And relax. BBVA results not the shocker disasternistas were hoping for, the cult of AAPL continues to fleece its disciples and it is looking more as though that was NOT the big one re Europe.
TMM can’t help but think this has got a july 2009 feeling about it. We had the QE sugar rush from mar09 to jun09, then the market sold off because no-one believed it. But then the earnings season was good and the market ripped higher, never looking back. OK it may be a bit premature, but with all the noise subsiding and the market blaming the quiet on “waiting for the FOMC” which to be frank no one really cares about, TMM are more inclined to believe that the markets are “shagged out after a long squawk”. Whatever the reason, we will be invoking the “do not short a quiet market” rule and expecting more up drift.
Whilst it is quiet we will have a look at something we believe is about to change the world much more than any Apple iteration – the changing shape of energy supply. TMM would like to start today’s post with an interesting chart showing energy costs per Gigajoule for major fossil fuel sources in the US. White is Power River Basin coal, orange is henry hub gas, yellow is oil and pink is international coal (Newcastle spot).
As you can see, the big story of energy prices going to the moon over the last decade remains very much intact but gas has been doing something very unusual – after spiking hard it has gone into a massive decline and is almost as cheap as powder river basin coal on a per GJ basis.
The cause of this is the fracking revolution in gas production which has massively increased the US’ fossil fuel reserves. It is already being keenly felt in power markets where US coal companies are being killed by the increased competitiveness of gas fired power generation as the portion of the day in which it makes sense to burn gas is longer and more profitable, reducing those peak time margins that coal fired power plants make much of their profits from.
For coal equities this is hardly news – Cliffs Natural Resources, Alphadyne and Arch Coal have not been feeling the vim and vigor of a resurgent US economy. Similarly the US’ strategic exposure via oil imports to the Middle East and less than friendly regimes like Venezuela is waning judging by the chart below. Crude import percentage from Saudi in white, Canada in orange and Venezuela in yellow (Note the post Libya ramp in Saudi imports – that won’t be around for long).
TMM can’t help but feel that the money for the “war on terror” could have been better spent, but the US appears to have been a classic case of “better lucky than smart” in that regard since they have secured a reduced exposure to middle eastern madness through oil sands. Now, not that oil is mattering as much as it used to – below are vehicle miles travelled in the US in orange, inferred gasoline demand in green and average MPG of sales in white.
Not hard to see what is going on here: a period of high oil prices has pushed consumers into buying much more efficient vehicles and vehicular travel has peaked. Much like any business if unit sales and prices are down revenues are down a lot. TMM are wary of hockey sticks though so we thought we would do the comparison of a new efficient hybrid, say a Prius C and a Corolla. In summary – it’s ugly, and the google docs link is here.
You need $2 gasoline to even think twice about not buying the hybrid. In addition, companies like Ford are offering vehicles in gasoline, electric and LPG versions. No points for guessing how gasoline stacks up in the lifetime cost analysis there. Simply put, the vehicle mileage hockey stick is going further, a lot further unless WTI halves. It would be particularly disturbing if people widely moved to plug in electric cars which essentially allow you to do what the power grid does – determine which fuel is cheapest to burn then burn that. In that case you would expect oil and gas to converge on a per GJ basis which would be a catastrophe for WTI.
In summary a few very important things are happening in energy, but particularly so in the US:
- Energy prices are falling for gas, with knock on effects for other markets in which it is substitutable. Similarly, vehicle fleets are becoming more efficient and gasoline demand in DM is probably in a structural bear market on that alone. This has major implications for US inflation most of which has been from food and energy in recent years despite motor fuel being only ~5% of CPI basket and heating and utilities being another 5%. It may be the case that even if housing recovers and “rent equivalent cost of ownership” (~40% of the basket) stabilizes that the US has a very benign inflationary environment for structural reasons. Buy all the gold you want, but if people’s gas bills cease to exist or go into a nominal decline then that will take the bite out of a lot of quantitative easing in commodities.
- The historic segmentation of the energy markets into transport fuels and utility fuels is starting to blur and is likely to continue to do so. For that reason, the pricing per GJ for each should converge over time. You may not be able to make everyone in the US buy an electric car tomorrow but the ability of WTI to command a big premium over henry hub will weaken over time.
- US energy imports are falling fast and will continue to do so as the vehicle fleet turns over. This is going to have major implications for US defence spending – how much does the US care about the Middle East, ex oil? TMM would note that if the straits of Hormuz are closed, China has more to lose from it than the US. In addition, it has major implications for US tax receipts if people buy LPG cars or electric ones. US utilities pay cash taxes in the US, Saudi Aramco does not. The major problem of the US from a macro standpoint, its twin deficits and high debt may be reduced materially by these trends and the historically cheap USD may be the best buy in FX for the next decade.
- Make it in America? The US and particularly the Democrats have developed some kind of romantic attachment to manufacturing and politically astute CEOs like Andrew Liveris of Dow have picked up on this theme and have called for the US to have an industrial policy, aka, handouts for corporate along the lines of China. TMM see this for what it is – getting something for nothing and think it is largely unnecessary for most businesses. It is highly unlikely the US is going back to making garments or in any way competing with the scale efficiencies of southern China when it comes to cheap labour, especially as China’s factories increasingly replace labour with capital. Where it can compete however is in areas that are skills or technology intensive (when in doubt, buy out Asia’s best and brightest with grants) and anything that is energy cost intensive. Liveris notes that labour is <12% of COGS at Dow and Energy is 25% or more. TMM think that $2 gas makes a much bigger difference than looser labour laws or tax holidays.
The Downside….There is another side to all this aside form extolling the virtues or hope of a resurgent America, and that is the effect it will have on those on the long side of the commodities trade. For the likes of the Middle East and Russia TMM have this to say:
Saudi and Russia in particular have developed fiscal arrangements (Saudi’s covered well here) such that their economies “don’t work” at much less than $90 WTI. Russia is not that much better and is more dependent upon gas, something that the European buyers they have held to ransom for so long might not want to buy if they can frack their own as Romania is currently exploring. For that reason TMM are hard pressed to think of currencies they dislike more than the rouble – all the terms of trade frothiness of Australia with a boatload of political risk and a much bigger credit bubble as can be seen below.
Even in the case of Australia all those lazy RBA terms of trade and commodity price projections may go awry if China manages to produce a lot of fracked gas – China SOEs have never been ones to shy away from renegotiating off take of commodities if it suits them though that is likely a late 2010s / early 2020s problem. Some countries have the political wherewithal to take such a crunch in terms of trade (Brazil, Australia) others might not make it and require some institutional change when they can’t deliver their side of the autocracy / milk-and-honey trade.
Of course the real crunch comes against renewables. Whilst cost differentials have been narrowing between traditional fossil fuels and solar and wind,. will the energy addicts be able to resist dirt cheap carbon emitting gas for the benefit of the environment? TMM think not as austerity drives people to short term survivalist individualism rather than long term community spirit though that is arguably in the price these days. The larger shock is that by the time we start running out of gas energy prices might be following solar’s quasi Moore’s law – which wouldn’t hurt any of TMM’s power bills.