil prices impacted the results.

The company saw production rise in the Central and Western divisions by 6% and 5%, respectively, over the year ago period.

With the drop in crude and natural gas prices, the company reduced its drilling rig activity by 70% since the third quarter of 2008. In response to the economic conditions, it has cut its overall per-unit cash costs.

On the positive side, the Pipeline Group grew compared with the same quarter in 2008 but this was offset by the decline on the E&P side of the company. The Pipeline Group brought two projects into service during the quarter.

El Paso has price protection through hedging for 70% of its domestic natural gas production for the second half of 2009. The company also hedges its oil production, with fixed-price hedges on 1.3 million barrels of crude oil with an average price of $53.75 per barrel.

Full Year Zacks Consensus Estimate Moves Higher

The third-quarter Zacks Consensus Estimate has been stable over the past 60 days, holding at 21 cents per share.

Analysts are a bit more bullish on the full year, as the Zacks Consensus Estimate has risen 8 cents to $1.07 per share in the last month.

Value Fundamentals

El Paso is a Zacks #1 Rank (strong buy) stock. It has a price-to-book of 2.35. The company has a solid 5-year average return on equity (ROE) of 10.31%. As an added bonus, El Paso pays a dividend with a current yield of 2.10%.

Zacks Investment Research

Production

Chesapeake’s average daily production for the quarter increased 5% year over year and 4% sequentially to 2.45 billion cubic feet equivalent (Bcfe), of which natural gas was 92%.

Taking into account the company’s voluntary production curtailments due to low natural gas prices (averaging about 74 million cubic feet equivalent per day – MMcfe/d), three 2008 volumetric production payment sales (averaging approximately 139 MMcfe/d) and estimated impact from the sale of its Woodford Shale and Fayetteville Shale properties (averaging roughly 81 MMcfe/d), Chesapeake’s year-over-year and sequential production growth rates were 16% and 4%, respectively.

Realizations

Average realizations for the quarter were $5.56 per thousand cubic feet (Mcf) for natural gas, compared to $6.05 per Mcf in the previous quarter and $8.18 per Mcf in the year-ago period. Realizations came to $56.72 per barrel of oil, compared to $39.12 per barrel in the previous quarter and $76.96 per barrel a year earlier.

Proved Reserves

At the end of the quarter, Chesapeake had proved reserves of approximately 12.5 trillion cubic feet equivalent (Tcfe), an increase of 6% from the end of the previous quarter. Total drilling and net acquisition costs for the quarter were $0.72 per Mcfe.

During the quarter, the company replaced 223 billion cubic feet equivalent (Bcfe) of production with an estimated 897 Bcfe of new proved reserves for a reserve replacement rate of 402%.

Liquidity

At the end of the quarter, Chesapeake had a cash balance of $554 million and a debt-to-capitalization ratio of 53.1%, compared to 52.3% as of Mar 31, 2009. The company plans to reduce its debt level and strengthen its balance sheet through asset monetization and the growth of its proved reserve base.

For this, Chesapeake is aiming to monetize its leasehold along with its producing properties, midstream assets and other assets for $2.35 to $3.05 billion in 2009 and $1.25 to $1.80 billion in 2010.

Company Guidance

Chesapeake is guiding for production of 12 million barrels of oil and 875–885 Bcfe of natural gas in 2009. In 2010, the company expects 12 million barrels of oil production and 940–960 Bcfe of natural gas. It sees an increase in planned drilling activity levels and raised its drilling capital expenditure budget for 2009 and 2010 to $6.7 billion from $6.0 billion.

Outlook

With the bulk of its projected 2009 production hedged at attractive prices and with access to resource-rich assets, Chesapeake remains better positioned than most of its peers to operate in the current low commodity price environment.

A steep decline in natural gas production on the back of lower drilling activity will soon lead to tighter natural gas markets. This will lift natural gas prices and improve the company’s profitability in 2010 and beyond, in our view.

Additionally, the company’s asset-monetization initiatives have led to greater financial flexibility. Chesapeake is expected to post 4%–5% volume growth this year and 7%–8% in 2010, highlighting the quality of its asset base. We recommend a Neutral rating for Chesapeake shares.

Company Description

Canadian Natural Resources is an independent oil and natural gas exploration and production company. Based in Calgary, Canada, it has operations in Western Canada, the North Sea and Offshore West Africa.

The company is also invested in the Horizon project in the Canadian oil sands of Alberta.

Canadian Natural Resources Surprised by 111.76% in the First Quarter

On May 7, the company reported first quarter 2009 results which beat Wall Street estimates by 57 cents. The company reported $1.08 compared to analysts' estimates of 51 cents.

Adjusted net earnings fell 16.6% to C$727 million from C$872 million in the year ago period.

Production in both crude and NGLs rose 7% quarter over quarter to 330,017 bbl/d. It also rose slightly compared to the first quarter of 2008 where it was 327,217 bbl/d.

The increase reflects the initial production from Horizon, the project in the oil sands, and the first oil production at the Olowi Field in Offshore Gabon.

"Cash flow remained strong in Q1/09. We benefited from favorable heavy oil differentials and our substantial hedging program," said John Langille, Vice-Chairman.

Dividend Payout Continues

The company continued with its practice of paying a cash distribution. It declared a quarterly dividend of 10.5 cents Canadian per share which was payable on July 1.

The current yield is 0.80%.

Second Quarter Outlook

Canadian Natural Resources issued an optimistic forecast for production in the second quarter of between 321,000 and 359,000 bbl/d of crude oil and NGLs.

Estimates Rise

Analysts liked what they saw in the first quarter results and have been raising estimates on both the second quarter and the full year.

Second quarter consensus has jumped nearly 20% to $1.10 per share with 2 out of 2 covering analysts raising in the last 30 days.

There are 10 analysts covering the full year and 3 of those analysts have raised in the last month, including 2 in just the last week. Consensus estimates are up 7 cents to $3.83 per share.

Value Fundamentals

Canadian Natural Resources is a Zacks #1 Rank (strong buy) stock. It is trading with a price to book of 1.71. The company has an outstanding 5-year return on equity (ROE) of 24.43%.

Zacks Investment Research

Last week, YPF SA, Spanish oil firm Repsol’s (REP) Argentine unit, together with other South American oil majors, won a bid to explore for oil in offshore blocks near the coast of Uruguay. YPF will have a 40% interest in the exploration consortium, the same as Petrobras Uruguay, a unit of Brazil ’s state-run oil giant Petrobras (PBR). Portugal’s Galp Energia will control the remaining 20% share.

YPF is the operator of ‘Block 3,’ while Petrobras will operate ‘Block 4,’ both located along the coast of Punta del Este. Situated around 150 kilometers off the coast of Uruguay, ‘Block 3’ is at a depth of 100 to 200 meters beneath the ocean surface. Block 4 is at a distance of 300 kilometers from the mainland at depths varying from 200 to 1,500 meters. The companies can conduct studies on the blocks for four years before deciding on drilling.

YPF, which reported a 59% decline in first quarter net income, accounts for two-thirds of the Spanish group’s oil production. Though YPF did not specify the quantum of investment it plans for the projects, we believe that the awards could boost the company’s (and its parent Repsol’s) development profile.

Any drilling success in the long-term will help Repsol (which makes much of its profit from refining in Europe) strengthen its crude reserves and both stabilize and build earnings. Until then, we prefer to remain on the sidelines and maintain our Hold recommendation on the company.

We believe that the long list of challenges facing Repsol will continue to weigh on its valuation, limiting its upside from current levels. These include declining reserves, weak volumes, very low reserve lives, and rising costs.

Chicago, IL - June 17, 2009 - Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include: Nabors (NBR), Patterson-UTI (PTEN), Schlumberger (SLB), Baker Hughes (BHI) and Alexza Pharmaceuticals (ALXA).

Get the most recent insight from Zacks Equity Research with the free Profit from the Pros newsletter: http://at.zacks.com/?id=5513

Here are highlights from Tuesday's Analyst Blog:

Land Driller Gains Unsustainable

We are scratching our heads to justify the impressive recent gains made by land drillers such as Nabors (NBR) and Patterson-UTI (PTEN). We are of the view that these gains lack fundamental support and remain unsustainable.

Shares of land drillers have been star performers lately. In the last 12 weeks, land drillers are up an average 41%, compared to a little over-12% gain for the S&P 500. During the same time period, the deepwater offshore drillers gained roughly 25%, while the large-cap oilfield service companies, such as Schlumberger (SLB) and Baker Hughes (BHI) went up by about 32%. Year-to-date, the land drillers are up 31%, while the deepwater offshore and the oilfield service groups are up 56% and 53%, respectively.

Oilfield service activities outside the U.S. are largely centered on looking for, developing and maintaining oil production. Offshore drilling, particularly the deepwater end of it, is similarly oil-centered. As such, it makes perfect sense for the stock prices of the large global oilfield serve players and the deepwater offshore drillers to be making handsome gains given the roughly doubling of oil prices from their Feb'09 lows.

But land drilling in the U.S. is primarily for natural gas. And natural gas prices have not moved much, if any, in recent days. In the last 12 weeks, natural gas prices are flat to modestly down, basically stuck around $4. A massive storage overhang, still growing domestic production, fears of increased LNG imports, and recession-hit demand, particularly in the industrial sector, continues weighing on natural gas prices.

Alexza Buying Symphony-Allegro

In what we consider to be a fantastic transaction for both management and shareholders, Alexza Pharmaceuticals (ALXA) announced on June 16, 2009 that it has entered into an agreement with Symphony-Allegro to require the rights to all product candidates subject to the December 2006 agreement with Symphony Capital Partners Inc. et al.

The formation of Symphony-Allegro, initially funded with $50 million in capital to facilitate the development activities for AZ-002, AZ-004, and AZ-104, has been a substantial impediment to partnering discussions on these three candidates, and a significant overhang on the stock. Our May 8, 2009 report, entitled "The Symphony-Allegro Squeeze," outlined our belief that the stock would remain under pressure until this overhang was lifted.

To re-acquire the full rights to these three candidates, Alexza will issue Symphony-Allegro 10 million shares of newly registered common stock, plus 5 million warrants to acquire additional shares (at 1:1) at an exercise price of $2.26/share. Symphony-Capital's new total ownership in Alexza Pharmaceuticals will stand around 23% once the deal closes in the third quarter 2009. Symphony-Capital will also nominate one member to the board of directors.

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When I first began working on my Ph.D. dissertation in 1980, I was intrigued by the fact that the oil embargo of 1973-74 and the collapse in Iranian oil production after the revolution in 1978 were both followed by global recessions. But when I called attention to the fact there had been a sharp increase in the price of oil prior to 6 of the 7 postwar U.S. recessions up to that point, the general response was one of skepticism.

By the time I was presenting evidence of this relation at various seminars in 1981-82, the Iran-Iraq War had produced yet another shock to world oil markets and the NBER declared that the U.S. experienced a new recession immediately on the heels of the previous downturn, meaning that the evidence had now become that 7 out of 8 recessions had followed oil price increases. That research was subsequently published in the Journal of Political Economy in 1983 and the Energy Journal in 1985. My ideas about how this relationship might be explained by disruptive changes in the composition of spending appeared in the Journal of Political Economy in 1988.

We received some more evidence on this relationship when Saddam Hussein invaded Kuwait in August 1990, causing oil prices once again to double and coinciding with the 9th postwar recession. The price of oil also shot up before the 2001 recession. Add in the conjunction of the oil shock of 2007-08 with our current economic pickle, and my count is now up to 10 out of 11.

For the record, my position has never been that oil prices were the sole cause of all of these recessions. But the evidence persuaded me that oil must have been a contributing factor in at least some postwar recessions.

Given my long interest in this area, the Brookings Institution approached me about the possibility of writing a paper on the causes and consequences of the oil shock of 2007-08. In that paper I compared what happened last year with what we'd seen in the many previous episodes. I presented those findings at a Brookings conference earlier this month, and described some of the results for Econbrowser readers here and here.

One of the things I did in that paper was to examine a number of different models of the effects of oil prices on the economy that had been developed for earlier data, and look at what those models would have predicted to happen in 2007-08. My conclusion was that most of those models held up pretty well. Using any of the estimates surveyed, the oil shock of 2007-08 was big enough to have made a material negative contribution to real GDP over the period 2007:Q4 to 2008:Q3, and the details of what happened over that period are quite consistent with the predictions.

The reason that I think this is an interesting finding is that this period-- 2007:Q4 to 2008:Q3-- was when the U.S. entered recession #11. The fourth quarter of 2008 saw a very dramatic deterioration in all the economic indicators, but if you focus just on the first 12 months of the recession-- 2007:Q4 to 2008:Q3-- things wouldn't have had to be much better before most analysts would have said that the economy was not even in a recession prior to 2008:Q4. For example, real GDP actually grew by 0.7% between 2007:Q3 and 2008:Q3.

Dave Cohen argues that the GDP figures are too optimistic, and I agree. But whatever your preferred measure might be, it wouldn't take much to nudge 2007:Q4-2008:Q3 into a range that's not usually associated with recessions. For example, gross domestic income on average fell by -0.45% over 2007:Q4-2008:Q3. My paper calculated that using any of the models surveyed this would have been a positive number if there had not been the contractionary effects of the oil shock. Alternatively, a 12-month drop in total employment is sometimes used as another indicator of whether the economy is in a recession. We crossed that threshold in the summer of 2008. But if we had not shed 150,000 jobs in auto manufacturing-- job losses that I think were pretty clearly tied directly to the oil price shock-- employment growth would still have been positive going into the fall of 2008.

Comparison of the effects on auto industry employment of the oil shocks of 1990 and 2007-08. Graph shows cumulative change in the number of workers employed in motor vehicles and parts manufacturing in months subsequent to July 1990 (red) and July 2007 (blue).

Why does it matter whether, in the absence of the oil shock, the experience over 2007:Q4-2008:Q3 might have been a bit better in terms of such measures as GDP or employment? My answer is that the drops in overall spending that were caused by higher oil prices proved to be the knockout punch for an economy that was already wobbly. Whatever your preferred culprit might be for our current difficulties-- loan default rates, falling house prices, debt burdens, or pessimistic sentiment-- that measure would have had a more favorable value going into the fall of 2008 if we had experienced more favorable fundamentals in terms of income and jobs over 2007:Q4-2008:Q3. And there's no question that more favorable fundamentals are exactly what we would have had if the price of oil had never gone over $100 a barrel.

The fact that the biggest drop in output didn't occur until well after the oil price went up, and resulted not from the oil price itself but instead from the interaction with other factors and the dynamic forces unleashed when the overall level of economic activity began to decline, is also exactly the same pattern we saw in each of the previous recessions.

Was the oil shock of 2007-08 the sole cause of the recession? Certainly not. But did it make a material contribution? In my opinion, the answer unquestionably is yes.

You can also find a lot more discussion over at theoildrum.com ([1], [2], [3]).

Technorati Tags: oil, oil prices, oil shocks

World real GDP increased by 9.4% between 2003 and 2005. That growth in world income was the primary cause behind an increase in world petroleum consumption of 5 million barrels per day between 2003 and 2005, a 6% increase over the two years. The next two years (2006 and 2007) saw even faster economic growth (10.1% cumulative two-year growth), with Chinese oil consumption alone increasing 870,000 barrels per day. Yet between 2005 and 2007, global oil production stagnated.

Thin line. Monthly global crude oil production, including lease condensate, natural gas plant liquids, other liquids, and refinery processing gain, in millions of barrels per day, 2003:M1-2008:M10. Data source: EIA. Bold line: 12-month moving average of values from thin line centered at indicated date..

What persuaded residents outside of China to reduce petroleum consumption in the face of booming levels of income? The answer is that the price of oil had to increase. How much the price should have risen depends on the price elasticity of demand. Consider the following illustrative calculations. It seems reasonable to maintain that the economic growth in 2006 and 2007 would have resulted in at least as big a shift of the demand curve as resulted from the slightly weaker GDP growth of 2004 and 2005. Adding in the first half of 2008 (when global GDP continued to rise), consider then the consequences of a rightward shift of the demand curve of 5.5 million barrels per day. With production only increasing by 0.5 mb/d over this period, a demand elasticity of ε = 0.06 would imply that the price should have risen from $55/barrel in 2005 to $142/barrel in 2008:H1.

Illustrative price effects of 5.5 mb/d rightward shift of demand curve and 0.5 mb/d rightward shift of supply curve between 2005 and 2008:H1 assuming price elasticity of 0.06. Source: Hamilton (2009).

A short-run elasticity of 0.06 for crude petroleum demand could certainly be defended on the basis of estimates in the literature, though so could a higher or lower value. I offer the above calculation simply as an illustration that the observed price behavior could be fully reconciled with reasonable assumptions about supply and demand.

But why then did the price subsequently collapse even more dramatically? A shift of the demand curve back to the left as a result of the impressive global economic downturn is certainly part of the answer. Note, however, that even if global real GDP were to fall by more than 10%-- which so far fortunately it has not-- that would only put us back to where we were in 2005 (at $55 a barrel), and the price was observed to fall even more than this. We therefore would need to postulate a second factor behind the price decline of 2008:H2, namely, an increase in the price elasticity of demand as consumers had time to make adjustments. Again such a hypothesis is consistent with previous experience, and in particular, between 2007:Q3 and 2008:Q3, U.S. petroleum consumption fell by 8.8%. That drop in U.S. petroleum consumption unambiguously represented the combined effects of lower income and price-induced changes in use.

If we say that one elasticity (0.06) is to be used to account for the 2008:H1 price and another higher elasticity for 2008:H2, there is an implicit claim that market participants were learning imperfectly about the price elasticity of demand. There was a surprisingly long period in which demand responded less than some might have expected to the oil price increases (i.e., consistent with an elasticity of 0.06), and then a very dramatic drop in oil use as a result of the combined influence of falling incomes and changing consumption habits.

My paper also has an extensive examination of an alternative explanation based on a speculative bubble in the price of oil. I will not attempt to reproduce much of that analysis here, but only note the bottom line: in order to reconcile a proposed speculative bubble story with the observed behavior of the physical quantities demanded, supplied, and going into inventories, it is necessary to postulate a very low price elasticity of demand through 2008:H1-- precisely the same conditions one would need in order to attribute the price moves entirely to fundamentals.

In terms of policy implications, the paper suggests that sales out of the Strategic Petroleum Reserve could have been explored as a possible tool for curbing excessive speculation, and proposes that the U.S. Federal Reserve needs to take account of possible consequences of its actions for relative prices of commodities. My bottom line was nevertheless the following:

But while the question of the possible contribution of speculators and the Fed is a very interesting one, it should not distract us from the broader fact: some degree of significant oil price appreciation during 2007-08 was an inevitable consequence of booming demand and stagnant production. It is worth emphasizing that this is fundamentally a long-run problem, which has been resolved rather spectacularly for the time being by a collapse in the world economy. However, the economic collapse will hopefully prove to be a short-run cure for the problem of excess energy demand. If growth in the newly industrialized countries resumes at its former pace, it would not be too many more years before we find ourselves back in the kind of calculus that was the driving factor behind the problem in the first place. Policy-makers would be wise to focus on real options for addressing those long-run challenges, rather than blame what happened last year entirely on a market aberration.

Technorati Tags: oil, oil prices, oil shocks

Company Description

Berry Petroleum is an independent exploration and production company with operations in California, Colorado, Texas and Utah.

As of Dec 31, 2008, proved oil and gas reserves had grown 45% to 246 million BOE compared to 169 million BOE at the end of 2007. The company's proved reserve mix was 51% oil and 49% natural gas by the end of 2008.

The company is geographically diverse, with 45% of proved reserves in California, 35% in the Rocky Mountain region and 20% in East Texas.

Berry Beat Wall Street Estimates by 26.09% in the Fourth Quarter

On Feb 24, Berry Petroleum reported fourth quarter and full year earnings which surprised analysts' estimates by 6 cents per share. Net income was a loss of $12 million, or a loss of 27 cents per share, compared to $32.3 million, or 71 cents, in the fourth quarter of 2007.

The loss was a result of the write-off of $38.5 million (pre-tax) of accounts receivable due from Big West of California as a result of its bankruptcy filing in Dec 2008.

Excluding the write-off, Berry earned 29 cents per share. Analysts expected 23 cents.

For the year, net income rose 3% to $2.94 from $2.89 in 2007. Total revenue jumped 37.6% to $802 million from $583 million in the year ago period. Operating cash flow was $410 million for the year compared to $239 million in 2007 due to strong mid-year commodity prices and increasing production.

2008 production rose 19% to an average of 31,970 barrels of oil equivalent per day (BOE/D) from the 26,900 BOE/D in 2007.

Outlook for 2009

The company is optimistic about 2009 despite falling commodity prices.

"We expect our 2009 operating cash flow to be between $175 and $200 million, which will fund our entire 2009 development program," said David Wolf, executive vice president and chief financial officer.

"Our hedge position makes our 2009 operating cash flow fairly insensitive to changes in commodity prices with a $10 change in WTI prices impacting our cash flow by approximately $2 million and a $1 change in Henry Hub prices impacting our cash flow by approximately $6 million."

The company will be hedging over 90% of its oil production, so that if WTI averages $40 per barrel, the realization will be $65.50 per barrel. It also expects to increase production slightly to 32,000 BOE/D.

2009 Consensus Estimates Rise

Given the company's outlook, covering analysts are bullish about 2009. Full year consensus estimates rose 17.9% to $1.71 in just the last week with 2 out of 4 analysts raising estimates.

Value Fundamentals

Berry Petroleum is a Zacks #1 Rank (strong buy) stock. It has surprised on estimates 3 out of the last 4 quarters by an average of 8.46%.

BRY is cheap, trading at only 3.9x forward earnings. Its price-to-book is just 0.36. The company has an outstanding 5-year average return on equity (ROE) of 30.01%.

Additionally, because of the recent drop in the share price, the company's dividend currently yields 4.51%.

Zacks Investment Research

This from Penny Sleuth:

Question: Where is the price of petroleum going?
Eric Sprott: Long term, up… I can see it hitting $200 or $300 or $400 a barrel.
— Barron’s, Aug. 18, 2008

Eric Sprott runs the Sprott Offshore Fund, a fund that’s delivered sizzling returns of 32% per year since 2002. Certainly, timing is important, as 2002 was the last great bottom. Even so, it’s not so easy. Lots of people have done a lot worse…

Oy. “The $700 billion financial bailout program,” the New York Times sums up Treasury Secretary Paulson’s speech this morning, “will not be used to buy troubled mortgage-backed assets, as originally intended. Instead, capital would be provided directly to nonbank companies, as well as banks and financial institutions, and that more would be done to prevent home foreclosures.”

Is it any wonder 83% of Americans think the U.S.…

Oy. “The $700 billion financial bailout program,” the New York Times sums up Treasury Secretary Paulson’s speech this morning, “will not be used to buy troubled mortgage-backed assets, as originally intended. Instead, capital would be provided directly to nonbank companies, as well as banks and financial institutions, and that more would be done to prevent home foreclosures.”

Is it any wonder 83% of Americans think the U.S.…

This from Today’s Financial News:

This cannot be good for the oil industry. There is a very left-leaning Democrat packing his bags and heading to Washington. The high-profit, we’ve-got-them-bent-over-a-table oil industry must be pinching itself hoping this is nothing more than a bad dream.

Unfortunately, it is real. Democrats now control the White House, the Senate, the House, the courts, our schools, and a large chunk of our nation’s banks. All that is left for us pro-business voters to do…

More from Penny Sleuth:

News that Shell is to halt development of its vast Canadian tar sands project is a sign of changing times in the oil industry – and one that will not be well received at the AIM-listed provider of data to the oil industry, GETECH (LON:GTC). This is a pity because…

Now, twelve months later, as W’s presidential twilight years draw to a close, another of the West’s leaders journeys to the Gulf region. Like Bush, England’s Gordon Brown is not particularly popular in the polls. But this captain from the west has more pressing issues to deal with than the restoration of his public image; he needs…

Second Planet Needed to Meet Natural-Resources Demand

That's what humans will need by the mid-2030s to keep up with our demand for metals, fossil fuels, timber and waste disposal, the environmental group WWF said in a global survey that found the United Arab Emirates to be the most wasteful country.

The temples of doom

"We think we are different," says Jared Diamond, the American evolutionary biologist. "In fact...all of those powerful societies of the past thought that they too were unique, right up to the moment of their collapse." The Maya, like us, were at the apex of their power when things began to unravel, he says. As stock markets zigzag into uncharted territory and ice caps continue to melt, it is a view increasingly echoed by scholars and commentators.

What, then, is the story of the Maya? And what lessons does it hold for us?

According to Diamond's thesis, this: the ancients built a very clever and advanced society but were undone by their own success. Populations grew and stretched natural resources to breaking point. Political elites failed to resolve the escalating economic problems and the system collapsed. There was no need for an external cataclysm or a plague. What did for the Maya was a slow-boiling environmental-driven crisis that its leaders failed to recognise and resolve until too late.

Investment key to meeting oil demand

The IEA believes oil companies and oil-producing countries will need to invest a total of about $360bn a year until 2030 to replace falling oil production and increase supply by enough to satisfy the demands of emerging countries such as China.
Investment decisions by Opec will be critical, the study argues, adding that the share of world oil production from members of the cartel, particularly in the Middle East, will grow significantly, from 44 per cent in 2007 to 51 per cent in 2030.

This from Taipan Daily:

The petrocrats were richly rewarded as crude oil climbed to new heights. Now a sharp decline in the price of oil threatens to tear their world apart. A time for drastic action could be at hand…

Today I want to talk about a situation that feels like a ticking time bomb - a time bomb that could go off sooner rather than later. It starts with…

"The Kazakh government is ready to step in,'' Kazakhstan's Prime Minister Karim Masimov said this morning in a telephone interview with Bloomberg "The Kazakh banking system with the support of the government and central bank will fulfill all obligations to international investors.....We have our own specific plan to survive without any external support....I don't think we need support from the International Monetary Fund or overseas.''

Ranked as the ninth largest country in the world by size, it is also the world's largest landlocked country, with a territory of some 2,727,300 km² (which is greater than the whole of Western Europe). It is bordered by Russia, Kyrgyzstan, Turkmenistan, Uzbekistan and China. On the other hand, and despite its enormous size, Kazakhstan has a comparatively small population. No one actually has an exact idea of the actual size of the Kazakhstan population (not to mention the thorny issue of just how many foreign migrants live and work there), but the US Census Bureau International Database list the current population of Kazakhstan as 16.763 million, while sources drawing their data from the United Nations (like the IMF which I have relied on for the chart below) give a 2008 estimate of 15.135 million. In any event the current population level, after falling in the early 1990s as ethnic Russians left, has now stabilised, and is virtually stationary. This virtually stagnant population constitutes, as we will see, a significant problem for a country with such a massive resource base, and such enormous economic and development potential as Kazakhstan would seem to have.

Record Oil Revenue Boom

Kazakhstan is the biggest energy producer in Central Asia and the country's $100 billion economy has in fact grown at an average of 10 percent a year rate since 2000 (see chart below), in particular as the price of oil has surged. This rapid GDP growth produced a rapid increase in per capita income as well as national creditworthiness, and these in turn sparked in their wake a substantial construction boom. Indeed it has precisely been the bursting of this boom in the autumn of 2007 - on the back of the seize-up in global wholesale money markets which followed August's financial turmoil in the USA - which lies at the heart of Kazakhstan's current growth slowdown. Kazakhstan's economy expanded at a 'mere' 5.3 percent rate in the first quarter of 2008, half the pace achieved in the same period a year earlier, following a dramatic curtailment in bank lending, and if Kazakhstan is still able, despite all the problems we will see below, to maintain some sort of growth momentum at this point it is undoubtedly the result of the oil and other commodity resources which the country has at its disposal, and indeed as part of its initial response to the present crisis the country increased crude production by an annual 6.3 percent in the first four months of the year, according to official government data.




Now one of the most curious details about the present slowdown in Kazakhstan, has been the fact that at the very same time as the economy started to lose velocity the central bank found itself busy struggling to curb an inflation rate which was steadily shooting onwards and upwards towards the outer stratosphere, as revenue from record oil prices pushed up domestic demand, and the resulting construction and consumption boom drove up wages far beyond normal "productivity-gain" rates of increase (remember, there are not THAT many people in the country, and much of the population is rural and unskilled in relation to the needs of a modern technological and services economy). In fact inflation hit year-on-year rates of increase approaching 20% in the autumn of last year (see chart below), although it had dropped by to an annual 18.2% by September.




So, as well as containing the property bust, the Kazakh authorities have also had to conduct an inflation fight (more details below). So far from lowering rates like the US Federal Reserve has been able to do, Karakhstan's central bank was forced to raise the key interest rate to 11 percent in December 2007, at a time when annual inflation was riding at almost 19 percent, the highest for the country in over eight years. The refinancing rate was then maintained at the 11% level until it was finally lowered to 10.5% at the last central bank meeting in July.



Not Just Energy - Vast Resource Potential

The fact that Kazakhstan's industrial output growth has lost a lot of momentum in 2008 as the slowdown in the building industry provoked a slump in cement and other materials production should not take our minds too far away from the fact that the underlying potential in Kazakhstan is enormous. In fact while industrial output growth was reduced to an annual 3.8 percent growth rate in the January-June period, it was at least still growing.

The low point seems to have been hit back in January, when cement production which, not surprisingly, was among the hardest hit sectors, was down 26 percent year on year, the sharpest January fall in five years, as growth in the construction industry stalled, brought to a halt by the fact that the Kazakh banks, who had been struggling to borrow from abroad following the collapse of the U.S. subprime mortgage market, virtually stopped lending to homebuyers and builders.

Copper and rolled-iron output also declined an annual 13 percent in January while output from oil refineries and manufacturing industry decreased an annual 2.9 percent as the problems rolled in. Thus there is evidence of a very sharp shock initially hitting the local economy. On the other hand, since the country is resource rich and the given that first half of 2008 saw a very significant global commodities boom, there were other economic sectors to fall back on, and mining production was up 6 percent from a year earlier in the first quarter, bolstered by an increase in natural gas and coal output, which climbed 15 percent and 11 percent respectively. At the same time crude oil production went up by an annual 5.4 percent.

Apart from oil and gas Kazakhstan has a huge array of potential resource reserves just waiting to be tapped. Among these there is copper. London-listed Kazakhmys accounts for the bulk of Kazakh copper output - and this was down 17.5 percent year-on-year in January-April. Industrial output in Karaganda region, home to Kazakhmys and Arcelor Mittal mines and smelters, declined 5.5 percent year-on-year in January-April.

Kazakhmys reported that their first-quarter output fell 9.9 percent on "severe winter weather'' and repairs at its Balkhash smelter. Production of finished copper plates, or cathodes, from the company's ore fell to 75,500 metric tons, from 83,800 tons a year earlier. These drops in output are, of course not entirely associated with the credit crunch, but they do give an idea of the challenging and volatile environment in which the mining and extraction industries work in Kazakhstan. Realistically speaking it seems quite likely that output in these sectors will return to more normal levels during the second-half of 2008, having alreadt rebounding significantly from the low point reached in the first-quarter.

On the other hand industrial output in capital Astana and commercial hub Almaty, where most construction activities are based, was down 13.2 percent and 8.6 percent, respectively, in January-April, and this activity may well take much longer to recover.

Kazakhstan has also had to cut its 2008 oil production forecast to 67.6 million tonnes (1.35 million barrels per day) from a previous estimate of 70 million tonnes citing maintenance works and transport bottlenecks. The country is able to produce a lot of oil, but it does have a large problem getting that oil to the places where people want it. Three major pipeline routes - the Atyrau-Samara and Caspian Pipeline Consortium (CPC) links to Russia, and the Atasu-Alashankou pipeline to China - carry Kazakh crude off towards its end destinations, but none of these are proving sufficient to the demands on them.

"It is impossible to transport crude out of Kazakhstan without some difficulties," Senior Associate Klara Nurgaziyeva from law firm Dewey & LeBoeuf told an oil and gas conference last week in the Kazakh financial capital Almaty.

In a smoke-filled bar in the Kazakh financial capital Almaty, the laughter of Scottish ex-pats is loud and boisterous. More than three thousand miles (5,491 km) separate the Scottish Highlands and the Central Asian steppe, but a mutual interest in oil and gas has created a surprising alliance. Residents estimate that around 400 Scots live in ex-Soviet Kazakhstan, a resource-rich country roughly the size of western Europe.

Most come from Aberdeen, Britain's northeastern oil hub, and they bring with them their technical expertise."We're going to try attract Kazakhs to Aberdeen over the next few years and look at initiatives, and create further investment in Scotland from Kazakhstan," Lord Provost Peter Stephen of the Aberdeen City Council told an energy conference last week in Almaty. He said over 100 companies from in and around Aberdeen are active in Kazakhstan, and the Scottish oil town even has a Kazakh consulate to serve the hundreds of Kazakhs who go to Scotland to train up for the oil business. The Kazakh-British technical university, set up by a group of Scottish universities seven years ago, occupies a grandiose columned building in the centre of leafy Almaty, which housed parliament before the capital was moved to Astana.

Prices for residential property soared 30.2 percent in 2007, reaching a record average mid-year high of 161,300 tenge ($1,338) per square meter, up from 123,900 tenge in 2006, according to the Astana-based state statistics agency. In the financial capital, Almaty, the average price was 345,200 tenge.

The drop in prices from these peaks and the sudden drying up of credit has caused numerous problems for would.be buyers, and Bank TuranAlem, Kazakhstan's second-biggest bank by assets, received $81.2 million last December from the state emergency investment program simply to finance the completion of unfinished construction projects.

The most recent government bailout of the construction sector was announced during the summer - just two weeks before the celebrations of Nazarbayev's 68th birthday and the 10th anniversary of the founding of the new capital Astana on July 6 - following the announcement by a group representing people who had purchased apartments in the unfinished buildings that they were planning a protest march to be held in Astana bang in the middle of the official festivities.

The Industry and Trade Ministry have said that there were 939 residential buildings, with 45,130 apartments pre-paid by homebuyers, under construction as of last January. Minister Edil Mamytbekov said in July that the cases of 4,558 homebuyers in 18 buildings "remain problematic'' because of conduct for which the builders in question had been "charged with crimes.'' The Kazakh Prosecutor General's Office said 123 construction companies that received 104 billion tenge ($865 million) in pre-payments from homebuyers were behind schedule or haven't even begun work on new apartment buildings.

Assets of "careless construction companies,'' including buildings and vehicles, have been seized to compensate lost investments of homebuyers and the government, according to the Prosecutor General's Office. Criminal investigations have been opened into eight companies. A total of 285 companies are building 407 residential projects in Kazakhstan and have received 231 billion tenge in pre-payments from more than 50,000 individuals and companies, prosecutors said. Of 200 ``problem'' projects delayed by at least six months, 110 are located in the capital Astana and 42 in Almaty.

The July rumpus was provoked by the fact that at the start of the summer the Kazakh government had spent only 51 billion tenge to complete stalled residential projects, a fraction of the bailouts promised by Prime Minister Karim Masimov in the autumn of 2007, according to data made public by the Ministry of Industry and Trade on June 23. The government had said on Nov. 14 2007 that it would spend $1 billion by the end of 2007 and another $3 billion in 2008 to "provide economic stability and growth'' by supporting the real estate market and small and medium-sized businesses. Following publication of this data, and some international press coverage, Masimov said that his original emergency investment program was in the process of being expanded, and his government announced plans to spend 17.2 billion tenge to complete residential projects in Astana.

President Nursultan Nazarbayev instructed the state to step in and finish projects, ``which have no source of financing,'' to ``help to reduce social tension,'' according to Edil Mamytbekov, a deputy minister of industry and trade, on June 20. President Nursultan Nazarbayev also said it was necessary to take ``tough measures against careless builders". As a result the Almaty mayors office announced on July 26 that another 46.4 billion tenge had been allocated to support residential projects in Almaty. The state had already invested 22.4 billion tenge and was going to spend the remaining 24 billion tenge by year's end, according to the announcement.

In April, however, the government had announced that the state development holding Kazyna would distribute 59 billion tenge to commercial banks during 2007 to finish 131 buildings in Almaty. Sergei Kuyanov, spokesman for Almaty Mayor Akhmetzhan Yesimov, declined to comment on the discrepancy between the numbers when question by journalists in July.

Whatever the complications of the present situation and the ins-and-outs of putting the construction and banking problems straight, we should not lose sight of the fact that Kazakhstan has, large financial resources which will surely help it weather the current situation. Official foreign currency assets totaled $46 billion in early June, comprising NBK reserves of $21 billion and oil fund (NFRK) assets of $25 billion. Commercial banks also have foreign assets of which about $3.5 billion are thought to be liquid. Total foreign assets broadly match foreign liabilities when the intracompany debt of the oil sector is excluded, while liquid foreign currency assets comfortably cover potential short-term foreign currency drains.


Favourable Demographics But Migrants Needed, And With Them Modern Citizenship Rights


The chart you will find below is known as a “heat chart”. It depicts the ongoing changes in Kazakhstan's age structure. Each dot represents the number of people in any given age group at any given point in time. A dark red dot represents the largest concentration of people, by age, in a particular year while deep blue dots show the lowest concentrations. A single dark red dot is the equivalent of almost 406,000 people while each deep blue dot represents nearly 23,000 people.


In the upper left-hand corner of the chart the bright reds and yellow areas depicts the population boom that started in the mid 1970s and lasted until the late 1990s. The remnants of that boom extend downward from left to right across the chart. The band also narrows as this population segment ages. This is simply a reflection of the reduction in the total numbers in the population bulge cohorts as out-migration has taken its toll.

Many ethnic Germans and Russians, for example, left Kazakhstan during the years following the end of the Cold War. In the lower left-hand side of the chart there is a preponderance of dark blue dots, indicating a relatively small number of people over the age of 60 years. Over time these dark blue dots are replaced by light blues and greens, a pattern reflecting a gradual but steady increase in the number of elderly people.

The strong budget position in Kazakhstan has provided scope for the government to use fiscal policy to support the economy as growth has slowed. We believe that the increase in spending in the recent supplementary budget is appropriate, and that the automatic fiscal stabilizers should be allowed to work, with any revenue shortfalls due to a weakening economy being accommodated in the near future rather than offset with expenditure cuts to meet budget targets. Going forward, the government's recently announced three-year budget plan maps out a transparent path for fiscal policy over the medium-term. We believe, however, that it is important that the government not commit to further large increases in public sector wages and pensions in future years given uncertainties about budget revenues—particularly from the oil sector—and the stage of the macroeconomic cycle in two or three years time.

Kazakhstan has large financial resources to help it weather the current situation, and medium-term economic prospects remain favorable. Official foreign currency assets, comprising central bank (NBK) reserves and oil fund (NFRK) assets, reached $48 billion at end-September, well above the mid-2007 level. The current account balance has strengthened significantly this year, and oil production is set to increase substantially in the years ahead.

As at the time of the Article IV consultation discussions in April, we believe that in the short-term policies should remain focused on managing risks to the outlook and setting the stage for the resumption of strong and sustained growth. Since our last visit, the authorities have continued to skillfully handle the difficulties the economy has faced, and we welcome the policy steps that are being taken in the monetary, fiscal, and supervisory areas to strengthen the resilience of the Kazakhstani economy. Nevertheless, considerable challenges remain, and these have been heightened by the renewed bout of global financial market volatility.

Greg Guenthner isn't sweating it.

Oil prices have been caught up in widespread panic selling of recent months. It remains a scarce and essential commodity. This means it is only heading in one direction over the long term.

Greg recommends following oil guru Richard Rainwater's cue and buying into oil stocks with both hands.

This from Penny Sleuth:

When the markets go to hell, it’s all too easy to become caught up in the moment. Fear is a powerful emotion. We all witnessed this firsthand as the market’s decline accelerated. As the markets continue to crumble, many investors lose sight of their goals. They sell positions indiscriminately; they become irrational.

The sell-off we’re experiencing right now is global. And aside from some safe-haven gold buying, no stock or commodity has avoided the bears. That’s why we’re looking at a scarce and valuable resource for steady long-term gains: oil.

One energy guru has recently made a big bet on oil.

He bought back shares of Exxon (NYSE:XOM), ConocoPhillips (NYSE:COP), Pioneer Natural Resources (NYSE:PXD), BP (NYSE:BP) and Statoil (NYSE:STO) — all at rock-bottom prices. We say he bought these shares back because, in a prescient move, this sage sold off every oil stock he owned in May…back when oil was sitting atop $129 per barrel.

A Fresh Oil Investment

Richard Rainwater knew he would be a bit early to the party — and probably miss the top — when he sold his oil investments back in spring. But with a stellar track record including massive gains betting on everything from hospitals to cell phones, he knew gains from his $300 million invested in oil stocks and futures were in jeopardy.

“I just felt that America was not ready for $4 gas and we would see a pause here,” he told Time magazine in June.

Rainwater pulled his billions in profits just before oil’s peak in July. Now, he’s ready to do it all over again, spreading his millions across Exxon, ConocoPhillips and other big-name petroleum pushers.

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Oil at $150 per barrel and gasoline at $8 a gallon or more…

The oil is running out. It’s as simple as that.

But that’s not what you hear from so-called experts. If you ask government officials, our intelligence agencies and even powerful Wall Street financiers, they tell you the opposite.

They say the Saudis could quickly double their oil production from the current level if they wanted to. And given a few years, they think the Saudis could produce four times as much oil as they do now.

They are dead wrong. Check it out here…

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Overwhelming Demand Will Prop Oil Prices

Rainwater’s outlook is simple: Increased worldwide demand will continue to push the oil price up in the long term. Rainwater’s not alone, either. Analysts and industry experts — like oil tycoon T. Boone Pickens and OPEC President Chakib Khelil — have been making it perfectly clear…oil’s on the rise again.

On July 11, 2008, oil made a record ascent to $147.27 — a 123% jump in only 12 months.  With oil sitting around $80 right now, oil aficionados like Pickens are bracing for the run-up to come. “The Saudis claim they have more oil; they don’t. The president wasted his time to go to Saudi Arabia, to say, 'Give us more oil.' They can't give any more oil...they're stacking up the money as fast as they can stack it up," warned Pickens in an interview with CNBC.

The allure of oil is hard to refute.

With finite supplies and unquenchable demand, it’s clear why many investment houses put oil above $200 in the near future.

According to Pickens, it’s just a case of an oil-hungry economy overwhelming producers: “Eighty-five million barrels of oil a day is all the world can produce, and the demand is 87 million. It's just that simple. It doesn't have anything to do with the value of the dollar.”

Now is the time to buy oil. The third quarter of 2008 saw the largest drop in oil prices in 17 years.

Now with OPEC slashing its production outlook for the rest of 2008 and 2009, it’s unclear just how long prices will be able to stay under $100.

Source: Prevailing in the Midst of Paranoia

But Smart Commodities UK editor Garry White says a number of nuclear power projects are already underway in other parts of the world. India plans to build between 18 to 20 new nuclear plants over the next 15 years. Even the Middle East is shifting to the atom for its future energy needs.

Nuclear plants are also proven to be effective at water desalination. This will be vital in emerging markets, where populations are rising rapidly.

This is from Fleet Street Daily:

He [Bodman] made the comments on the same day as the US senate signed off the nuclear co-operation deal with India. It was also a few days after Russia agreed to help Hugo Chavez with a nuclear programme. But if you want to feel assured about the prospect for nuclear power, just have a look at what is going on in the Middle East. A place awash with petrodollars.

There are two main reasons for the rush to nuclear power in Iran and Saudi Arabia. And neither of them is the pursuit of nuclear weapons.

The first of these is the fact that they don’t have as much oil as everybody thinks. The second is water.

Let’s take a look at Iran’s reserve situation.

The simple fact is that Iran HAS to develop nuclear power because the country is running out of oil. Iran’s “massive” oil reserves are a big, fat lie.

One of the people who made that reality crystal clear to Iran's leaders a few years ago was Dr Ali Morteza Samsam Bakhtiari.

Dr Bakhtiari started working for the National Iranian Oil Company back when the Shah was in power. For 36 years he worked for the company in a variety of senior positions until he retired.

This is what he told President Mahmoud Ahmadinejad:

"As for Iran, the usually accepted official 132 billion barrels is almost 100 billion barrels over any realistic assay."

The current estimate of Iran's reserves is 136 billion barrels. That's the second highest oil reserves in the Middle East after Saudi Arabia. Dr Bakhtiari thinks this should be closer to 36 billion barrels.

I believe that Ahmadinejad needs to go nuclear because his country's oil industry is struggling to keep its oil production at close to 4 million barrels per day. And it’s only going to get worse.

That’s why Iran needs nuclear – and that’s why Ahmadinejad will never give up his nuclear programme.

The second reason is water.

The population in the Middle East is set to soar in the next 15 years. In Saudi Arabia, almost 40% of the population is under the age of 14. It has a fertility rate of 5 children per woman. The country is set for a massive population explosion at a time when its infrastructure is creaking.

The Kingdom is already the world's largest producer of desalinated water. It currently has 27 desalination plants which provide 70% of its drinking water requirement. But it will need more. Much more.

That’s where nuclear power comes in.

Desalination is an extremely energy-intensive process, but nuclear plants can be used for the duel purpose of producing electricity and desalinating water.

Nuclear desalination is a proven technology. Kazakhstan produced water by nuclear desalination for almost 30 years until its reactor was decommissioned in 1999.

The country’s BN-350 fast reactor at Aktau successfully produced up to 135 MW of electricity and 80,000 m3/day of potable water over 27 years. Around 60% of its power was used for desalination.

Then there’s Japan...

It has ten desalination facilities linked to pressurised water reactors operating for electricity production. They have yielded 1000-3000 m3/day each of potable water.

India has also got in on the act. In 2002 it set up a demonstration plant coupled to twin 170 MWe nuclear power reactors at its Madras Atomic Power Station.

So, Mr Bodman needs to be a little less US-centric when talking about the future of nuclear power. The world’s going nuclear whether the US does or not. There’s plenty of money in the Middle East, in Venezuela, in India and in China.

Source: Iran Needs Nuclear because it’s Running Out of Oil

Slowing growth and inflation problems means the short-term outlook for commodities is not pretty. But over the long term, scarcity of resources is strongly bullish for commodities prices.

This is a great chance to add commodities stocks to you your portfolio and hold for long-term profits.

This from Chris in Penny Sleuth:

Jeremy Grantham heads up GMO, a respected money manager. Grantham has been largely spot on in the big-picture sense of staying bearish on stocks for the last eight years or so. He is bullish long-term on commodities. In his latest quarterly letter, Grantham makes some good points about the future of commodities and emerging markets.

His conclusion first: “In the short term, slowing world economic growth combines with credit, currency and inflation problems to dominate the outlook and offer poor prospects for emerging markets and commodities. Longer term, the reverse is true, and they look like the assets to own.”

It is mostly the long term (looking out a couple of years) that interests me, although I obviously don’t aim to step into any immediate problems if I can help it.

Longer-term backing for commodities demand comes from two sources, Grantham says:

The first is that if enough people enter economic take-off at approximately the same time, as 2.3 billion Chinese and Indians have now done, then the pressure on resources might happen to increase marginal costs slightly faster than technology could offset them.

This has already happened. It’s why the price of oil, for example, is so much higher than historical averages. All that demand hits very quickly, but it takes time to bring new supply to market. In the interim, higher prices result.

This seems well-known already. Most investors realize that behind the commodities boom stands surging demand from countries such as China — former ‘runts’ now muscling in on the global dinner table.

The second reason is more interesting. Grantham believes that the global growth spurt has come at the expense of eating away at some hard-to-replace resources:

“Underground water resources that currently sustain some of our most productive land but, like a metronome, tick off a reduction of several feet each year; rain-fed waters that, although renewable, are finite and already so overused that previously valuable lakes retreat to sometimes disastrous local effects and river volumes, once seemingly limitless, are now fought over; subsoil, which took thousands of years to form, is depleted through casual use (in the Midwest, for every bushel of wheat produced, it is said that a bushel of subsoil is lost. Our farmers are in the mining business! Yes, the soil is incredibly deep, but it is still finite); high-grade mineral ores are fully developed, the very best are long gone and all are irreplaceable; previously fertile land has often been overgrazed and turned into desert.”

At Mayer’s Special Situations, we’ve been on the water beat since this publication began in summer 2006. We’ve also watched the agricultural boom unfold, and we’ve picked up nice profits along the way. We are, in fact, still invested in these ideas.

Along with these ideas, oil, natural gas and base metals all have become more difficult and expensive to produce. Recently, we’ve had to sit through a pretty tough correction on the commodity names. Stocks in these sectors have sold off in a big way this summer, as I’ve noted. Based purely on fundamentals, though, these stocks haven’t looked this cheap in years.

But short term, such drawdowns are common on the way to eventual higher prices. Grantham, too, says as much:

“The prices of commodities are likely to crack short term, but this will be just a tease. In the next decades, the prices of all future raw materials will be priced as just what they are: irreplaceable. Oil, for example, will never again be priced on the marginal cost of pumping a marginal barrel from some giant Saudi oil field, as has been the practice for most of the last 100 years of oil production. Real cost is always replacement cost, and oil, a precious feedstock for chemicals and fertilizers, simply cannot be replaced.”

I don’t take as hard a plumb line as old Grantham does. I believe there is, even now, lots of room for innovation and replacement. Oil, for example, is replaceable in a broad sense. We can get energy from a broad array of sources. But it’s not an easy or painless transition.

Slowing economic growth is the bigger issue. That’s problematic for most commodities, short term. The market, though, is probably punishing the commodity companies too severely. That creates some interesting opportunities.

You can more easily pick up stocks trading for discounts to readily ascertainable net asset values now than anytime in the last five years, in my view.

It doesn’t mean making money in commodities is a lock or that it will be easy. Lots can go wrong with individual companies, and the drawdowns will probably be more than most investors can stomach. But longer term, looking out a few years, I think an investor will be happy with the portfolio assembled in the doubtful summer days of 2008.

Source: Vancouver’s Laboring Drunks