This inverse relationship between the value of the U.S. dollar and the price of crude oil has been very clear for most of this century. Will it continue in the future? More than likely it will, partly because, while the relationship is logical, it has become a short-term trading indicator. In the past several weeks, after WTI reached and surpassed the $50 a barrel threshold, one could virtually answer the question of what happened to oil prices each day if you were told what happened to the value of the U.S. dollar that day.

After watching this ying and yang of oil price movements and the value of the U.S. dollar, we were interested in the two-page chart on the profits of the Fortune 500 companies by sector over the past 20 years. We cut out the pages and scanned the chart (Exhibit 7 below), shrinking it to fit on one page. Unfortunately, we lost the 1995-1996 part of the chart, but the visual impact of the chart remains relevant.

What struck us while looking at the chart was the huge bulge in Energy profits during 2005-2012 before they started contracting and then collapsed after oil prices dropped at the end of 2014. The Energy sector profits during that period were driven by high oil prices - $80-$100+ per barrel, even after adjusting for the 2008-2009 financial crisis and recession. As Energy profits mushroomed during the era of high oil prices and the shale revolution, it was easy for Wall Street to convince investors to throw money at exploration and production and oilfield service companies who were leading America to the promised land of Energy independence. The Energy stocks were soaring as analysts and investors fell in love with the shale revolution that married horizontal drilling with massive hydraulic fracturing to produce huge volume of natural gas, natural gas liquids and tight oil. Remember that it was during this era that we were assured that we had hundreds of years of cheap natural gas supply. One Wall Street firm even wrote a report explaining how this revolution was turning us into ‘Saudi America.” 

The chart shows clearly what happens when an ill-founded boom collapses. As you scan the lower right hand corner of the chart, it is very difficult to see the thin black line reflecting current Energy sector profits, or what is left of the thick line that existed throughout most of the 2000s. In fact, if oil prices hadn’t climbed back to $50 recently, it is possible that the thin line would become impossible to see as there wouldn’t be any profits. Many investing in Energy today are hopeful that one day in the foreseeable future that thin black line will once again become a thick black line. We are comfortable is saying the line will be thicker, we just don’t know how thick it will eventually grow and when that will be.

A link to the full report is posted in the Subscriber's Area.

The Dollar Index failed to sustain the move below 92.5 in May and has now bounced back above the 200-day MA. Considering the size of the upward dynamic a retest of the upper side of the 18-month range, near the psychological 100 is now looking more likely than not. 

The amount of electricity generated using solar panels stands to expand as much as sixfold by 2030 as the cost of production falls below competing natural gas and coal-fired plants, according to the International Renewable Energy Agency.

Solar plants using photovoltaic technology could account for 8 percent to 13 percent of global electricity produced in 2030, compared with 1.2 percent at the end of last year, the Abu Dhabi-based industry group said in a report Wednesday. The average cost of electricity from a photovoltaic system is forecast to plunge as much as 59 percent by 2025, making solar the cheapest form of power generation “in an increasing number of cases,” it said.

Renewables are replacing nuclear Energy and curbing electricity production from gas and coal in developed areas such as Europe and the U.S., according to Bloomberg New Energy Finance. California’s PG&E Corp. is proposing to close two nuclear reactors as wind and solar costs decline. Even as supply gluts depress coal and gas prices, solar and wind technologies will be the cheapest ways to produce electricity in most parts of the world in the 2030s, New Energy Finance said in a report this month.

“The renewable Energy transition is well underway, with solar playing a key role,” Irena Director General Adnan Amin said in a statement. “Cost reductions, in combination with other enabling factors, can create a dramatic expansion of solar power globally.”

My guess is that even these optimistic forecasts will be significantly exceeded by 2030, as the solar power industry becomes progressively more efficient.  Moreover, the accelerated rate of technological innovation will lead to new forms of solar power which are all but unimaginable today.

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More supercomputer news this week: The US is responding to China’s new Sunway TiahuLight system that was announced Monday, and fast. First, the Department of Energy’s (DOE) Oak Ridge National Laboratory is expected to take delivery of a new IBM system, named Summit, in early 2018 that will now be capable of 200 peak petaflops, Computerworld reports. That would make it almost twice as fast as TaihuLight if the claim proves true. (We had originally reported in 2014 that both Summit and Sierra would achieve roughly 150 petaflops.)

TaihuLight (pictured below) now sits at number one on the twice-yearly TOP500 list of the fastest supercomputers in the world, with a Linpack benchmark score of 93 petaflops and a claimed peak of 124.5 petaflops. The latest TOP500 announcement Monday caused a bit of a stir. Not only is TaihuLight roughly three times faster than China’s Tianhe-2, the prior champion, but it also uses no US-sourced parts at all for the first time, as it’s powered by Sunway 260-core SW26010 processors that are roughly on par with Intel Xeon Phi, as well as custom proprietary interconnect.

 

Supercomputers might be a somewhat esoteric topic but the fact China has developed the fastest computer in the world without requiring US sourced components is a major testament to the technological competence it has achieved. In turn that should help Chinese researchers to further develop artificial intelligence and big data projects. 

Economics have achieved what environmentalists have sought for years: the shutdown of California’s nuclear power plants.

PG&E Corp. is proposing to close two reactors at Diablo Canyon in a decade that would end up costing more to keep alive as California expands its use of renewable Energy, Chief Executive Officer Tony Earley said Tuesday. They won’t be needed after 2025 as wind and solar costs decline and electricity from the reactors becomes increasingly expensive, he said.

Diablo Canyon became California’s only operating nuclear power plant after Edison International three years ago shut its San Onofre plant north of San Diego after a leak. Tuesday’s announcement follows decisions this month to retire three other U.S. nuclear plants struggling to make money amid historically low power prices and cheap natural gas.

“It’s going to cost less overall as a total package than if you just continued to operate Diablo Canyon,” Earley said. “It’s going to operate less because of the Energy policies that are in place.”

 

Nuclear in North America and Europe suffers from a boy who cried wolf problem. By over promising on cost and production and under delivering, particularly on safety, public ambivalence has grown substantially. That’s an unfortunate development because new nuclear technologies really do hold the potential to fulfil earlier promises, but they are unlikely to be built in either North America or Europe. China is now the primary bastion of support for developing nuclear technology and is already exporting its designs to other countries. 

The commercial success of Musk's vertical integration idea hinges -- in terms of turning a profit rather than generating a high market capitalization -- on battery technology that would have mass rather than niche appeal. The assumption upon which Musks' concept -- and Tesla's $32.3 billion market capitalization -- is built is that Tesla is betting on the right battery technology and no one will come up with a much better one. That is the big hole in the donut: The assumption is far from safe.

Cheap and reliable Energy storage is central to the idea of an off-the-grid, solar-powered household. Such a home needs Energy at night, when the sun isn't shining: It has fridges, air conditioners and other appliances running, and a Tesla charging in the garage. So it needs a good battery, and Tesla's Powerwall doesn't necessarily fit the bill -- if only because the cost of the Energy it supplies, including amortization, is higher than grid prices. Because of this, and given the high price of Tesla cars, the lifestyle on offer is an expensive statement. In terms of cost and convenience, it's not competitive with the traditional grid-and-fossil fuel model.

 

Let’s call Tesla Motor’s acquisition of SolarCity what it is; a bailout. The tide of highly attractive subsidies for solar has turned. NV Energy, Warren Buffett’s Nevada utility, successfully argued that it should not have to bear the full cost of the electrical grid when solar producers get to use it for free and get preferential rates on the electricity they supply. That represented a major upset for SolarCity in particular but also highlighted a deeper challenge for the solar leasing business model which has contributed to increased scepticism among investors about the prospects for related companies. The big question is whether other states, particularly in the sun-belt will announce similar charging structures. 

OPEC's members are divided by many things: language; size; politics; sometimes outright war.

And money. Don't forget money.

If you want to understand why OPEC has responded to its current crisis with all the cohesion of cat herding, some numbers in the Energy Information Administration's "OPEC Revenue Fact Sheet," published on Tuesday, provide some important clues. First up, estimated revenue, adjusted for inflation:

Tight Oil

OPEC's real net oil export revenue is expected to be the lowest since 2003

The estimate for this year, $337 billion in real terms, is barely a third of 2012's peak -- and, uncannily, exactly the same as the consensus forecast for the combined revenue of Exxon Mobil and Chevron in 2016. Of course, those two only have to pay their employees, creditors and shareholders. OPEC's members have about 700 million people to answer to, roughly double the amount in 1980. So, on a per capita basis, those numbers look worse:

Note the charts in this article, including: “The gap between OPEC’s haves and have-nots in terms of oil export revenue.  

Even the low end of the forecast by Wood Mackenzie, which provides in-depth analysis for a wide range of clients including large oil companies, utilities and banks, is a more bullish outlook for electric-car adoption than many oil-and-gas companies have espoused.

Spencer Dale, the chief economist of Energy company BP PLC, said last week in Houston that while he expects electric cars to start gaining traction, the internal-combustion engine still has significant advantages over electric alternatives and widespread adoption won’t happen in the next two decades.

“It will still take some time,” Mr. Dale said. “Electric vehicles will happen. It is a sort of when, not if, story.”

The electrification of the automobile has evolved more slowly than some expected, in part thanks to low fuel prices and limited battery life that meant drivers had to recharge every 100 miles. But more capable cars are coming to market as tightening air-pollution regulations in places such as Europe and China force auto makers to engineer better electric vehicles.

The U.S. market today remains tiny, with pure electric cars amounting to less than 1% of total sales so far this year. But Tesla’s decision to build cars with sizable batteries that can run for more than 200 miles before recharging has led a number of competitors to double down on their own electric-car designs.

 

Tesla remains the standard bearer for electric cars because, more than any other company, it has succeeded in marketing a car people aspire to own. However it is not the only, or even the biggest company manufacturing electric vehicles. In fact Tesla’s success ensures it will deal with a lot more competition as incumbent manufacturers release their own models. 

In my last article for OilPrice.com (May 16, 2016), I laid out my reasoning for a prediction that the Global Oil Markets would soon be back in balance. Picking an exact date when an oil cycle will end is difficult, but they do call them “cycles” for a reason. This cycle is no different than all of the others that came before it. Oil producers and consumers respond to price changes, which brings supply & demand back into balance, just like they always do.

The last six major oil price cycles lasted an average of two years. This one started in July, 2014.

On June 14, 2016 the International Energy Agency (IEA) issued their monthly Oil Market Report. In the report the IEA revises their first quarter increase in global demand forecast from a 1.4 to 1.6 million barrel per day year-over-year increase. They are also forecasting a big spike in demand of 1,270,000 barrels per day from the 2nd quarter to the 3rd quarter. Since demand ALWAYS spikes in the 3rd quarter, this was not a surprise to anyone.

Since this cycle has been so severe, I predict that it will not end well for speculative traders that continue to short oil futures. If some of you purchased a gas guzzling SUV because you believed the talking heads that said oil would never sell for $100/bbl again, you may want to consider a smaller second car.

• Global oil production in May was 590,000 barrels per day less than it was a year ago.

• Nigeria’s oil sector is under attack and the situation seems to be getting worse

• OPEC production fell by 110,000 barrels per day as increases in Iranian production were more than offset by big losses in Nigeria, Libya and Venezuela

• Global demand is up 1,600,000 barrels per day year-over-year as Chinese demand has held up and demand from India is very strong

Canadian wildfires at their peak took 1,500,000 barrels per day off the market. This production should be restored in the 3rd quarter. The situations in Nigeria, Libya and Venezuela are much worse. Inf fact, there is now concern that the government in Venezuela may collapse under the debt load created by low oil prices.

The direction of the oil market should now be crystal clear to everyone. Demand growth is relentless. The products refined from oil are essential to a high standard of living on this planet. We will all complain when gasoline is back over $3.00/gallon, but we will continue to pay for it. Within 6 to 9 months, demand for oil should exceed production. High storage levels provide a cushion, but oil prices will continue to ramp higher.

Dan Steffens is correct in saying that there is always an oil cycle.  In fact, commodities have long been among the most cyclical of all markets.  He is also right in saying that demand for oil is clearly rising – have a look at the graph in his report.  Yes, production of oil is falling as demand is rising.  That is what happens in a cyclical commodity market. 

However, Dan Steffens is also overlooking some important factors, one of which is even more important than all of his bullish points combined. 

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“There is some rebalancing, and I believe the oil price will be in the region of $50, maybe $55 for the rest of the year,” Paolo Scaroni, deputy chairman at NM Rothschild & Sons and former chief executive officer of Eni SpA, said in a Bloomberg television interview. “I personally believe there is a cap. If prices go beyond $60, shale oil producers will start all over again.”

Rigs targeting crude in the U.S. rose by 9 to 337 this week, capping the first three-week gain since August, Baker Hughes Inc. said Friday. Explorers have dropped more than 1,000 oil rigs since the start of last year.

 

Crude oil accelerated to its January low and has since staged in an impressively consistent rally which has seen prices almost double. This has resulted in Energy companies being a major contributor in the ability of the wider market to rally from the January lows. For example the majority of the top 10 best performers on the S&P500 year-to-date are Energy/resources related. 

We’ve added more than half a billion tons of carbon to the air since the industrial revolution. This device could help clean it up.

What about all the carbon we've already poured into the atmosphere? If only there were a device that could take some of it back out.

Researchers at Arizona State University’s Center for Negative Carbon Emissions are working on one. They discovered a commercially available resin that can grab carbon dioxide at low concentrations when the material is dry and release it when the material is moist. The CO2 it collects could be stored underground, used in greenhouses, or fed to algae for biofuel production.

"Right now, we are taking carbon out of the ground. We then convert the Energy into something useful. Then there’s a third step that we ignore—namely, to clean up after ourselves," said Klaus Lackner, the center’s director.

Technology can solve all manmade atmospheric problems and it is obviously in our interests to do so.  The process described in the article above will be unobtrusive in the process.  Scientific developments which help the planet are a no brainer and will most likely eventually make a profit in the process. 

The accompanying video is more informative than the article.   

Previously a commodity with volatile price swings due to a domestic market that was short supply, the outlook for natural gas through 2020 shows a well supplied market capable of delivering to growing demand sources. There will be s-t dislocations (weather / infrastructure constraints) and the introduction of LNG exports will re-couple the U.S. to the global economy, but we see an emerging theme of natural gas entering a range bound period of $3-3.50/mmbtu. The 5 year build up in demand (2013-18) now looks to be meeting up with the 10 year buildup in supply (2005-15), creating a period of price equilibrium with upward and downward pressures on both sides.

Demand – Focus On The Known Drivers
After a 15 year period of stagnant consumption (1995-2009), demand for natural gas has enjoyed consistent growth over the past 5 years (2-3Bcfpd annually), a trend we expect to pick up through 2020. The drivers of growth are visible – power generation, industrial use, and Mexico exports – and will provide a base level of consumption growth. The reemergence of natural gas on the global scene via LNG exports has also long been a theme and will be additive to demand, though the quantifiable impact is tough to point to as capacity utilization will vary based on global prices and supply. We estimate ~6Bcfpd of export demand in 2020 in our base case, which is needed to balance the S/D outlook. In total, we see demand growth approaching ~98Bcfpd by 2020 (ex pipeline imports) up from ~78Bcfpd in 2015.

Supply – Filling Demand Needs…Just Need More Pipeline Capacity
U.S. supply has increased ~50% over the last 10 years to ~75Bcfpd, a rate of growth not witnessed since the 1960-1970s and following a brief pause in 2016/17, we anticipate growth to resume in 2018. We see four key trends from our supply forecast: 1) Supply is ~2Bcfpd below demand (weather normalized) in 2016/17 but ~3Bcfpd oversupplied in 2018, 2) Northeast supply growth increases by ~9Bcfpd in 2018, driven by the pipeline build out, 3) The bull case for supply by 2H18 is based on demand as the Northeast has excess pipeline capacity, and 4) The Northeast isn’t the only source of growth as we anticipate the Haynesville and Associated Gas Basins to return to growth by 2018, and implementing new technology could support growth elsewhere. Our forecast grows to meet demand and fills storage with enough deliverability in 2018, creating a more range bound environment with equal s/d pressures.

 

A link to the full report is posted in the Subscriber's Area. 

The natural gas market was the original recipient of the innovations that led to the boom in unconventional supply. Since then it has offered an object lesson in the ramifications of how that is likely to play out for other commodities where supply is surging not least oil. The greatest beneficiaries have been consumers who have seen prices for essential Energy commodities decline to levels not preciously imaginable. That has also resulted in demand increasing not least from substitution which has also benefitted consumers in other sectors. 

As electricity is gaining importance in the nation’s Energy mix, the role of electric vehicles is being promoted by environmentalists who see them as a way to end the use of petroleum. These same groups are pushing electric cars as the perfect vehicle for autonomous vehicles that are envisioned as a way to reduce the number of cars needed in future economies, with concomitant less use of petroleum fuels. As they build their case, we have been overwhelmed by articles praising the increase in the number of electric vehicles in today’s vehicle stock and how they will (need to) grow in order to fulfil the UN climate change agreement. 

A recent electric car article offered the chart in Exhibit 3 (next page) showing how the number of these vehicles in the world have grown. The chart reflects the cumulative total between 2010 and 2015, showing dramatic growth. Because it is cumulative, the growth is deceiving. More important is the penetration rate of electric vehicles into the world vehicle fleet. 

As the chart shows, the global industry has over 1.2 million electric vehicles on the world’s roads – but that is out of an estimated one billion vehicles. The point is that for all the dramatic growth (which presentation charts can make look impressive) in the number of electric vehicles on the roads, they barely register as a component of the global vehicle fleet total.

An interesting area for research into the success of electric cars is to see how many of them are owned by governments – federal, state and municipal – along with ones purchased by utility companies in an effort to demonstrate their environmental sensitivity. Our guess is that in the U.S. these buyers would account for the largest portion of the electric vehicles on the road. That would suggest that real consumers – not those motivated by making political statements – are not embracing electric vehicles, despite the concerted efforts of governments to promote them through mandates and financial

If we look at the dark green portion of each bar that represents the number of electric cars in the United States, the country has gone from a minimal number in 2010 to 400,000 vehicles in 2015. Yes, that is dramatic growth, but the 2015 number is less than half the number President Barack Obama called for to be on America’s roads. More telling is the difference between the height of the dark green portion of the bar in 2014 and 2015, showing that the industry added slightly over 100,000 vehicles. That number comes in a year when the U.S. auto industry produced and sold over 17 million vehicles. The penetration of electric cars into the American vehicle stock is paltry as 400,000 units barely registers in a fleet of about 300 million vehicles on the road. 

A link to the full report is posted in the Subscriber's Area. 

Electric vehicles (EVs) are on an exponential growth curve. However we are still in the very early stages of that growth where big numbers do not equate to large numbers of vehicles on the road. For example Tesla’s orders for more than 400,000 Model 3s is equivalent to the entire US fleet of EVs on the road today. With that kind of growth rate it’s important to keeps one’s feet grounded in reality. 

The spread of electric cars is driving up demand for lithium-ion batteries, the main technology for storage devices that are attached to utility grids and rooftop solar units.

That’s allowing manufactures to scale up production and slash costs. BNEF expects the technology to cost $120 a kilowatt-hour by 2030 compared with more than $300 now and $1,000 in 2010.
That would help grid managers solve the intermittency problem that comes with renewables -- wind and solar plants don’t work in calm weather or at night, creating a need for baseload supplies to fill the gaps. Today, that’s done by natural gas and coal plants, but the role could eventually be passed
to power-storage units.

The researcher estimates 35 percent of all light vehicles sold will be electric in 2040, equivalent to 41 million cars.

That’s about 90 times the figure in 2015. Investment in renewables is expected to rise to $7.8 trillion by then, compared with $2.1 trillion going into fossil-fuel generation.

“The battery industry today is driven by consumer products like computers and mobile phones,” said Claire Curry, an analyst at Bloomberg New Energy Finance in New York. “Electric vehicles will be the driver of battery technology change, and that will drive down costs significantly.”

The industry still has a long way to go. About 95 percent of the world’s grid-connected Energy storage today is still pumped hydro, according to the U.S. Energy Department. That’s when surplus Energy is used to shift large amounts of water uphill to a reservoir so it can be used to produce electricity later at a hydropower plant. The technology only works in areas with specific topographies.

There are several larger-scale battery projects in the works, according to S&P Global. They include a 90-megawatt system in Germany being built by Essen-based STEAG Energy Services GmbH and Edison International’s 100-megawatt facility in Long Beach, California.

“Utility-scale storage is the new emerging market for batteries, kind of where electric vehicles were five years ago,” said Simon Moores, managing director at Benchmark Mineral Intelligence, a battery researcher based in London. “EVs are now coming of age.”

 

Innovation in the chemistry that supports batteries has been a lot more difficult to achieve than the Moore’s law related enhancements that have been commonplace in chip manufacturing and increasingly in solar technologies. Nevertheless as the requirement for storage grows increasingly urgent, the capital expended on R&D is expanding and innovations are being achieved. In the meantime economies of scale through larger manufacturing plants are helping to drive efficiencies. 

The increasing importance of renewable Energy continued to be led by wind power (17.4%, 125 TWh). But solar power is catching up fast, expanding by almost a third in 2015 (32.6%, 62 TWh), with China overtaking Germany and the US as the largest generator of solar power.

The older stalwarts of non-fossil fuels – hydro and nuclear Energy – grew more modestly. Global hydro power increased by just 1.0% (38 TWh), held back by drought conditions in parts of the Americas and Central Europe. Nuclear Energy increased by 1.3% (34 TWh), as rapid expansion in China offset secular declines within mainland Europe. This gradual shift of nuclear Energy away from the traditional centres of North America and Europe towards Asia, particularly China, looks set to continue over the next 10-20 years.

And

The key lesson from history is that it takes considerable time for new types of Energy to penetrate the global market. Starting the clock at the point at which new fuels reached 1% share of primary Energy, it took more than 40 years for oil to expand to 10% of primary Energy; and even after 50 years, natural gas had reached a share of only 8%.

Some of that slow rate of penetration reflects the time it takes for resources and funding to be devoted in scale to new Energy sources. But equally important, the highly capital intensive nature of the Energy eco-system, with many long-lived assets, provides a natural brake on the pace at which new energies can gain ground.

The growth rates achieved by renewable Energy over the past 8 or 9 years have been broadly comparable to those recorded by other energies at the same early stage of development. Indeed, thus far, renewable Energy has followed a similar path to nuclear Energy.

The penetration of nuclear Energy plateaued relatively quickly, however, as the pace of learning slowed and unit costs stopped falling. In contrast, in BP’s Energy Outlook, we assume that the costs of both wind and solar power will continue to fall as they move down their learning curve, underpinning continued robust growth in renewable Energy.

Indeed, the path of renewable Energy in the base case of the Energy Outlook implies a quicker pace of penetration than any other fuel source in modern history. But even in that case, renewable power within primary Energy barely reaches 8% in 20 years’ time.

The simple message from history is that it takes a long time – numbering several decades – for new energies to gain a substantial foothold within global Energy.

 

A link to the full report is posted in the Subcsriber's Area.

The evolution of renewable Energy technology represents a major paradigm shift for the Energy sector not least because the cost of production continues to decrease independently of the oil price and environmental concerns result in a compelling case for adoption. In tandem with wind and solar, the rollout of electric vehicles is a related but separate development which is likely to represent a continued headwind for demand growth.

Since 2013, the federal regulatory agencies have been warning banks and investors about the potential risks in leveraged lending. These warnings have been both timely and prescient, particularly in view of the ongoing credit debacle in the Energy sector. In addition to the well-documented credit risk posed by leverage loans, we believe that the widespread practice of selling participations in leveraged loans represents a significant additional risk to financial institutions and other investors from this asset class.

While regulators have appropriately focused on the credit risk component of leveraged loans held by banks and nonbanks alike, the use of participations to distribute risk exposures to other banks and nonbank investors also raises significant prudential and systemic risk concerns. The weakness in oil prices, for example, has caused investors to cut exposure to companies in the Energy sector. This shift in asset allocations caused by the decline in oil prices has negatively impacted prices for leveraged loans and high yield bonds. In some cases, holders of these securities are attempting to exit these exposures by securitizing the participations.

The investor exodus away from leveraged loans with exposure to the petroleum sector brings back memories of the 1970s oil bust, an economic shock that led to the failure of Penn Square Bank in 1982, the subsequent failure of Seafirst Bank later in that year, followed by Continental Illinois Bank in 1984. Before its failure, Penn Square technically continued to "own" — and service — loan interests held by other banks with participations. As receiver for the failed bank, the Federal Deposit Insurance Corp. deemed those investors to be nothing more than general creditors of the failed bank's estate. Those participating banks lost their entire investment.

 

Leveraged loans issuance overtook the 2007 peak a couple of years ago. That fact is bemusing to many people who remember claims that bankers would never again engage in such activity. Yet with interest rates so low and the demand for yield so high the rationale for issuing to less than optimal borrowers is hard to resist. 

The new topic being opened by efforts such as Otto and the platooning demonstration in Europe is the impact on fuel and labor costs within the trucking industry. In the United States, trucks drive 5.6% of all vehicle miles and are responsible for 9.5% of highway fatalities, according to Department of Transportation data. Because heavy-duty trucks have a significantly lower fuel-efficiency performance, they account for a larger share of diesel fuel consumption than diesel cars or other types of equipment. Because diesel fuel is included in distillates, we cannot determine the exact weekly volumes. However, we know that for the week ending May 20, distillate volumes of slightly over 4 million barrels a day represented 20% of total fuel supplied in the U.S. By examining the latest inventory data, distillates are broken down by the amount of sulfur in the fuel. Diesel fuel for vehicle use needs to be low sulfur – 15 parts per million or less. That fuel category accounted for 88% of all the distillate in storage, therefore we would think this is a reasonably close approximation of the highway quality diesel fuel being supplied to the U.S. market. If 62% is used by over-the-highway trucks, then the daily consumption is approximately 2.2 million barrels. Improved fuel savings from autonomous technology could eventually account for upwards of 200,000 barrels a day in savings. 

Autonomous vehicle technology is being hailed as a way to reduce the number of accidents. The largest impact of the technology, however, may be on the employment of truck drivers. There are more than three million truck drivers in this country. According to the American Trucking Associations, the truck industry accounts for one of every 15 jobs in the United States. By eliminating the need for second drivers on many trucks due to the ability of the primary driver to fulfill his rest obligations while the truck drives itself, there will be a negative employment impact from autonomous technology. 

Although perceived as a negative, autonomous technology might actually become a positive as the trucking industry deals with an aging workforce and a less-than-attractive employment career as long-haul driving can be tedious and keeps drivers away from home for extended time periods. While younger drivers enjoy the first and last miles of truck driving, they wish to avoid the boring portion, which autonomous technology would eliminate. In the U.S., according to consultant Oliver Wyman, by 2023 it is projected that there will be shortfall of 240,000 drivers, or approximately 8% of the estimated current number of truck drivers. 

Canada has a similar employment outlook for its highway trucking industry. According to the Canadian Trucking Alliance there are about 300,000 long-haul truck drivers. Similarly, the Canadian Trucking Alliance estimates that the Canadian industry will have a shortfall of 48,000 drivers by 2024 — about 15 per cent of the total driving force – due to an aging workforce and a less-attractive employment career. 

Another impact of autonomous technology for trucks is that vehicles can be kept on the highway for more hours per day. That could not only reduce the need for additional drivers, but it could also reduce the cost for transporting goods, further contributing to deflationary forces in the economy. 

All of these considerations influenced our previous article’s conclusion that autonomous trucks were more likely to be on the roads before autonomous cars. That may be why Mr. Levandowski left Google. He said that his decision to leave was motivated by being eager to commercialize a self-driving vehicle as quickly as possible. At Google, he was responsible for drafting legislation to permit self-driving vehicles, which ultimately became law in Nevada. While certain states such as California have motor vehicle regulations that would prohibit the idea of trucks traveling on the freeway with only a sleeping driver in the cab, other states currently do allow it. “Right now, if you want to drive across Texas with nobody at the wheel, you’re 100 percent legal,” said Mr. Levandowski. Stay tuned for self-driving trucks on a freeway near you. 

A link to the full report is posted in the Subscriber's Area.

The technology behind autonomous vehicles is progressing towards greater utility and it makes sense that haulage vehicles represent the primary source of demand considering the high cost of fuel, personnel and regulations. It represents an additional example of the deflationary role technology has and the benefits that accrue to consumers as a result. 

The share of Germany's electricity generated from renewable sources has tripled during the past decade, to 30.1 percent. That's impressive, especially when compared with what has happened in the U.S.

On the other hand, the percentage of Germany's electricity generated by burning coal isn't all that much lower than it was a decade ago, and is higher than it was in 2010. In the U.S., coal's share has been falling a lot in recent years.

Both countries are going through major shifts in how they keep the lights on, but they're very different shifts. Germany is in the midst of a large-scale, government-driven Energy transition toward renewables (the "Energiewende"). The U.S. has also favored renewable Energy with tax incentives and other subsidies, but the effort has been modest compared with Germany's. Here, the big news has been rising natural gas production thanks to fracking, plus pressure on utilities from the government and private groups to shut coal-fired power plants.

So which country is doing a better job of shifting its Energy mix? It depends on your priorities. The Germans have long been uncomfortable with nuclear power, and in 1998 made plans to phase out its use by 2022. There was some hemming and hawing in subsequent years, but after the 2011 Fukushima reactor accident in Japan, the government recommitted to the 2022 phase-out. Since 1998, nuclear power has gone from supplying 27.5 percent of German electricity to 18.1 percent.

The article above does not address critical point regarding average costs of electricity in Germany, the USA and a number of other countries. 

However, another article from OVO Energy shows three separate bar graphs for average Energy costs in over a dozen countries, based on: “How much does electricity cost”, and “Electricity prices relative to purchasing power”.  On average, electricity prices are almost 200 percent higher in Germany than in the USA.  That is why heavy manufacturing firms have been moving some of the factories out of Germany and other European countries, and moving them to the USA and other nations which have lower Energy costs. This will continue to be reflected by comparative GDP for countries over the longer term.  

Brent for July settlement decreased 12 cents to $49.62 on the London-based ICE Futures Europe after. The contract earlier climbed as much as 1.6 percent to $50.51. The global benchmark crude was at a 15-cent premium to WTI.

"We’re seeing a steady decline in U.S. production, which is going to continue, and outages around the world," said Bill O’Grady, chief market strategist at Confluence Investment Management in St. Louis, which oversees $4.3 billion. "This doesn’t mean we’re going to continue going higher; a lot may be priced in. It was a lot easier being bullish oil with sub-$40 prices than it is near $50."

U.S. crude production dropped for an 11th week to 8.77 million barrels a day, the Energy Information Administration reported Wednesday. Crude inventories slid by 4.23 million barrels last week, exceeding an expected drop of 2 million. Stockpiles at Cushing, Oklahoma, the delivery point for WTI and the nation’s biggest oil-storage hub, fell by 649,000 barrels.

 

Brent Crude Oil has posted an orderly rebound from its January low and has almost doubled in the process. A progression of higher reaction lows is evident with reactions of between $5 and $6 constituting entry opportunities along the way. A reaction of greater than $7 would be required to question the consistency of the advance. Nevertheless the round $50 area represents a psychological level for many investors so it would not be surprising to see prices pause in this area. 

Saudi Arabia, one of the founders of OPEC, is sounding the group’s death knell.

The world’s biggest crude exporter has already undermined OPEC’s traditional role of managing supply, instead choosing to boost output to snatch market share from higher-cost producers, particularly U.S. shale drillers, and crashing prices in the process.

Now, under the economic plan known as Vision 2030 promoted by the king’s powerful son, Deputy Crown Prince Mohammed bin Salman, the government is signaling it wants to wean the kingdom’s economy off oil revenue, lessening the need to manage prices. Moreover, the planned privatization of Saudi Arabian Oil Co. will make the nation the only member of the Organization of Petroleum Exporting Countries without full ownership of its national oil company.

“The main take-away from Saudi Vision 2030 is that there’s just no role for OPEC,” Seth Kleinman, head of European Energy research at Citigroup Inc. in London, said by phone on May 16. “Or, you can have an OPEC without Saudi Arabia, which just isn’t much of an OPEC.”

The first change of oil ministers in more than 20 years may also recast the country’s relationship with OPEC. The group’s 13 members, which contribute about 40 percent of the world’s supply, gather in Vienna on June 2.

King Salman on May 7 replaced Ali al-Naimi, the most influential voice in OPEC and the architect of current Saudi oil policy. While there’s likely to be considerable continuity, his replacement, Khalid Al-Falih, is an ally of Prince Mohammed, who scuppered a plan al-Naimi had supported for capping production. When producers considered freezing output to curb a global glut in April, the young royal’s view that no deal was possible without Iran prevailed, and talks collapsed.

“We don’t care about oil prices,” Prince Mohammed said in an April 25 interview in Riyadh. “$30 or $70, they are all the same to us. We have our own programs that don’t need high oil prices.” Benchmark Brent crude was trading at $48.11 a barrel on Tuesday at 11:23 a.m. in London.

OPEC will not be missed.  Cartels are power arrangements for maximising profits at everyone else’s expense. 

Oil prices will remain volatile but the current surplus of supply will prevent the strong recovery that some commentators have forecast.  Even as the global economy eventually recovers and the record amounts of crude in storage are gradually reduced by consumption, the advance of technology has enabled more conventional oil to be produced than was imaginable less than a decade ago.  Supplies may be finite but there are also vast quantities of shale oil, largely untouched.   

Meanwhile, technology will continue to hasten declines in costs for renewable forms of Energy, led by solar.  Most countries now have the capacity to lower their Energy costs.  However, Energy prices paid by business and consumers will vary considerably among nations, subject to their willingness to utilise all forms of available Energy, plus their individual taxation policies on these vital resources.    

(See also: OPEC Brings Oil Price War Home in Pursuit of Asia Cash - Oct 20, 2015)

China holds the record as the world’s top wind installer, accounting for about a third of the total global installed wind capacity. The United States trails in second place, accounting for just more than 17 percent. But despite its higher total capacity, China still isn’t putting out as much wind-generated electricity as the United States. In other words, it has built the technology, but it just is not able to use it to the max.

New research, published Monday in the journal Nature Energy by researchers from Tsinghua University in Beijing, Harvard University and other U.S. and Chinese universities, examines a handful of factors thought to be responsible for the discrepancy, using a mathematical approach to evaluate the relative importance of each.

Wind turbines can produce only as much Energy as the wind provides — so the researchers were interested in whether differences in wind flow could account for some of China’s problems. But they found that these differences played a relatively small role. Although the United States tends to get superior winds nationwide, the researchers point out that China has approached this issue by promoting more development in the regions with the best wind resources, mostly to its north and northeast.

Instead, the findings suggest that the primary challenges to wind power in China involve lower turbine quality, delayed connections to the grid and grid operators failing to transmit wind power to users in favor of other Energy sources, such as coal — all of which play about equally important roles.

These issues are capable of putting a substantial dent in China’s wind electricity output, it turns out. The researchers noted that in 2012, China’s wind-generated electricity was 39.3 terawatt-hours less than that of the United States.

“This is a large number — larger than the total amount of wind power generated in the United Kingdom in 2015, which can power around 8 million UK homes,” wrote Joanna Lewis, an associate professor and expert on China’s Energy landscape at Georgetown University, in a comment on the new study, also published Monday in Nature Energy.  

To evaluate the quality of turbines in China — which, the authors note, has not been done in previous studies — the researchers used the output from a specific type of wind installation (the GE 2.5 megawatt turbine) as a standard for comparison, concluding that overall turbine quality in the United States is higher than in China. They chalked up the quality issues to a need for “technology catch-up” in domestically produced turbines, which account for most of the installations in the country. The fix in this case is relatively simple: The authors recommend a short-term switch to more international suppliers, while focusing on domestic research and development efforts and technology transfer agreements with other nations in the long term.

Credit to China for being the world’s fastest developing economy, even as it struggles with monumental transformational challenges, which it is also attempting to resolve in record time. 

This item continues in the Subscriber’s Area.

About two-thirds of Chinese cities exceed the air pollution limits specified by the Environmental Air Quality Standards, according to China’s State Information Center. Rapid increase in internal combustion engine (ICE) vehicle ownership and the consequent traffic congestion, especially in large Chinese cities, are perceived to contribute significantly to carbon dioxide and other harmful gas emissions, and the level of inhalable particulate matter (PM). This makes China one of the most polluted countries in the world.

To curb environmental pollution and improve air quality, various countries have implemented or tightened policies to gradually reduce fuel consumption and/or harmful gas emission. China also has tightened requirements for emission and fuel consumption. Since the country had a slower start in emission controls (Figure 6), it should be one of the fastest to tighten emission controls to catch up with developed countries (e.g. the EU and Japan) (Figure 7).
While countries have multiple means to lower auto emission, e.g. diesel adoption and using conventional hybrid engine technologies, China has placed a greater emphasis on using electric vehicle (EV) or plug-in electric vehicle (PHEV) technologies. To this effect, the State Council in 2012 issued a roadmap for China’s NEV industry development, The 2012-2020

Development Plan for Fuel-efficient and New Energy Vehicle Industry. 
According to the plan, the government targets an accumulated NEV (including EVs and PHEVs) sales volume of 500k units by 2015 and 5m units by 2020E, with an annual NEV production capacity of 2m units by 2020E. Despite rapid growth in NEV sales volume in 2012-14, the absolute sales volume was meager in China, making up less than 0.2% of its vehicle sales during the period and falling way short of its 2015 target ownership level. However, NEV sales catapulted in 2015 at a 3.4x YoY growth rate and made up 1.3% of China vehicle sales (Figure 8). Aggregate NEV sales also approached closer the 2015 target NEV fleet size. In our view, soaring demand for NEVs in China is fueled by massive government subsidies and policy support (to be discussed in the next section).

 

A link to the full report is posted in the Subscriber's Area. 

China has a massive pollution problem and perhaps more importantly it is now a political liability as an increasingly vocal middle class demand a healthier standard of living. Additionally China’s geopolitical considerations are never far from the minds of its leadership. The fact China does not have the domestic Energy resources necessary to fuel its economic growth represents a challenge for policy markets. 

Oil rose from a two-week low on concern that supplies from Nigeria and Libya, holders of Africa’s largest crude reserves, will be disrupted.

Futures advanced 2.8 percent in New York. Royal Dutch Shell Plc and Chevron Corp. are evacuating workers from the Niger Delta because of deteriorating security, a union official said.
In Libya, some fields will be forced to halt output unless a port blockade is lifted, according to the National Oil Corp.

Canada’s oil-sands companies curbed supply as wildfires ripped across Northern Alberta last week. Gains accelerated as global equities rose.

"The market is getting support from the disruption in Canadian oil sands production and increased threats to output in the Niger Delta," said Gene McGillian, a senior analyst and broker at Tradition Energy in Stamford, Connecticut.

"The underlying fundamentals remain weak. If not for supply disruptions and the decline in U.S. production, prices would be lower."

Crude has rebounded from a 12-year low earlier this year on signs the global oversupply will ease as non-OPEC output declines and regional supply faces threats in Africa and Canada.

 

Oil prices have been the subject of a great deal of media coverage over the last few months not least because of Saudi Arabia’s court politics. There are so many moving parts to this market that we can really only be guided by the price action as an arbiter of what people are doing with their money. 

Saudi Arabian Oil Minister Ali al-Naimi, the architect of the 2014 switch in OPEC policy that’s since roiled the Energy market, companies and entire economies from Mexico to Nigeria, is leaving his post.

An 80-year-old who rose from modest Bedouin roots, al-Naimi headed the ministry for almost 21 years, steering the world’s largest crude exporter through wild price swings, regional wars, technological progress and the rise of climate change as a key policy concern.

“During my seven decades in the industry, I’ve seen oil at under $2 a barrel and $147, and much volatility in between,” al-Naimi told a gathering of the who’s who of the American oil industry in February in Houston. “I’ve witnessed gluts and scarcity. I’ve seen multiple booms and busts.”

The departure of al-Naimi, who for years could move markets just by uttering a few words, is the latest sign of how the country’s young Deputy Crown Prince Mohammed bin Salman is stamping his authority over oil policy. Khalid Al-Falih, chairman of Saudi Arabian Oil Co., the state-owned producer, will replace him as minister of Energy, industry and mineral resources. Al-Falih is known to be close to King Salman and to Prince Mohammed.

“Khalid has been integral to the current oil policy of Saudi Arabia and has worked very closely with the deputy crown prince,” said Jason Bordoff, director of the Center on Global Energy Policy at Columbia University in New York and a former White House oil official.

While al-Naimi enjoyed a relatively free hand to implement oil policy under King Fahd and King Abdullah, his room for maneuver seemed to have narrowed since last year’s accession to power by King Salman and the growing influence of his 30-something son, Prince Mohammed.

At the April 17 meeting in Doha where producers discussed a possible production freeze to shore up prices, al-Naimi lacked authority to complete a deal, according to his Russian and Venezuelan counterparts. The view of Prince Mohammed, who had insisted that no accord was possible without Iran, eventually prevailed and the talks collapsed.

All change as Deputy Crown Prince Mohammed bin Salman ups the stakes in this war of attrition.  Consumers and oil importing countries will be the long-term beneficiaries.   

Global lithium S&D analysis highlights opportunity for high-quality assets
The emergence of the Electric Vehicle and Energy Storage markets is being driven by a global desire to reduce carbon emissions and break away from traditional infrastructure networks. This shift in Energy use is supported by the improving economics of lithium-ion batteries. Global battery consumption is set to increase 5x over the next 10 years, placing pressure on the battery supply chain & lithium market. We expect global lithium demand will increase from 181kt Lithium Carbonate Equivalent (LCE) in 2015 to 535kt LCE by 2025. In this Lithium 101 report, we analyse key demand drivers and identify the lithium players best-positioned to capitalise on the emerging battery thematic. 

Global lithium demand to triple over the next 10 years
The dramatic fall in lithium-ion costs over the last five years from US$900/kWh to US$225/kWh has improved the economics of Electric Vehicles and Energy Storage products as well as opening up new demand markets. Global battery consumption has increased 80% in two years to 70GWh in 2015, of which EV accounted for 35%. We expect global battery demand will reach 210GWh in 2018 across Electric Vehicles, Energy Storage & traditional markets. By 2025, global battery consumption should exceed 535GWh. This has major impacts on lithium. Global demand increased to 184kt LCE in 2015 (+18%), leading to a market deficit and rapid price increases. We expect lithium demand will reach 280kt LCE by 2018 (+18% 3-year CAGR) and 535kt LCE by 2025 (+11% CAGR). 

Supply late to respond but wave of projects coming; prices are coming down 
Global lithium production was 171kt LCE in 2015, with 83% of supply from four producers: Albemarle, SQM, FMC and Sichuan Tianqi. Supply has not responded fast enough to demand, and recent price hikes have incentivized new assets to enter the market. Orocobre (17.5ktpa), Mt. Marion (27ktpa), Mt. Cattlin (13ktpa), La Negra (20ktpa), Chinese restarts (17ktpa) and production creep should take supply to 280kt LCE by 2018, in line with demand. While the market will be in deficit in 2016, it should rebalance by mid-2017, which should see pricing normalize. Our lithium price forecasts are on page 9.

 

A link to the full report is posted in the Subscriber's Area.

The cost of lithium ion batteries falling rapidly and the fact this is occurring at the same time solar cells costs have been trending lower is a major incentive for installations of both technologies; increasingly in parallel. With costs coming down and technology improving growth in demand is a major consideration as factories achieve scale and miners invest in additional supply. 

Energy companies are playing an important role in the junk bond sector. What would oil at $ 38 mean for the credit markets?

Just like oil, the high yield market has enjoyed the easy rally. I think it’s basically over. I don’t see how you are supposed to be all fond off high yield bonds, since they are facing enormous fundamental problems. I thought people would learn their lesson but the issuance in the years 2013/14 was vastly worse than the issuance in 2006/07. Also, in the bank loan market covenant lite issuance rose to 40% in 2006/07. In this cycle it climbed to 75%. The leverage in the high yield bond market is enormous and you’re about to have a substantial increase in defaults. I wouldn’t be surprised if the cumulative default rate in the next five years were going to be the highest in the history of the high yield bond market.

What would be the consequences of that?
We are now in a culture of default. There is no stigma about defaulting anymore. During the housing crash, homeowners walked away from their mortgages. That was the beginning of a massive tolerance of default. Today, people talk about Puerto Rico defaulting like it’s nothing. But if Puerto Rico defaults why won’t some clever person in Illinois say: «Let’s default, too! » Constitutionally, Illinois is not allowed to default, but Puerto Rico wasn’t either. For Illinois it just seems impossible to pay their pension obligations. And then, what about Houston, what about Chicago, what about Connecticut? I am surprised that people have lost their focus on the enormity of the debt problem. Remember, in 2010 and 2011 there was such a laser focus on the debt ceiling in the US and we were worried about Greece. Nobody is worried anymore. People are distracted by this negative interest rate experiment. 

 

The first time I visited Boston was about four years ago and there was a sign from Prudential above the Charles which proclaimed “We have $1 trillion under management”. That’s an impressive number but what popped into my head was “What do they own?” The answer of course is that a great deal of that money is invested in bonds. In fact regulators insist conservative portfolios, aimed at the pensions market, have to own bonds in order to ensure some degree of security that future liabilities can be met. The fact bonds have been in a 35-year bull market has only bolstered the sector’s “risk free” credentials. 

Meanwhile, net gasoline exports are at record high levels. Exports have increased 1,443 kbpd since June 2005.

So, consumption has increased but remains far below pre-2012 levels. Production is again approaching earlier peak levels but most of the increased volume is being exported. The belief that U.S. consumption is approaching record highs is simply not true.

Americans Are Driving More But Using A Lot Less Gasoline

Americans are driving more than ever before. Vehicle miles traveled (VMT) reached an all-time high of 3.15 trillion miles in February 2016 (Figure 2).

VMT have increased 97 billion miles per month (3%) since the beginning of 2015 and gasoline sales have increased 187 kbpd (2%). The rates of increase are not proportional.

For example, VMT was fairly flat from mid-2011 until oil prices collapsed in September 2014 yet gasoline sales fell more than 1 million barrels per day during the same period. Americans traveled the same number of miles but used a lot less gasoline. Even with the VMT increase since 2015, sales are still 539 kbpd less than in January 2009.

 

Generally speaking Energy demand represents a constant long-term growth trajectory because so much of the global economy depends on Energy consumption to fuel growth. However the evolution of electric and CNG vehicles, as well as increasingly stringent emissions regulations reflect an additional consideration that was not so much of a factor previously.

The gains come after five straight years of annual losses when slowing Chinese demand and rising output produced a global supply overhang for most commodities. The rout hurt producers including Exxon Mobil Corp., Freeport-McMoRan Inc., Glencore Plc and Anglo American Plc, who boosted production following a decade-long so-called super cycle of rising consumption and higher prices.

“I believe with what we’ve witnessed early in 2016 will be the trough for the commodity markets,” Albanese said on a conference call after Vedanta reported quarterly earnings.

Oil prices in New York are up about 19 percent this month in New York, the largest increase since April 2015. U.S. crude output declined for a seventh week, according to data Wednesday from the Energy Information Administration. Futures traded at $45.60 at 11:45 a.m. on the New York Mercantile Exchange.

 

Crude Oil is by far the largest, most liquid commodity market and represents a significant cost in the production and transportation of other commodities. The falling cost of Energy was a major enabler for marginal producers remaining in business so the subsequent rally has been a catalyst for increased interest right across the commodity spectrum. 

 Often derided as a blot on rural landscapes, wind turbines got bigger and stronger than ever anyway. The next generation are even larger and designed to withstand an Arctic battering. 

The granddaddy of them all is a machine with rotors that cut a 164 meter (538 foot) swath made by a Vestas Wind Systems venture with Mitsubishi Heavy Industries. A single blade is 80 meters, about the entire wingspan of an Airbus A380 jumbo jet. In the intensely competitive wind turbine business, it’s rare for executives to allow a close-up look of what they’re developing, lest they tip off rivals. Vestas allowed Bloomberg News to visit and photograph the prototype units this month.

As they got bigger, the units became more efficient, boosting global installations 23 percent last year to a record 63.5 gigawatts, which at full tilt would be about as much as what flows from 63 nuclear reactors. Wind is now the most installed form of low-carbon Energy. While few people outside the industry noticed, the trend lifted shares and profit of manufacturers from their crash during the financial crisis. Vestas is due to report its fifth consecutive increase in quarterly profit on Friday, overcoming a slump that forced it to cut 3,000 jobs since 2011.

Even the plunge in crude prices since  2014 has failed to derail industry growth.

“The doubling of turbine size this decade will allow wind farms in 2020 to use half the number of turbines compared to 2010,” said Tom Harries, an industry analyst at Bloomberg New Energy Finance. “This means fewer foundations, less cabling and simpler installation -- all key in slashing costs for the industry.”

The average turbine installed in Europe was 4.1 megawatts last year, 28 percent larger than in 2010, according to the London-based researcher, which expects 6.8 megawatts to be the norm by 2020. Harries said Siemens has hinted it’s working on a 10 megawatt turbine.

Standing in northern Denmark, where fjords cut through flat farmland, MHI Vestas Offshore Wind has erected the world's most powerful turbine. The turbine produces 8 megawatts of power, enough for about 4,000 homes. It could challenge the lead in offshore wind accrued by Siemens, which has almost two-thirds of installed capacity, according to BNEF. MHI Vestas is in second place, with 19 percent.

A Siemens spokesman said a 7-megawatt turbine the company is working on has a “track record of reliability” that will reduce costs for customers. It won its biggest contract for the machine on Wednesday from the Spanish utility Iberdrola, which will buy 102 turbines valued at as much as 825 million pounds ($1.2 billion).

The 80-meter blades of the MHI Vestas V164 make the machine almost as high as the Times Square Tower in New York, and are so large that they were “a nightmare” to transport on narrow country roads, Jens Tommerup, chief executive officer of the venture, said in an interview. This prototype is built for use offshore and has been tested on land since January 2014 at the wind turbine field in Osterlid, managed by the Technical University of Denmark. The goal is to spot faults before they enter service.

As with all technologies, windmills are becoming more efficient, which is obviously very good in terms of the Energy produced.  Aesthetically, I do not like them.  They remind me of the invasion machines from H.G. Wells memorable science fiction novel: The War of The Worlds, first serialised in 1897.  If you live within earshot of a windmill the effects can be very disturbing.  Nevertheless, we will see more of them around the globe because their technology is improving and they are helping us to inch closer to a world in which our Energy is mainly of the renewable variety.   

You've drawn attention to the 12 month T-bill rate a couple of times over the past week. Additionally, it is also very instructive to monitor inflation expectations to gauge what is discounted in terms of the future direction of interest rates. The five-year “breakeven” rate, a market measure of inflation expectations derived from comparing the yield of Treasury Inflation protected bonds (Tips) and conventional Treasuries, has climbed from a low of 0.95% in early February, to 1.56% now. It peaked at 2.4% in October 2012 after reaching an unprecedented minus 0.9% in 2008. 

Movements in Tips have tended to reflect investor expectations about future consumer price inflation, and these have been stoked by the recent rise in oil prices and a weaker dollar, which means higher import prices. In fact, the breakeven rate has been rising in tandem with oil prices since February. Interestingly, the “core” US inflation rate, which strips out the impact of volatile components such as Energy and food, has also been rising. The current buying of Tips reflects a view that the cycle of dollar strength and commodity weakness has come to an end. 

Like you and David, I also think that commodities have bottomed. However, there are no signs of strong underlying demand and inflationary pressures from the real economy at the moment. Furthermore, Janet Yellen, the Fed chair, has cast doubts on the durability of the recent pick-up in core inflation and inflation expectations, arguing that the case for moving cautiously on interest rates was still strong. It is not surprising that she would say that given that the Fed has reduced the likely number of rate rises this year. 

My view is that the US breakeven rate will rise with commodity prices which will push conventional yields up and stock markets down but I don't believe that oil prices, for example, will get anywhere near the previous peak for the reasons discussed by this Service. Thus bond yields too will peak at a much lower level. The collapse in commodity prices in the last few years has distorted valuations in various markets and there will be a ripple effect across the other asset classes.

 

 

Thank you for this thoughtful email and for highlighting breakeven rates which I have not looked at in a while. I watch the 12-month yield because if gives us a good indication of how the bond market is pricing the risk of the Fed raising rates. 

The reform blueprint is inspired by a McKinsey study – Beyond Oil – that laid out how the country can double GDP over the next fifteen years and reinvent itself with a $4 trillion of investment across eight industries, from electrical manufacturing, to cars, healthcare, metals, steel , aluminium smelting, solar power, and most surprisingly tourism. McKinsey warned that half-hearted reform risks disaster, and bankruptcy.   

There is some logic to the Vision2030 plan given Saudi Arabia’s access to cheap Energy. Delivery is another matter. “We have seen these sorts of transition plans before and they never come to much,” said Patrick Dennis from Oxford Economics.

“I don’t think they can pull this off. The riyal peg is grossly overvalued and that makes it even harder. We think market pressures will become overwhelming if there is little evidence of real reform by 2018.”  

Under the plan, Riyadh will sell up to 5pc of the state oil giant Aramco to global investors, and convert the secretive behemoth into a modern company with transparent accounts.

He valued the group at $2 trillion but this figure is plucked out of thin air. Investment funds have demanded a steep discount before buying into partial privatisations of this sort in Russia and other petro-states with a weak rule-of-law, fearing that they may be held hostage to politics.

The aim is to transfer the proceeds into the country’s sovereign wealth fund, using the money to diversify into global investments. These will generate a non-Energy income in the future along the lines of the Norwegian petroleum fund.

It is unclear how this Saudi fund can plausibly reach $3 trillion unless oil rises back above $100 a barrel, and stays there for a long time. The country is currently depleting its foreign exchange reserves by $10bn a month to cover a budget deficit still near 15pc of GDP, drawing down its overseas wealth to fund its military build-up, a war in Yemen and life-support for Egypt, as well as paying state salaries.

The Saudis may have left it too late to break oil dependency in time, especially as renewable Energy reaches parity and the COP21 climate accords signal a move to worldwide carbon pricing. India is already examining plans to switch its entire transport system to electric power.

I hope Prince Mohammad bin Salman succeeds, as that would be best for a degree of stability in the Middle East.  However, I agree with all the reservations in this article above and also others which I have published.  Nevertheless, at least the Prince has ambition, Energy and a plan for dragging his country into the 21^st century.  Good luck to him.

This item continues in the Subscriber's Area where a PDF of AE-P's article is also posted.

San Francisco has passed a law requiring all new buildings below 10 stories to have solar panels installed on their rooftops. It becomes the first major US city to mandate solar panel installations on new constructions and forms part of a wider vision to generate 100 percent of its electricity via renewable Energy.

The Better Roofs Ordinance was passed unanimously by the city's Board of Supervisors, and will apply to new constructions both commercial and residential from January next year, according to the San Francisco Examiner.

"Activating underutilized roof space is a smart and efficient way to promote the use of solar Energy and improve our environment," says Supervisor Scott Wiener, who introduced the legislation in February. "We need to continue to pursue aggressive renewable Energy policies to ensure a sustainable future for our city and our region."

Other governments around the world have adopted similar policies, including the states of Maharashtra and Haryana in India. Dubai also plans to make rooftop solar panels mandatory for all buildings starting in 2030, as part of the Dubai Clean Energy Strategy 2050. More locally, the smaller Californian cities of Lancaster and Sebastopol introduced compulsory rooftop solar panels in 2013.

Hardly a month goes by without reports of new developments within the solar industry which increase the variety, flexibility and overall efficiency of these installations.  Our ability to capture and generate power from the sun’s rays is limited only by our imagination.   

  (See also: 3D solar towers offer up to 20 times more power output than traditional flat solar panels, and Solar Panels made three times cheaper and four times more efficient.)

Even if some SUNE obligations are not fulfilled, TERP expects to continue operating

Defaults may now exist under many of TERP’s non-recourse project-debt financing pacts (or such defaults may arise in the future) due to SUNE bankruptcy filing, delays in preparation of audited financial statements

Defaults “are generally curable"; TERP will work with its project lenders to obtain waivers and/or forbearance agreements

No assurances can be given that waivers, forbearance agreements will be obtained

 

SunEdison rallied impressively from its 2012 lows following the adoption of a quickstep leveraged strategy aimed at acquiring or building solar Energy power plants while simultaneously divesting of the completed assets into two MLPs. This saddled the parent with the risk of acquisition and building without holding onto the residual cash flows from a working utility once completed. The strategy was predicated on the rapid pace of solar installations persisting indefinitely. They do not appear to have factored in the role a drop in oil prices would have on that business model. 

Our commodities analysts believe that China’s demand for commodities will normalise to a level consistent with its GDP/capita, as the economy transitions from investment-led (i.e. where the government pays) to consumption-led (i.e. where the consumer pays). In short, fewer roads, buildings, bridges and airports, and more cars, air conditions, fridges and the like. This part of an economy’s development is less commodity-intensive, and we expect China’s commodity demand evolution to follow a more conventional path. This suggests a significantly lower level of demand than that seen through 2003-2014.

The implication for the supply-demand balances of the major metals is that without a significant change on the supply-side of the equation, oversupply will widen and prices will fall further

Which brings the argument back to liquidity. We would argue that mines don’t close through choice, but because they have to. Typically, this point comes when a company runs out of funds to meet its obligations (liquidity). We have seen African Minerals and London Mining join and leave the London stock market and their mines close - the capital markets were not prepared to continue to fund losses.

Ultimately, if demand does not return, then the industry’s current position could prove to be something of a holding pattern. Keep producing, drive more productivity and cost reduction and wait for the capital markets to pass judgement when the more weakly positioned companies need to refinance.

The role of Energy prices in the total cost of production for mining operations is a topic that does not appear to be covered by this report. Yet, it is a major consideration for miners and declining oil prices were a key factor in the ability of very marginal operations remaining viable. That is one of the primary reasons why the rebound in oil prices has been a positive catalyst for commodities. 

The collapse of OPEC talks with Russia over the weekend makes absolutely no difference to the balance of supply and demand in the global oil markets. The putative freeze in crude output was political eyewash.

Hardly any country in the OPEC cartel is capable of producing more oil. Several are failed states, or sliding into political crises. 

Russia is milking a final burst of production before the depleting pre-Soviet wells of Western Siberia go into slow run-off. Sanctions have stymied its efforts to develop new fields or kick-start shale fracking in the Bazhenov basin.  

Saudi Arabia’s hard-nosed decision to break ranks with its Gulf allies at the meeting in Doha - and with every other OPEC country  - punctures any remaining illusion that there is still a regulating structure in global oil industry. It told us that the cartel no longer exists in any meaningful sense. Beyond that it was irrelevant.

Hedge funds were clearly caught off guard by the outcome since net ‘long’ positions on the futures markets were trading at a record high going into the meeting. Brent crude plunged 7pc to $41 a barrel in early Asian trading, but what is more revealing is how quickly prices recovered.

Market dynamics are changing fast. Output is slipping all over the place: in China, Latin America, Kazakhstan, Algeria, the North Sea. The US shale industry has rolled over, though it has taken far longer than the Saudis expected when they first flooded the market in November 2014. The US Energy Department expects total US output to drop to 8.6m barrels per day (b/d) this year from 9.4m last year.

China is filling up the new sites of its strategic petroleum reserves at a record pace. Its oil imports have jumped to 8m b/d this year from 6.7m in 2015, soaking up a large part of the global glut.  Some is rotating back out again as diesel: most is being consumed in China.

Goldman Sachs says the twin effect of rising demand and supply disruptions across the world is bringing the market back into balance, leading  to a “sustainable deficit” as soon as the third quarter. The inflexion point could come sooner than almost anybody expects if a strike this week in Kuwait drags on as oil workers fight pay cuts. The outage is already costing 1.6m b/d.

Kuwait’s woes are the first taste of how difficult it will be for the petro-sheikhdoms to impose austerity measures or threaten the cradle-to-grave social contracts that keep a lid on dissent across the Gulf.

While I had seen this article in The Telegraph and was planning to use it, I also received this email from a subscriber today:

I am sure you have read the above. He is saying precisely what you said many moons ago, but the conclusion is I think somewhat different.

Thanks, and yes, he does have a different conclusion which I will comment on below but first here is the article’s headline from the printed edition:

Saudi Arabia’s strategy has killed Opec – the cartel is now irrelevant

OPEC was rapidly losing control, thanks to technology.  However, the Saudis have hastened this process by flooding the market.  This was always going to be a Pyrrhic victory at best and it cut every oil producers’ revenue much more quickly than was necessary.  They could have kept prices at least $30 to $40 higher for the lengthy medium term by making some marginal supply cutbacks, rather than flooding the markets with oil. 

That opportunity was lost, so what happens next?

This item continues in the Subscriber’s Area, where a PDF of AE-P's article is also posted.

Australian central bank Governor Glenn Stevens speculated that monetary policy may have reached its limits in spurring economic growth and suggested this could explain why markets are being easily rattled.

“Monetary policy alone hasn’t been, and isn’t, able to generate sustained growth to the extent people desire,” Stevens said in a speech in New York on Tuesday. “Maybe we need to be clearer about what we can’t do. Monetary solutions are for monetary problems. If there are other problems in the underlying working of the economy, central banks won’t be able to solve those.”

The irony here is that Stevens, who has resisted the global movement to further easing and kept his benchmark rate at 2 percent for almost a year, is facing a currency that has reversed course in the past three months and threatened his push to broaden Australia’s growth drivers. He warned in minutes of this month’s policy meeting Tuesday that the Aussie’s appreciation could complicate efforts to rebalance the economy away from mining.

Stevens, who is in the final months of his 10-year stint at the helm of the Reserve Bank of Australia, also questioned in the notes of his speech whether central banks and their unorthodox policies are solely responsible for the decline in long-term interest rates. 

“Monetary policy is not supposed to be able to affect real variables -- like real interest rates -- on a sustained basis,” he said. “Presumably, changes in risk appetite, subdued growth and expectations that growth will continue to be subdued have also played a role in lowering real rates.”

 

The need for Australia to develop additional sources of economic growth outside the resources sector was a major focus of attention while the price of commodities was falling. With the rebound in Energy, industrial resources and soft commodities now underway the urgency of that drive is less pressing. In fact it is likely to act as headwind because the RBA will be less inclined to ease monetary policy when commodities are doing well. 

After taking over defense and economic planning, Saudi Arabia’s Deputy Crown Prince Mohammed bin Salman has now stamped his authority over oil policy.

In so doing, the 30-year-old son of King Salman upended the Saudis’ decades-long approach of separating commercial from political considerations. Over the weekend, Saudi officials quashed an agreement among major oil producers in Doha to freeze output due to Iran’s refusal to participate, a sign the regional rivalry is infecting the market.

“Everything at Doha was about politics,” said Yasser Elguindi, an oil analyst at Medley Global Advisors, a consultant that advises large hedge funds.

The change means that everyone exposed to Energy prices, from oil majors such as Exxon Mobil Corp. to traders like Vitol Group BV, will have to heed the opaque politics of the Middle East -- and the House of Saud. With Saudi Arabia and Iran weathering one of their worst diplomatic crises since the Islamic revolution in 1979 installed a Shiite theocracy in Tehran, and both countries taking opposite sides in civil wars in Syria and Yemen, the oil market should brace for a wild ride.

“The fact that Saudi Arabia seems to have blocked the deal is an indicator of how much its oil policy is being driven by the ongoing geopolitical conflict with Iran,” said Jason Bordoff, director of the Center on Global Energy Policy at Columbia University in New York and a former White House oil official.

This looks like a power play by Deputy Crown Prince Mohammed bin Salman.  Is he just reminding everyone within OPEC that he is in charge?  Does he want them to pressure Iran into line?  It is anyone’s guess and this remains a difficult situation.

The most interesting development concerns what is happening in the markets.

This item continues in the Subscriber’s Area.

Oil rallied above $42 a barrel, buoying stocks and commodity prices worldwide amid a revival in optimism over the global economy.

Energy shares in the Standard & Poor’s 500 Index surged the most since February after Russia and Saudi Arabia were said to have forged a deal on freezing oil output. Metals jumped, bolstering the Bloomberg Commodity Index and offsetting the impact of the International Monetary Fund’s warning on global stagnation. The yen fell versus all its major peers, as Treasuries and German bunds slid amid diminished demand for haven investments.

Crude oil is extending its 14 percent climb this year amid prospects a drop in U.S. shale production will help ease a global glut in the commodity. Traders are focused on a meeting in Doha set for April 17, where major producers, including Russia and Saudi Arabia, are due to discuss arresting production. Speculation the oil market could soon find some enduring stability is helping to prop up equities, even as investors brace for what’s projected to be the worst American earnings season since the global financial crisis. The Federal Reserve’s pared timeline for interest-rate increases is also supporting gains.

“There’s continued positive sentiment that is a function of a more dovish Fed as well as continued oil price strength and weakness in the dollar,” said David Spika, the Dallas-based global investment strategist for GuideStone Capital Management. “Oil prices have really been the driver of sentiment, with a high positive correlation.”

While the Doha meeting this Sunday may be only another small step, the reality is that oil producers are still burning through cash reserves at today’s prices.  Oil is no different from any other commodity; less production is the key to higher prices.  Most of this year’s rally to date has come from short covering.  

(For considerably more coverage of industrial commodities and precious metals, please listen to the Audio.)

While global producers are “buying time” and waiting for the focus to shift from the oversupply to rising demand, U.S. producers will “absolutely” be the ones driving the potential rebalancing of the oil market, according to Hansen.

“No doubt, because they have the ability to react much quicker to price changes,” he said, referring to U.S. producers. He warned that a price surge to $55 to $60 a barrel may prompt drillers to pump more. Others including Goldman Sachs Group Inc., UBS Group AG and IHS Energy have also said a recovery in crude may sputter once prices go high enough to keep U.S. oil flowing.

After surging to 9.6 million barrels a day last year, the highest level in more than three decades, daily U.S. production has dropped to about 9 million as of early April. Meanwhile, the number of rigs drilling for oil in the U.S. has dropped to the lowest level since 2009.

Still, the market may reach equilibrium in 2017, according to Hansen. The International Energy Agency has warned that investment cuts taking place now because of the Energy downturn increase the possibility of oil-security surprises in the “not-too-distant” future.

 

The USA is an increasingly important swing producer of crude oil which is not a condition many people predicted before last year. Unconventional oil and gas remain gamechangers for the sector and the increasing potency of the US on Energy prices as a supplier rather than just a consumer is a part of that.

Corporate earnings peaked at $1.845 trillion (£1.3 trillion) in the second quarter of 2015, and recessions typically start five to seven quarters after the peak. "We will not be dancing on the volcano like so many others," said Saint-Georges.

If we are lucky it will be a slow denouement with a choppy sideways market going nowhere for another year as the US labour market tightens, and workers at last start to claw back a greater share of the economic pie. 

The owners of capital have had it their way for much of the post-Lehman era, exorbitant beneficiaries of central bank largesse. Now they may have to give a little back to society. Yet this welcome “rotation” spells financial trouble.

Strategists Mislav Matejka and Emmanuel Cau, from JP Morgan, have told clients to prepare for the end of the seven-year bull run, advising them to trim equities gradually and build up a safety buffer in cash. “This is not the stage of the US cycle when one should be buying stocks with a six to 12-month horizon. We recommend using any strength as a selling opportunity,” they said.

Their recent 165-page report on the subject is a sobering read. The price-to-sales ratio (P/S) of US stocks is higher than any time in the sub-prime boom. Share buy-backs are at an historic high in relation to earnings (EBIT). Net debt-to-equity ratios have blown through their historical range.

This is happening despite two quarters of tighter lending by US banks. Spreads on high-yield debt have doubled since 2014, jumping by 300 basis points even after stripping out the Energy bust. The list goes on; the message is clear. “One should be cutting equity weight before the weakness becomes obvious,” they said.

There are a number of good points in this article, inspired by the bearish 165-page report from JPMorgan mentioned above, which I assume Jamie Dimon would have encouraged given his recent comments.

This item continues in the Subscriber’s Area where some conflicting evidence is illustrated and discussed.  A PDF of AE-P’s article is also available.

The announcement of this meeting has been very supportive for the oil price as it led to a large short covering by financial players, since a deal to freeze production should limit the potential downside in oil prices. Now with the statements by MBS in the Bloomberg interview last week, the outcome of this freeze deal is much more uncertain. In the interview MBS said that Saudi Arabia will only freeze output if Iran and other major producers do so. If all countries agree to freeze production, we’re ready," MBS said . "If there is anyone that decides to raise their production, then we will not reject any opportunity that knocks on our door.” This stands in contrast to prior statements from the Saudi Oil Ministry and from Russia which had suggested that a freeze deal could happen without any commitment from Iran. The market took this statement very negatively for the oil market because Iran has made no indications that they will join the freeze deal and even if they did, most analysts would probably doubt that production from Iran would be frozen anyway.

If Saudi Arabia indeed see any chance that a freeze deal cannot be accomplished then it is relevant to ask the purpose of even arranging the meeting. If a meeting is held and Saudi does not accept a deal without Iran participating then we believe a deal will not happen and if a meeting is held without a successful deal, then the oil price may drop quite significantly on that kind of news. Would that be in Saudi Arabia’s interest. Would MBS like to see a lower price again to inflict even more pain on the other global oil producers and hence set the stage for higher prices later? It seems odd that MBS is not coordinated with the oil ministry in this issue, but could his statement have been meant for domestic politics? And is it not very strange if MBS in the last minute should undermine the Russian effort to achieve this now famous freeze deal? Is this a negotiating trick to achieve something in return from the Russians vs Iran in Syria or other places?

The problem with this statement from MBS is that he outranks everyone else in Saudi when it comes to economic policy as he heads the newly formed Economic Council. This implies that if he actually means what he is saying here, there will be no production freeze deal in Doha, because we are confident that Iran will not take part in any production freeze deal. Before this statement by MBS we were 90% certain that there would be a production freeze deal coming out of the Doha meeting, because why hold this meeting if a freeze is not already agreed? It would, as described above, send the oil price in tailspin if a meeting was arranged and ended up with no agreement. After the MBS statements we see the chances for a freeze deal meaningfully reduced, maybe down to 50%.

If the meeting to hold the freeze deal in Doha is cancelled or if it is held without a successful outcome we would reduce our short term (3-month) price target for Brent which is currently 45 $/b. We would however not do anything with out 6-month target of 55 $/b and our 12-month target for 65 $/b. Our 24-month target (currently 70 $/b) on the other hand may be adjusted slightly higher due to the extra damage that may be inflicted to the supply side of a potential revisit to 25-35 dollar oil prices.

On Monday this week the Russian Energy Minister Alexander Novak however stated that “Russia can conduct extra talks with Saudi Arabia on oil output freeze before the meeting in Doha on April 17th”. Novak also stated that he is confident that an agreement will take place. This suggests that maybe the statements from MBS in the Bloomberg interview last week may have been meant for his domestic audience. Also the Kuwait OPEC governor Nawal Al-Fuzaia said on April 5 that there are indications that oil producing countries in both OPEC and non-OPEC are poised to agree on a production freeze to January levels. This statement seemed to give the market some restated confidence that there could still be a freeze deal in the Doha meeting on April 17th. But nonetheless the MBS interview last week has added a lot more uncertainty to the April 17th meeting than what the oil market would prefer. 

A link to the full report is posted in the Subscriber's Area.

Brent crude prices firmed today on positive inventory data but the result of the April 17th meeting between major OPEC and non-OPEC producers is a major consideration for traders.

Saudi Arabia is fighting wars on three fronts and higher oil prices would certainly help with affording this adventurism as well as its highly accommodative domestic social programs. While Iran remains its greatest competitor for regional hegemony and the administration will not wish to give it any advantage, economic factors will probably take precedence. 

Yer man, while I often feel like I am part of the new old economy. I am not concerned in the near term that electric vehicles will have mass adoption. I am puzzled how the electrical grid will power all these new super cars? Coal which is the worst emitter of GHG's is the primary source of electrical generation in North America and that is being phased out for natural gas as you know. The environmental movement is flawed with hypocrisy and makes no economic sense. In Canada the govt has chosen to demonize the oil and gas industry which funds the majority of our social services and yet we bail out Bombardier and the auto industry. I sound like a grumpy old man.

Thanks for this topical comment to a piece I posted on Friday. It’s been a long time since we shared an apartment in London; when we were both new to London, and I’m glad you’re still in the heat of the action in Calgary. I think everyone finds it hard not to be grumpy when things are not going one’s way at any age. 

This article from the state.com from 2014 estimates that if every car in America was an electric vehicle it would represent only about a 30% increase in electricity demand because electric vehicles are more efficient. 

Record-low costs for power in the U.S. haven’t translated into lower monthly payments for consumers.

As the price of electricity in the eastern U.S. fell by half over the last decade, utilities raised monthly bills for residential customers by 26 percent, according to government data. Consumer advocates say the power companies are using falling electricity costs as cover to raise other charges. Utilities counter that it’s payback for billions of dollars worth of government-mandated improvements to long-neglected infrastructure.

It’s “a good thing that Energy prices have fallen off and allowed the required capital to be installed and be done without impacting the consumer,” said Exelon Corp. Chief Executive Officer Chris Crane in an interview during a conference organized by Bloomberg New Energy Finance in New York on Monday.

Electricity itself makes up about a third of the average utility bill, down from about half just eight years ago, thanks to a flood of cheap fuel, natural gas extracted with fracking from tight-rock formations. The rest of the retail charges are for delivering supplies, including adding enough capacity to handle demand surges.

The too often postponed infrastructure repairs are clearly necessary and obviously not just in the USA.  Imagine how much worse this situation would have been if technological innovation had not led to lower prices for crude oil and natural gas. 

In another example, Japan still faces higher Energy costs because it understandably closed all its nuclear reactors following the Fukushima meltdown.  They previously provided almost 30 percent of Japan’s electricity.  Japan is increasing its solar and wind power but this currently produces less than 15 percent of its electricity.  Consequently, Japan has had to import more coal, oil and natural gas.  This situation is only just beginning to improve as Japan is gradually reopening some of its nuclear reactors, in what are regarded as geologically safer regions, following additional safety measures.   

Most countries should benefit from lower Energy costs in years ahead as renewables become more efficient, oil and gas prices stay low and new nuclear is used more widely. 

The rally year to date reflects a rotation into sectors benefiting from a weaker US dollar, Chinese stimulus and the oil price rebound more than it reflects the slowly improving fundamentals - and we think each of these positives is now priced in. The sector has re-rated to a P/NPV of 0.86x, in line with the average trough multiple since 2003. It's the same for earnings multiples, where we now forecast a sector 2017e PE of 30x, well above the average trough PE of 9x, and the 17x of the most recent low in May 2015. We prefer Rio at 0.76x P/NPV compared with BHP at 0.92x. We have downgraded Glencore to Hold (0.8x NPV), but prefer it to Anglo (0.6x) given deleveraging progress.

FCF now healthy across the sector and gearing coming down
The 1Q16 commodity price recovery, with the oil price and producer currency weakness early in the quarter, plus continued ‘self-help’, has boosted free cash flow across the sector. 17 of the 19 companies under our coverage are now producing free cash flow after dividends in 2017. FCF yields average 10% for the big four diversified miners and 8.4% for the whole sector next year. Gearing is also reducing: we forecast a drop from 26% in 2015, to 22% in 2016 and 16% in 2017.

Lots for sale, lots of window shopping, no real buying…yet
A few companies are starting to use their balance sheets in selective M&A, but for rich multiples which are too high for most to justify when downwards pressure on long-term commodity prices prevails: today we have cut our LT copper price by 7% to USc300/lb and our LT iron ore price by 14% to US$57/t. There is a lot of window shopping going on, but valuations have run hard very quickly and we think both buyers and quality “for sale” assets remain scarce. 

 

A link to the full report is posted in the Subscriber's Area.

The commodities sector was about as unloved as is possible late last year and an impressive short covering rally has taken place over the first quarter. A similar move in oil prices has been the catalyst for renewed interest in miners because somewhat higher Energy prices will have helped to push marginal supply out of the market. 

Malaysia’s Energy exports are tumbling, its prime minister is battling corruption allegations and corporate profits are weakening. With all that, the Southeast Asian nation is also home to the world’s most resilient bull market for stocks.

Overseas funds are piling in at the fastest pace in Southeast Asia. Kuala Lumpur’s benchmark equity gauge has more than doubled from its 2008 lows without succumbing to a 20 percent drop. Tan Ming Han says he knows its secret: the lowest volatility among the region’s markets. It’s an environment where a growing army of investors are willing to miss out on the highest highs if that means they also avoid the biggest crashes.

“Sometimes, too much excitement can cause a panic attack -- especially with volatile markets,” said Tan, senior investment manager at Amundi Malaysia. “Boring is sometimes beautiful.”

Sentiment remains stubbornly buoyant in Malaysia, home to some of the region’s highest dividends, as the country’s $166 billion pension fund underpins demand for equities with share purchases. Even after the FTSE Bursa Malaysia KLCI Index climbed 12 percent from a three-year low in August, it trades near the cheapest relative to global equities in almost a decade.

South East Asia’s so-called ‘Little Tiger’ stock markets had been out of favour for a lengthy period but Malaysia’s KLCI (p/e 18.67 & yield 3.04%) bottomed in August 2015 with a big upside weekly key reversal following a plunge to almost 1500.  Currently, there is no evidence that this recovery is over and the 200-day (40-week) MA has turned upwards, although overhead supply is likely to be a headwind at somewhat higher levels.

This item continues in the Subscriber’s Area.

Chinese companies, driven by favorable government policies and a desire to gain overseas assets, are on an unprecedented acquisition spree in the U.S. They've announced a record $40.5 billion of U.S. deals this year, already nearly double the amount for all of 2015. Here's a sample of what Chinese money is buying. 

Strategic Hotels & Resorts Inc.'s portfolio includes Four Seasons properties in Austin and Silicon Valley, as well as the Intercontinental Miami and Chicago. China's Anbang Insurance Group Co. is paying about $6.5 billion to buy the hotel group from Blackstone Group LP—just three months after the New York-based private equity firm acquired it.

Anbang is also currently the lead bidder for Starwood Hotels & Resorts Worldwide Inc., after twice topping Marriott International Inc.'s bid. Starwood owns real estate valued at about $4 billion, including the St. Regis in New York. Anbang's latest offer values Starwood at about $14 billion.

General Electric Co. agreed to sell its appliances business to China's Haier Group Co. for $5.4 billion in January—$2 billion more than Electrolux AB had agreed to pay for the business before the deal collapsed amid opposition from the U.S. Justice Department. Haier will need antitrust approval from authorities in the U.S., Mexico, Canada, and Colombia.

Zoomlion Heavy Industry Science & Technology Co., a Chinese industrial machinery manufacturer, is pursuing Westport, Conn.-based cranemaker Terex Corp. After Terex agreed to a merger with Finnish competitor Konecranes Oyj, Zoomlion made an unsolicited counter-bid in January; last week it upped the offer to $31 a share.

China's richest man agreed in January to buy Legendary Entertainment LLC, producer of Godzilla and the Dark Knight trilogy and co-producer of Jurassic World, for as much as $3.5 billion. Wang Jianlin is set to become the first Chinese person to control a Hollywood film company.

This is not a repeat of earlier efforts by China’s government, using companies it controlled, to controversially attempt to acquire strategic US assets, from Energy to important high-tech businesses.  Instead, apparently independent Chinese companies and exceptionally wealthy individuals are moving a record $40.5 billion into the US during the first quarter of 2016 alone, by paying over the odds for mostly consumer-related businesses. This looks like the latest effort in China’s difficult transition from a heavy manufacturing economy to one that is driven primarily by consumer demand.   

This assessment [see Wednesday’s lead item] does not surprise me. I travel to Brussels several times a year to EU meetings. Much of the city appears to be slowly degenerating with little sign of refurbishment of buildings or infrastructure. New buildings are mostly EU-related. Traffic is awful. The Eurostar station (Brussels-Sud) is from the 19th century and on return home London St Pancras/Kings Cross looks marvelous, with colour, Energy and modernity totally lacking in Brussels. Though Belgium still surprises with very good food and beer!

Subscriber feedback and other thoughts of general interest are always appreciated.

I suspect the food and wine have been good for centuries, a few wars aside, and I hope they are a favourable omen for Brussels’ future.  As for Parcras/Kings Cross, I can remember when they were very rundown and their revival is further evidence of London’s dynamism.  However, this cannot be taken for granted – we have a very important mayoral election on 5^th May.   

In two months on the road covering the 2016 presidential primaries, I've seen the U.S. going through something of an identity crisis, after decades of dominance. The candidates are talking about what the voters are thinking about: What does it mean for America to be great? 

To a traveler, America's greatness is revealed in simple, visual ways. Everywhere, even in sparse rural areas, there's a healthy bustle of activity. Americans get up early, and they find it hard to keep still. At a Florida intersection, I watched a man expertly juggle a mattress-store sign to attract customers. He might hold the sign for minimum wage, but that's not why he juggles it.

The whole country is never in repose; an Energy runs through it that you won't find anywhere else, and a sense of constant, habitual competition is ever-present. This is the biggest economy in the world, and it feels like it. It feels like a great nation.

To the presidential candidates, however, the issue of greatness is debatable.

America’s most attractive and inspirational quality of the 20^th Century, in my opinion, was that in this nation of immigrants people believed that they had the freedom and opportunity to achieve their realistic ambitions.

I believe that was an important key to America’s greatness.    

Mr. Burns, a long-time financial journalist and the creator of the “Couch Potato” investment portfolio, authored a column recently pointing out the dilemma faced by retirees who wished to finance their retirements without assuming any risk, or as he titled it, “How to cope with the great yield famine.”

The column, published about two weeks ago, pointed out that the last time anyone earned 6% on a six-month certificate of deposit (CD) was December 2000. The lowest yield on a six-month CD immediately after the dotcom market crash was 1.01% in June 2003. The highest yield on a six-month CD since June 2003 was 5.22% in July 2006. Today, according to Bankrate.com, the highest yield on a six-month CD nationwide is 1.10%, but the vast majority of banks offer less than 0.15%.

He then went on to figure out the retiree’s needs and how much capital was required to meet those needs risk-free. The monthly premium for Medicare Part B is $121.80, or $1,461.60 a year. To earn that much money from a 0.15% CD you would need to keep $974,400 on deposit. For most Americans that is a large sum, but it is not a problem since Social Security deducts the payment from your monthly check.

The official federal poverty level income for a family of two for 2016 is $15,930. To generate that income from a risk-free CD at 0.15% interest, you need to deposit $10,620,000. To finance a poverty-level retirement with a risk-free investment portfolio means you have to maintain $11,594,400 of your assets on deposit in those low-yielding CDs, which would place you among the top 1% of wealthy Americans. Think about that. If you don’t want to accept financial risk in your retirement, you must be in the top group of Americans in terms of wealth. The rich are poor! In order to keep our world spinning and boost its growth rate, there are no risk-free avenues available for ordinary Americans. Recognition of this condition, coupled with the stock market’s volatility, may be fuelling a portion of the anger we are seeing among the electorate today. This situation will also be an anchor on how fast our Energy needs grow.

 

A lik to the full report is posted in the Subscriber's Area.

The impact on savers of the near zero and increasingly negative interest rates we are now presented with represents a major challenge for savers. A subscriber left this comment on a piece I posted Friday and I believe it is well worth repeating here:

“I find it very concerning that central bankers, like finance ministers, never discuss the distortions produced in the future savings markets by the NIRPs.

“Pension funds and insurance companies are suffering even more than banks, but no one is discussing this. It seems to me that in the medium term the dysfunction of markets under NIRP will continue to produce counterproductive effects on risk appetite, which will negate the aim to increase risk acceptance by investment in business assets (as opposed to just paper).”

Have you seen this :- World First: Graphene Battery Plant Gears up for 2016 Commercial Production Spanish company Graphenano has introduced a graphene polymer battery it says could allow electric vehicles to have a maximum range of up to 497 miles. The battery can also be charged in just a few minutes, is not prone to explosions like lithium batteries, and can charge faster than a standard lithium ion battery by a factor of 33. The batteries are expected to be manufactured in Yecla, Spain and will have an Energy density of 1,000 Wh/kg. For perspective, conventional lithium batteries have an average Energy density of just 180 Wh/kg. To top it all off, the battery does not exhibit memory effect, a phenomenon in which charging a battery multiple times lowers its maximum charge

Thank you for this snippet and no I had not previously heard of Graphenano but it captured my attention because it sounds almost too good to be true. 

The issue stems from the fact that Linn is taxed as a master limited partnership, or MLP, rather than a corporation, a popular arrangement among Energy companies when oil prices were soaring.
In good times, that status allowed income to flow straight through to investors without the Internal Revenue Service taking a cut at the corporate level. Linn distributed some billions of dollars of cash to investors as U.S. Energy production boomed.

But the collapse in oil and gas prices has exposed the structure’s double-sided risk: Investors with potentially worthless shares—or units, as they are known—may nonetheless owe taxes on debt that is forgiven in a bankruptcy or an out-of-court restructuring.

That is because MLPs pay no corporate taxes and instead pass certain tax burdens, along with a share of their income, to investors. Debt forgiven in a restructuring counts as noncash income, or “cancellation of debt income,” which creates a tax liability for investors without an associated cash distribution.

The roughly 60% plunge in oil prices since the summer of 2014 already has sent a number of Energy companies into bankruptcy court, and more are expected to follow. Fitch Ratings expects the default rate for U.S. high-yield Energy bonds to rise to 11% by the end of the year, compared with 1.5% for bonds outside the battered Energy and metals-and-mining sectors.

A gusher of bankruptcies and debt restructurings could be especially painful for MLP investors, most of whom are individual investors. Big institutions like BlackRock Inc., as well as many endowments and foreign institutions, can’t legally own partnership units or don’t want to, given their complexity.

 

I’ve given talks and conducted The Chart Seminar all over the world but I was never asked about the tax implication of a decision to sell until I came to the USA. The tax code is complex, rates are high and sometimes tax savings can reside where you might not expect them such as in trusts. The details described above highlight some of the reasons why the MLP sector underperformed so acutely while oil prices were falling but with such a panic to get out, is the bad news already in the price?

But the biggest breakthrough is in the area of Energy storage. “I think that’s one area where we have delivered big time,” Williams told the Guardian.

The battery storage systems developed with Arpa-E’s support are on the verge of transforming America’s electrical grid, a transformation that could unfold within the next five to 10 years, Williams said.

The most promising developments are in the realm of large-scale Energy storage systems, which electricity companies need to put in place to bring more solar and wind power on to the grid.

She said projects funded by Arpa-E had the potential to transform utility-scale storage, and expand the use of micro-grids by the military and for disaster relief. Projects were also developing faster and more efficient super conductors, and relying on new materials beyond current lithium-ion batteries.

The companies incubated at Arpa-E have developed new designs for batteries, and new chemistries, which are rapidly bringing down the costs of Energy storage, she said.
“Our battery teams have developed new approaches to grid-scale batteries and moved them out,” Williams said. Three companies now have batteries on the market, selling grid-scale and back-up batteries. Half a dozen other companies are developing new batteries, she added.

 

Battery technology is the missing link in the supply chain between generating electricity via wind and solar and meeting requirements for base load. Until the last decade investment in batteries was puny compared to what has gone into other sectors. However the high oil price environment created an incentive to develop more efficient ways of generating and storing Energy. Some of that is now coming to fruition and it is likely to have a transformative effect on electricity costs and the potential for electric cars. 

To demonstrate how dramatically the outlook for petroleum demand growth has changed, we compared common year demand estimates from the 2004 and 2015 AEO forecasts and found the following data points: 2015 – 43.94 vs. 32.76 QBtus; 2020 – 46.97 vs. 33.16 QBtus; and for 2025 – 50.42 vs. 32.64 QBtus. These represent forecast differences between the 2004 and 2015 AEO forecasts of -25.4%, -29.4% and -35.3%, respectively. 

It is our belief that this dramatically altered long-term outlook for petroleum is at the heart of the Saudi Arabian oil strategy. High oil prices have hurt demand growth prospects while at the same time encouraging the development of high-cost, long-lived petroleum resources. These high oil prices have provided an umbrella for expensive alternative Energy sources and, given the global embrace of climate change and anti-fossil fuel policies and mandates, made petroleum’s long-term outlook even less rosy. In the U.S. where producers could sell everything they produced, few gave any thought to the shifting demand outlook globally and the role that domestic production growth would play in altering that outlook. 

Recognizing that the outlook for petroleum demand is lower requires a mindset change for oil company CEOs; something we sense is just now beginning to sink in. While oil CEOs talk about lowered production growth forecasts as a result of low oil prices and the forced reductions in their capital spending plans, recognition that there are substantial low-cost oil reserves in the world held by countries desperate for income is beginning to resonate. Zero production growth in a declining demand business may not be the worst outcome for oil companies. Without production volume growth, maximizing profitability becomes even more important. Determining how to organize and manage a company in this new black-swan-world of shrinking oil demand will be the real challenge. 

A link to the full report is posted in the Subscriber's Area.

I have not previously seen historic figures for how expectations of demand growth have inflated over the last decade. We know that China’s booming steel industry encouraged new mines to open and existing iron-ore miners to increase supply. The exact same thing happened in the Energy market and the problem now is that those demand growth forecasts have to be recast in the light of China’s moderating growth rate and the increasingly efficient use of Energy on a global basis. 

The commodity bulls are now roaring after Monday's near 20-per-cent jump in the price of iron ore, which sent shares in miners such as BHP Billiton, Rio Tinto and Fortescue Metals sharply higher.

The euphoric mood continued in trading overnight, helping to push oil prices higher. Brent crude, the global benchmark, climbed 5.5 per cent to a 2016 peak above $US40 a barrel. It is now 50 per cent above the 12-year low it hit in intraday trading in January. US West Texas Intermediate joined in the recovery, surging 5.5 per cent to $US37.90.

Oil prices have climbed on hopes the major oil producers will strike a deal to limit supply after Russia, Saudi Arabia, Venezuela and Qatar agreed last month to freeze output at January levels. These hopes were bolstered overnight, after the United Arab Emirate's Energy minister said that current prices meant it made no sense for any country to increase production.

"This is all good news for balancing the market", Suhail bin Mohammed al-Mazrouei told reporters. "We just need to be patient."

But not everyone is convinced that commodity prices will continue their upward surge. Some analysts argue that price gains in industrial metals, such as iron ore, are largely dependent on hopes that China will introduce more aggressive policies to stimulate growth.

The bulls are hoping that, faced with slowing economic activity, Beijing will abandon its efforts to steer its economy away from heavy industry, and towards services. They're betting that China will boost spending on major infrastructure projects, which will boost demand for steel (China accounted for about half of the world's steel output last year).

But more bearish analysts point out that iron ore prices will quickly drop if Beijing's efforts to boost growth fall short of expectations.

In grappling with this question we will continue to hear a great deal about China, which is the world’s largest consumer of many commodities.  Sure, China is obviously important but with commodities supply is always the most significant variable. 

Will commodity exporters increase production rapidly now that industrial resources are off their lows?  Well, some may but that is the equivalent of sitting on the wrong end of the branch which you are sawing off the tree. 

Meanwhile, the cure for low commodity prices is low prices, which encourage increased consumption at a time when all-important supply is also decreasing. 
 

But perhaps the most convincing evidence that solar is here and it's competitive is that oil companies are now using it to make oil extraction cheaper and cleaner.

Late last year news began coming out that the oil industry was turning to solar to help it pump crude.

Royal Dutch Shell (NYSE: RDS), Total (NYSE: TOT), the Kuwait State Oil Company, and Oman's sovereign wealth fund have teamed up to create a solar company called GlassPoint.

It is building a massive solar installation in the Oman desert to create steam to help pump oil. That one project will save more carbon than all electric cars sold so far by Tesla (NASDAQ: TSLA) and Toyota (NYSE: TM) combined.

What's more, using solar to help power an oilfield makes total economic sense. Up to 60% of the operating expenses at heavy oil fields are for fuel purchases.

So at a time when oil companies are cutting costs — curtailing exploration and laying off tens of thousands of workers — they are still interested in spending for projects that can reduce costs.

And that means solar.

Petroleum Development Oman, which is partly backing GlassPoint, accounts for 70% of the nation's oil production and 100% of its gas supply.

It is highly indicative that it is turning to solar to complement its fossil fuel operations.

This is only going to continue through 2030, as solar continues its march toward becoming the world's dominant source of electricity.

As that happens, the companies that improve solar technology and reduce its costs are going to be the biggest winners for investors.

 

Fuller Treacy Money has long maintained that solar power would dominate not only renewable Energy but also prove to be more successful than any fossil fuel, due to its unique advantages.

This item continues in the Subscriber’s Area, where a PDF of the article is also posted.

An alternate view is that US high yield, with or without the commodities sector, remains within the trading range we have seen since 2010. The European market is similar. In other words, high yield has been behaving much as it has throughout the post-financial crisis period which has witnessed several episodes of major market stress. These include Greece in 2010, the US rating downgrade in 2011, the eurozone crisis in 2011/12, and the China equity meltdown in August 2015. During these periods, high-yield spreads gapped out as investors feared a re-run of the 2008-09 experience when spreads and defaults soared. 

This time around, things are a bit different in that spreads have widened on account of macro concerns combined with genuinely higher defaults in the Energy and materials sectors (Figure 2). Investors must distinguish these two issues. Sure, macro concerns do keep mounting – prominent on the radar recently are US growth slowdown, China devaluation fears, slumping commodity prices, health of emerging market economies, European banks, the shift to negative interest rates and Brexit. But the view on the broader highyield market should have very little to do with the commodity cycle or the longevity of the recovery. Rather, it should have everything to do with whether one believes policymakers will keep muddling through or if they are about to make an error that plunges the global economy into another 2008-09 crash. 

If one believes policymakers will not make a significant blunder then high-yield is probably not on the verge of a default debacle, even if macro risks are on the rise. Even in the event of a major crisis, it is likely defaults will not reach the levels of recent cycles. Looking closely at past credit cycles provides some useful lessons.

Since 1970 there have been four major default cycles and one minor one in the mid-1980s (Figure 3). Note that while the default rate has averaged about four per cent over these 45 years, it is not a mean-reverting relationship – default rates are either low or high. Some have warned that hitting four per cent is an ominous sign beyond which defaults will likely keep rising much higher. However, the four per cent default level was breached thrice in the 1980s and again in 2012 without significant further increases. There is nothing sacrosanct or cataclysmic about hitting four per cent; every cycle has to be evaluated on its merits.

The business and default cycles of the past 45 years have mostly shared two broad characteristics – the Treasury yield curve has flattened and inverted and there has been explosive growth in corporate debt other than bonds. In the past three cycles a third factor has been asset bubble conditions in one or more sectors which caused these cycles to be particularly vicious. None of these three conditions conclusively exists now. 

A link to the full report is posted in the Subscriber's Area. 

This is one of the most bullish reports on bonds I’ve seen in quite a while and thought subscribers would benefit from a fresh perspective. One argument I have also seen proposed which makes sense is that while low oil prices have been a harbinger of defaults in the Energy sector, the rebound will remove some of the pressure so the pace of defaults might be lower that currently priced in. 

Even if Saudi Arabia wins its struggle with U.S. shale producers over market share, it will face a new billion-barrel adversary.

It won’t be regional nemesis Iran, a resurgent Iraq or long-standing competitor Russia. The answer will be more prosaic: Even when overproduction ends, a stockpile surplus of more than 1 billion barrels built up since 2014 will remain, weighing on prices. Inventories will keep accumulating until the end of 2017, the International Energy Agency forecasts, and clearing the glut could take years.

“We may get to the end of the year, and even though supply and demand are in balance, the market shrugs and says ‘So what?’ because it’s waiting for proof of inventory draw-downs,” said Mike Wittner, head of oil markets at Societe Generale SA in New York. “Moving from stock-builds to balance might not be enough.”

Since it was unveiled in late 2014, Saudi Arabia’s strategy to bring the world’s oversupplied oil markets back into balance by squeezing competitors with lower prices has proved grueling, dragging crude down to less than $30 a barrel last month. While a gradual decline in U.S. production signals supply will stop growing, the second act of the process may prove the longest as stockpiles slowly contract.

For a historical precedent, Goldman Sachs Group Inc. points to the oil glut that developed in 1998 to 1999 as demand plunged in the wake of the Asian financial crisis. Crude prices kept falling even as the Organization of Petroleum Exporting Countries made output cuts in March and then June of 1998, slipping below $10 a barrel in London in December of that year. It wasn’t until stockpiles in developed economies started dropping in early 1999 that the recovery took shape.

This is a useful reminder and I think we should always keep an eye on stockpiles, wherever possible, for any commodity of interest. 

I maintain that Saudi Arabia cannot achieve more than a pyrrhic victory from its efforts to curtail global production of crude oil through oversupply.  Moreover, this crude strategy (pun intended) will have made more long-term adversaries than friends.

This item continues in the Subscriber’s Area. 

The US has exported its first shipment of natural gas in a historic move that shifts the balance of power in the global Energy market and kicks off a struggle with Russia for market share. 

Surging US supply over the next five years threatens to break the Kremlin's dominance over Europe's gas market, and is already provoking talk of a "Saudi-style" counter attack by Moscow to drive US shale gas frackers out of business before they gain a footing.

At the very least, it sharpens a global price war as liquefied natural gas (LNG) bursts onto the scene, and closes the chapter on the 20th century system of pipeline monopolies. Gas is starting to resemble the spot market for crude oil, with the same wild swings in prices and boom-bust cycles.

A seven-year, $11.5bn project by Cheniere Energy finally came to fruition this week as the first LNG cargo left Sabine Pass in Louisiana - in a special molybdenum-hulled ship at -160 degrees Centigrade - destined for Petrobras in Brazil. "It is a big day for our natural gas revolution," said Ernest Moniz, the US Energy secretary.

Speaking at the IHS CERAWeek summit in Texas, he said the emergence of the US as a gas superpower is a geopolitical earthquake, though he has always been coy about the exact intention. "It is a change in the Energy security picture," he said.

The US is ramping up LNG exports to almost 130bn cubic metres a day (BCM) by the end of the decade, roughly equal to Russia's gas exports to Europe. This may rise to 200 BCM and possibly beyond as the shale industry keeps finding once unthinkable volumes of gas.

Mr Moniz said the world had been expecting the US to be a huge importer of LNG before the shale shock. The mere fact that this is no longer the case turns the market upside-down, and is a key reason why LNG prices have been in free-fall across the world.

The shift to net exports is something that almost nobody expected. Mr Moniz predicted that the US will match Qatar, and possibly exceed it to become the world's biggest exporter of LNG by 2020. 

The US is still a net importer of natural gas but that is because Canadian pipelines supply New York and Detroit. However, it does not alter the overall picture.

Martin Houston, chairman of Parallax Energy, said the US may account for a quarter of the world's LNG market within a decade, and is so efficient that it can deliver gas to Europe for as little as $5 per million British thermal unit (Btu) despite the high cost of liquefaction and shipping.

This article is well worth reading in full because it is about a monumental development – cheap Energy forever – at a time when investors are agonising over China, the EU and negative interest rates.  That is not a misprint; I did say cheap Energy forever, thanks to technology. 

This item continues in the Subscriber’s Area, where AE-P's article is also posted.

With all good technologies, there comes a time when buying the alternative no longer makes sense. Think smartphones in the past decade, color TVs in the 1970s, or even gasoline cars in the early 20th century. Predicting the timing of these shifts is difficult, but when it happens, the whole world changes.

It’s looking like the 2020s will be the decade of the electric car.

Battery prices fell 35 percent last year and are on a trajectory to make unsubsidized electric vehicles as affordable as their gasoline counterparts in the next six years, according to a new analysis of the electric-vehicle market by Bloomberg New Energy Finance (BNEF). That will be the start of a real mass-market liftoff for electric cars.

By 2040, long-range electric cars will cost less than $22,000 (in today’s dollars), according to the projections. Thirty-five percent of new cars worldwide will have a plug.

This isn’t something oil markets are planning for, and it’s easy to see why. Plug-in cars make up just one-tenth of 1 percent of the global car market today. They’re a rarity on the streets of most countries and still cost significantly more than similar gasoline burners. OPEC maintains that electric vehicles (EVs) will make up just 1 percent of cars in 2040. Last year ConocoPhillips Chief Executive Officer Ryan Lance told me EVs won’t have a material impact for another 50 years—probably not in his lifetime.

But here’s what we know: In the next few years, Tesla, Chevy, and Nissan plan to start selling long-range electric cars in the $30,000 range. Other carmakers and tech companies are investing billions on dozens of new models. By 2020, some of these will cost less and perform better than their gasoline counterparts. The aim would be to match the success of Tesla’s Model S, which now outsells its competitors in the large luxury class in the U.S. The question then is how much oil demand will these cars displace? And when will the reduced demand be enough to tip the scales and cause the next oil crisis?

Asking OPEC spokesmen and leaders of international oil companies about the impact of electric vehicles (EVs) on oil consumption over the next decade or two is similar to asking the manufacturers of buggy whips about the prospects for automobile manufacturers in 1910.  In other words, they could not hope to be objective about a monumentally important new technological development which threatened their industry. 

This item continues in the Subscriber’s Area.

For example, the surprise decision by Southwestern Energy (SWN-NYSE) to lay off 40% of its staff, or more than 1,100 employees, and shut down all its drilling rigs after having recently moved into a massive new headquarters building shocked the industry. Likewise, ConocoPhillips (COP-NYSE), after defending its dividend through the first year of this downturn even at the cost of laying off staff, finally caved and cut its quarterly dividend by two-thirds from 74-cents to 25-cents per share. ExxonMobil (XOM-NYSE), after reporting weak earnings results for its fourth quarter, followed up last Friday by announcing it had failed to replace its production last year for the first time in 22 years, announced a 25% cut in its 2016 capital spending plans and the suspension of its share repurchase program. These steps are designed to reduce the drain in the company’s cash balances. Another optimist, Pioneer Natural Resources (PXD-NYSE), after signaling late last year that it might actually increase its 2016 capital spending by 20%-30% as a result of the multiple attractive exploration opportunities it has in its Permian Basin acreage, announced a 10% capex cut this year, which means it will be forced to cut in half the number of drilling rigs it operates, going from 24 at year-end 2015 to 12 by mid-year 2016. The latest industry bombshell was Devon Energy’s (DVN-NYSE) announcement just last week that it was slashing its 2016 capital spending by 75% and laying off 1,000 employees, or about 20% of its staff. The shock from this announcement had barely been digested when Devon announced the sale of up to 69 million shares of stock and raising potentially $1.6 billion in cash to shore up its balance sheet. The cash infusion also helps the company by reducing the pressure to depend partially on selling assets to help fund capital spending. 

The sale of stock by Devon is another example of the continuing ability of Energy companies to tap capital markets, something a growing number of observers believe is prolonging the needed spending reduction that will cause oil output to fall off materially and set the stage for a recovery in prices. According to Bloomberg, the Energy industry has announced plans to raise $4.6 billion in new equity, accounting for nearly 30% of all new equity raised so far this year. The amount of equity being raised is almost evenly split among three deals – Pioneer Natural Resources, Hess Corporation (HES-NYSE) and Devon. Each of these deals was upsized from their original announcement reflecting high levels of demand from investors betting not only the individual companies surviving but that their share prices will soar when the oil price rises and Energy industry fortunes improve. 

The $4.6 billion equity raise so far this year compares with the $7.8 billion raised by exploration and production companies during the first two months of 2015, the fastest pace in raising new equity in over a decade. An interesting question is whether the capital raised in early 2015 has been wasted? If we consider what has been happening to companies within the E&P and oilfield service sectors, the oil price collapse is finally ending the corporate and investor strategy of “pretend and extend.” That strategy means that company executives have been selling lenders and investors on the view that a turnaround is just around the corner, so if they will just give them a little more time (and money?) the companies will be fine. As this strategy evaporates, the battle lines are drawn between managements and their owners. A change in the past is that many of the owners of the companies are investors who specialize in distressed securities. As a result, the struggle over how to redo the capital structure of Energy companies becomes more intense as debt-owners, who have legal claims against the assets of the company, fight to gain the most ownership and thus stand to benefit the most whenever the share price recovers. 

Many of these recapitalization struggles are being fought in the esoteric world of corporate bankruptcy law. The last great boom for the local bankruptcy industry occurred in the period of the 2008 financial crisis and the recession that followed. For Energy, the greatest bankruptcy boom was the demise of the industry in the 1980s bust. A recent article about the state of the bankruptcy business, in response to the collapse in oil prices, was in The Houston Chronicle. The article included a graphic showing the number of Chapter 11 (the section of the bankruptcy law that provides for restructuring of financially distressed companies rather than liquidations of companies that is conducted under Chapter 8 of the code) filed in the Southern District and the State of Texas. In 2015, the number of bankruptcies filed in the Southern District approached close to those filed in 2008, the start of the financial crisis. The article cited a survey of 18 bankruptcy legal experts by The Texas Lawbook calling for a doubling of filings this year. 

The fallout from the low oil prices and the hefty cash outlays producers have been making to play the shale revolution and/or to continue to generate cash flows is showing up in the growing number of exploration and production companies filing for bankruptcy. The Houston Energy practice of the law firm Haynes & Boone is tracking those filings for both E&P and oilfield service companies in the United States and Canada. As of the listings on their web site, as of early February, 48 E&P companies and 44 oilfield service companies have filed since the start of 2015. The total of secured and unsecured debt involved in these bankruptcy filings totals $25.1 billion, split $17.3 billion for E&P companies and $7.8 billion for oilfield service companies.

A link to the full report is posted in the Subscriber's Area.

This is the most comprehensive reporting of the measures taken by Texas Energy companies to preserve capital I have seen. I chose to reproduce it because it should serve as a useful record for subscribers look as this transition unfolds. 

The current crash in oil prices is sowing the seeds of a powerful rebound and a potential supply crunch by the end of the decade, but the prize may go to the US shale industry rather Opec, the world's Energy watchdog has predicted.

America's shale oil producers and Canada's oil sands will come roaring back from late 2017 onwards once the current brutal purge is over, a cycle it described as the "rise, fall and rise again" of the fracking industry.

"Anybody who believes the US revolution has stalled should think again. We have been very surprised at how resilient it is," said Neil Atkinson, head of oil markets at the International Energy Agency.

The IEA forecasts in its "medium-term" outlook for the next five years that US production will fall by 600,000 barrels per day (b/d) this year and 200,000 next year as the so-called "fracklog" of drilled wells is finally cleared and the global market works off a surplus of 1m b/d.

But shale will come back to life within six months - far more quickly than conventional mega-projects and offshore wells - once crude rebounds to $60. Shale output is expected to reach new highs of 5m b/d by 2021.

This will boost total US production of oil and liquids by 1.3m b/d to the once unthinkable level 14.4m b/d, widening the US lead over Saudi Arabia and Russia.

Fatih Birol, the IEA's executive director, said this alone will not be enough to avert the risk of a strategic oil crisis later in the decade, given the exhaustion of existing wells and the dangerously low levels of spare capacity in the world.

Long-term forecasting is more guesswork than analysis, not least as there are too many variable factors.  Additionally, most forecasts are influenced by an element of hopeful self-interest.  Considering these factors, what can we conclude about the International Energy Agency’s forecasts?

This item continues in the Subscriber’s Area, where a PDF of the report is also posted..

The world’s most powerful oilman brought a harsh message to Houston for executives hoping for a rescue from low prices: high-cost producers -- many of them sitting in the room -- need to either “lower costs, borrow cash or liquidate."

For the thousands of executives attending the IHS CERAWeek conference, the message from Saudi Arabia oil minister Ali al-Naimi means deeper spending cuts, laying off more roughnecks and idling drilling rigs.

"It sound harsh, and unfortunately it is, but it is the most efficient way to rebalance markets," Naimi told the audience in Houston on Tuesday.

As many as 74 North American producers face significant difficulties in sustaining debt, according to credit rating firm Moody’s Investors Service. Shale explorers from Texas to North Dakota will be “decimated” in coming months amid a wave of restructurings and bankruptcies, said Mark Papa, the former EOG Resources Inc. chief executive officer who helped create the shale industry more than a decade ago. The survivors will be more conservative, Papa, who is now a partner at private-equity firm Riverstone Holdings LLC, said during a panel discussion on Tuesday.

The message will resonate beyond the American Energy industry as declining spending, rising debts and layoffs are starting to spread to Main Street, with the impact spreading from regional banks in Oklahoma to the economies of cash-strapped Venezuela and Brazil.

For the oil industry itself, the warning is a sign of more months -- and perhaps years -- of financial pain. The S&P 500 Oil and Gas index has fallen roughly 60 percent since mid-2014 to its lowest since 2009. The debt of junk-rated U.S. oil companies is yielding more than 20 percent, the highest in at least 20 years, according to Bank of America Corp.

Naimi told the executives in Houston that Saudi Arabia believed that freezing oil production -- as it just agreed with Russia -- would be enough to eventually balance the market. Over time, high-cost producers will get out of the business, and rising demand will slowly eat up the oversupply, he said. The International Energy Agency believes that means another two years of low prices.

The freeze agreement isn’t "cutting production. That is not going to happen," Naimi said.

Well, Ali al-Naimi has chutzpah and this is certainly a game of attrition.  It may also be a game of high-stakes poker.  Every oil producer is losing, so who will blink first?

That remains to be seen but the economic damage is already considerable and increasing.  The US is both a loser within its oil sector and a big winner in terms of national consumption of oil.  If the US wants to up the ante, it can subsidise its oil sector.    

In the past, soft growth, tightening financial conditions and falling inflation expectations would have at least provoked a response from the Fed. Although we still believe that central banks in Europe, Japan and probably China will continue to ease, the Fed is in a bit of a bind. Economic data, particularly manufacturing, are soft while inflation expectations remain near multi-year lows. That said, most measures of realized inflation are improving. U.S. core inflation is now running at 2.2%, the fastest pace since the fall of 2008. Prices on imported goods, both oil and non-Energy-related products, continue to fall, but housing and medical inflation are accelerating.

The Fed is unlikely to raise interest rates four times this year, as it suggested last December, but will the central bankers wait out all of 2016? Probably not, yet this is exactly what the futures market is suggesting. As such, any hikes would represent a more hawkish stance than the market is currently discounting. If this occurs in the context of a stronger dollar, it will represent a further tightening of already challenging financial market conditions.

For investors, there are several implications. First, the Fed is unlikely to provide the same backstop for asset prices as it has in recent years. Second, in a world in which central bank policy is both less available and less potent, volatility is more likely to remain above its historical average.

Finally, today's inflation expectations are most likely too low. Even in a world of slow growth, weak productivity and diminishing labor market slack, inflation may be higher than today's diminished expectations suggest. Under this scenario, Treasury Inflation Protected Securities (TIPS) may represent a good long-term opportunity.

 

This is a useful summary of some of the background issues that are currently affecting investor confidence. The Fed is now less likely to step in to support prices at the first sign of trouble and that represents a change to the status quo which has prevailed since 2009. That’s a major evolution and helps to explain why the main Wall Street indices have been largely rangebound for more than a year. 

“It strikes me as a business that’s right up his alley,” said Jeff Matthews, an investor and author of Buffett-related books. “It’s a business that’s going to last for a long time,” he said. And the stock has “gotten crushed,” creating an opportunity to buy at an attractive price.

Oil drillers, gold miners and rig operators have sacrificed dividends to conserve cash amid tumbling prices in oversupplied commodity markets. When Kinder Morgan cut its dividend, it pledged not to issue any new shares through the end of 2018.

Shares Jump
Kinder Morgan jumped 7.5 percent to $16.79 at 6:50 p.m. in extended trading in New York. Berkshire’s portfolio is closely watched by investors for clues into how the billionaire chairman and his backup stock pickers are thinking. Newly disclosed holdings often send shares higher.

One of Buffett’s deputy investment managers, Todd Combs or Ted Weschler, could be responsible for the investment. Both have been building portfolios at Berkshire and tend to make smaller bets than their boss.

“Our guess is that it’s Todd or Ted,” said Tony Scherrer, director of research at Smead Capital Management, which oversees about $2.1 billion including Berkshire shares. “It’s not insignificant, but it doesn’t smell like a straight-up Buffett move to us.”

Energy Bets
Other closely watched investment managers added holdings in the Energy industry during the fourth quarter. David Tepper’s Appaloosa Management bought shares of Kinder Morgan and Energy Transfer Partners LP, while Seth Klarman’s Baupost Group increased its positions in Antero Resources Corp., an oil and gas producer, and Cheniere Energy Inc

At the Daily Journal AGM in 2014 Charlie Munger mentioned that Berkshire was set to become the biggest utility in the country. The acrimonious dispute with solar companies in Nevada highlights its participation in that power market but that only gives a small window on the kinds of businesses Berkshire seems to buy. The short answer could be that they tend to buy companies whose products are used every day. That’s as true of Coca Cola as it is of railroads, electricity and now pipelines. 

Saudi Arabia and Russia agreed to freeze oil output at near-record levels, the first coordinated move by the world’s two largest producers to counter a slump that has pummeled economies, markets and companies.

While the deal is preliminary and doesn’t include Iran, it’s the first significant cooperation between OPEC and non-OPEC producers in 15 years and Saudi Arabia said it’s open to further action. Oil pared gains after the accord was announced, signaling traders see no immediate end to the global supply glut.

The deal to fix production at January levels, which includes Qatar and Venezuela, is the “beginning of a process” that could require “other steps to stabilize and improve the market,” Saudi Oil Minister Ali Al-Naimi said in Doha Tuesday after the talks with Russian Energy Minster Alexander Novak. Qatar and Venezuela also agreed to participate, he said.

Saudi Arabia has resisted making any cuts in output to boost prices from a 12-year low, arguing that it would simply be losing market share unless its rivals also agreed to reduce supplies. Naimi’s comments may continue to feed speculation that the world’s biggest oil producers will take action to revive prices.

“The reason we agreed to a potential freeze of production is simply the beginning of a process” over next few months,” Naimi told reporters. “We don’t want significant gyrations in prices. We don’t want a reduction in supply. We want to meet demand. We want a stable oil price.”

Markets were soon disappointed with this surprise announcement because it did not change anything in terms of current oil production. However, it is an important achievement because, as savvy Saudi Oil Minister Ali Al-Naimi said, because it is the “beginning of a process” which could require “other steps to stabilize and improve the market.” 

This item continues in the Subscriber’s Area.

The scientists had built a solar cell by placing graphene on top of the high-performance semiconductor copper indium gallium diselenide (CIGS), which in turn was stacked on top of soda-lime glass (SLG), the same industrial-grade glass used for windows and bottles. When the researchers measured the baseline performance of the cell before proceeding to dope the graphene, they found to their surprise that the graphene had already been doped to the ideal level.

As they later discovered, this was because the sodium ions in the glass spontaneously transferred to the CIGS semiconductor by surface contact, and from there to the graphene, creating a concentration of impurities that happened to dope the graphene in just the right concentration.

Crucially, this method doesn't require high-temperature, chemical or vacuum processes, and the doping remained strong even when the cell was exposed to air for several weeks. What's more, the same method could also be applied to combinations of semiconductors and substrates other than CIGS and glass, where the concentration of doping impurities that reach graphene can be fine-tuned by inserting an insulating layer of the right thickness.

 

Graphene has been a long time coming and it has not quite reached commercialisation yet. but the number of discoveries relating to it continues to increase and its potential is undiminished. We don’t know when the key mass production breakthrough will be made but it will be particularly transformative for the battery sector which remains in need of a major breakthrough to revolutionise Energy storage. 

Rebounds in lenders, miners and Energy producers pushed European stocks to their biggest gains in three weeks.

Commerzbank AG jumped 18 percent, the most since 2009, after saying it returned to profit. That eased concerns that the region’s lenders will fail to find a way to remain profitable in a low-rate environment, which sent them to their biggest plunge since August 2011 on Thursday. Deutsche Bank AG climbed 12 percent after saying it will buy back about $5.4 billion of bonds. Energy producers posted their biggest surge since 2008 and miners their biggest since 2009 as commodities rallied.

The Stoxx Europe 600 Index rose 2.9 percent, rebounding from its lowest level since 2013. Data showing that the region’s recovery kept its momentum also helped sentiment: Germany led the euro area’s growth to 0.3 percent in the fourth quarter, matching economists’ forecasts.

“Markets have been scrabbling for a story -- we’ve changed our focus on fears about China, oil, financials and central banks in such a short time,” said Ben Kumar, an investment manager at Seven Investment Management in London. His firm oversees about $13 billion. “It’s crazy that the market is priced for recession and a complete failure of the financial system. But you wouldn’t want to call it the end of the rout quite yet. Nobody wants to be the first bull now.”

 

Most stock markets are deeply oversold relative to their 200-day moving averages, but investors remain fearful.   

This item continues in the Subscriber’s Area.

Construction of the plant is nearly complete, and the next 18 months will be spent installing the reactor components, running tests, and loading the fuel before the reactors go critical in November 2017, said Zhang Zuoyi, director of the Institute of Nuclear and New Energy Technology, a division of Tsinghua University that has developed the technology over the last decade and a half, in an interview at the institute’s campus 30 miles south of Beijing. If it’s successful, Shandong plant would generate a total of 210 megawatts and will be followed by a 600-megawatt facility in Jiangxi province. Beyond that, China plans to sell these reactors internationally; in January, Chinese president Xi Jinping signed an agreement with King Salman bin Abdulaziz to construct a high-temperature gas-cooled reactor in Saudi Arabia.

“This technology is going to be on the world market within the next five years,” Zhang predicts. “We are developing these reactors to belong to the world.”

Pebble-bed reactors that use helium gas as the heat transfer medium and run at very high temperatures—up to 950 °C—have been in development for decades. The Chinese reactor is based on a design originally developed in Germany, and the German company SGL Group is supplying the billiard-ball-size graphite spheres that encase thousands of tiny “pebbles” of uranium fuel. Seven high-temperature gas-cooled reactors have been built, but only two units remain in operation, both relatively small: an experimental 10-megawatt pebble-bed reactor at the Tsinghua Institute campus, which reached full power in 2003, and a similar reactor in Japan.

Regardless of the cost, China needs to import fossil fuels. From a national security perspective that’s a problem. Despite the fact the pace of growth is moderating the requirement the country is going to have for Energy means they have little choice but to fund any and every potential technology to supply their market. Nuclear is a big part of that and China is now the largest test bed for new reactor designs in the world. They will inevitably seek to capitalise on that investment and China is going to be a major competitor in the construction of nuclear reactors globally. 

One aspect of the presentation we found interesting as a sign of Saudi Arabia’s thinking about the long-term outlook for the oil business was a discussion of research efforts underway at the company’s newest research center located in Detroit. That facility was opened last November. Its focus is fuel technology and improved engines, but also strategic transport analysis. The latter effort involves scenario analysis of future transportation markets including ultimately issuing white papers on the topic.

With respect to their core technology focus, they are targeting passenger and commercial fuels and engine technologies. From descriptions of some of their research efforts, it seems they are focused on autonomous vehicle development, although that term was never used. Mr. Al-Tahini said that the over-arching research goal is to produce the most fuel-efficient vehicle with the lowest emissions.

Our take-away from that part of the presentation was that at some point in the past, Saudi Arabian officials began considering the forces at work reshaping the transportation business, a market dominated by crude oil. One broad trend impacting that market is demographics, but there is little Saudi Arabia can do to change the impact. Understanding these trends and their impact on the market is critical for long-term planning.

In recent years, the environmental movement has aggressively targeted the fossil fuel industry, which has resulted in a tightening of fuel-efficiency and carbon emission standards, the elimination of fuel subsidies in a growing number of countries around the world, and a strong push to urbanize the population and increase transportation alternatives. All of these forces will impact the growth of the transportation fuels market.
Given those forces, we have concluded that Saudi Arabia believes that oil demand may be closer to a peak than previously thought. This does not mean that the oil industry is going out of business anytime soon, but rather that its growth will slow in the future. Market share growth for Saudi Arabia will need to come from someone else’s share, which means increased price competition. It also means trying to slow the development of alternative Energy sources. Knocking out future oil sands and deepwater oil output as well as marginally shrinking shale oil opportunities will all benefit Saudi Arabia’s long-term market potential. Any negative impact on the oil output of other significant producers such as Russia, Iran and Iraq, coupled with boosting demand would all help Saudi Arabia. Lastly, technological developments that enable Saudi Arabia to reduce the cost and extend the life of its oil fields would also help the kingdom’s future. While none of this is new to our thinking, Mr. Al-Tahini’s presentation provided confirmation of what we think is motivating Saudi Arabia’s actions.

 

A link to the full report is posted in the Subscriber's Area. 

How Saudi Arabia views the market for its products matters. If they truly believe that the peak in demand growth has been reached that would help to explain the beggar thy neighbour approach that has been adopted over the last year. Major oil companies have responded by shelving expansion plans, Alberta put off its desire for more royalties from its producers and we can expect to hear a lot more about refracking in the unconventional supply sector. 

Executives across corporate America are being asked for their views on whether a recession is in the offing.

Growth in the U.S. decelerated to a 0.7 percent annualized rate in the fourth quarter as companies contended with a slower global economy. The median probability for a U.S. recession in the next 12 months jumped to 19 percent in last month’s Bloomberg survey of economists, the highest since February 2013.

As stock and oil prices slide, executives are offering their perspectives on the economy in conversations with analysts and investors. These comments were collected by Bloomberg from earnings calls, meetings and conferences the past three weeks.

John Thain, chairman and chief executive officer, CIT Group Inc.: 
“Given the recent performance of the equity market and our stock price, the market seems to indicate a recession is imminent. I don’t see that. Low Energy prices do not cause recessions. While the Energy sector itself is weak, the U.S. economy is still growing." (Feb. 2)

Stephen Schwarzman, chairman and CEO, Blackstone Group LP: 
“While it’s always possible that a market correction becomes something more significant, we, at Blackstone, do not see a recession in the U.S. We do believe that global GDP growth is slowing, and we’ve seen a slowdown within certain sectors and regions in our global portfolio as a result." (Jan. 28)

Stock markets are better indicators of investor sentiment than economic prospects.  Today, investors are frightened by uncertainty; excessively choppy market action due to high-frequency trading; forced sales by sovereign wealth funds, all of which are contributing to what will eventually be a healthy contraction in valuations.  

Exchange-traded funds that hold U.S. junk bonds slid to their lowest levels in almost seven years. BlackRock’s iShares iBoxx High Yield Corporate Bond exchange-traded fund and SPDR Barclays High Yield Bond ETF both fell to the lowest levels since 2009.

Financials and Energy were the two investment-grade sectors that added the most risk in the U.S., Markit CDX North American Indexes show. In high yield, Energy, communications and health care fared the worst.

Chesapeake Energy Corp., the U.S. natural gas driller that’s been cutting jobs and investor payouts to conserve dwindling cash flows, lost more than half it stock market value Monday after a report that it hired a restructuring law firm.

The company’s bonds led losses among high-yield debt on Monday. Chesapeake’s notes due March 2016 tumbled to a record to 74.5 cents, from 95 cents last week, while its bonds maturing in 2017 fell to an all-time low at 34 cents.

“Broad oil weakness has now turned into distressed Energy cases, which investors view as possibilities of higher risk of restructuring or debt exchanges," Ben Emons, a money manager at Leader Capital Corporation. “Nothing has been announced of that matter but markets move quicker ahead of such possibility happening."

 

Regardless of the answer, when someone asks whether a default is imminent one has to conclude that the situation is troubling. This is as true of Chesapeake today as it was of Greece, Portugal et al a few years ago. 

Chesapeake’s 2017 6.25% Senior UnSecured bullet bond now yields 150% suggesting very few people think it will make its last coupon payment due in July.   

A decision on cutting oil production is possible only if all crude-exporting nations are in agreement and there’s no timing for talks, Russia’s Energy Minister Alexander Novak said.

“We’re ready to discuss the issue of cutting oil output volumes” but not ready for a decision, Novak said Friday in an interview with Bloomberg Television. “We’re ready to consider the possibility; this should be a consensus. If there’s a consensus, it makes sense.”

Oil pared gains after Novak’s comments. Prices closed at the highest in three weeks on Thursday after Novak said that the Organization of Petroleum Exporting Countries and other producers may meet to discuss output. Traders have looked for signs of cooperation between producing nations after a global glut of crude pushed prices to a 12-year low. The head of OPEC this week called on producers outside the group to assist in reducing the oversupply, signaling once again its members won’t make output cuts alone.

“There’s no set date” for a meeting, Novak said. “As far as I understand they are discussing it with other possible participants.” Russia has taken part in such consultations before and “nothing new happened,” he said.

A carefully hedged statement, for sure.  We also know about all the rivalries, to put it mildly, between oil producers.  However, these considerations pale into insignificance against the background of today’s reality.

This item continues in the Subscriber’s Area.

There are signs that the strength in household goods expenditure is losing steam, possibly reflecting the recent cooling of the housing market spearheaded by Sydney. That said, the more recent data on retail spending continues to be relatively resilient, underpinned by improving trading conditions, while a lower AUD has encouraged tourism spending. ABS retail turnover growth for November (0.4%) was slightly below October (0.6%) to be 4.1% y/y, around the trend seen since late 2014. Meanwhile, NAB’s Online Retail Sales Index for November showed a 0.7% m/m rise in online spending. Despite soft wages growth, we expect a modest pick-up in consumer spending growth through to 2016, driven by a gradual reduction in households’ saving ratio and strong employment growth.

The Sydney housing market has clearly cooled, having recorded two consecutive months of price declines, while momentum in the Melbourne market has also slowed -but not as much as Sydney. Other capital cities experienced mixed outcomes in December. Recent property market outcomes are consistent with our view that prices growth will increasingly come under pressure as credit restrictions on investor lending bite, in combination with subdued incomes and slowing population growth/rising supply. We have maintained our previous forecast for much slower house price growth in 2016 (2%), although risks to the downside have escalated even more, especially in the apartment market.

Signs of stronger non-mining investment remain hard to find in the official data (especially the expectations data), while inevitable declines in mining capex continue – and could well become more pronounced given further falls in commodity prices. Despite significant signs of improvement in the business landscape, the NAB Business Survey reports that firms are still apparently gun-shy on investment. A fall in capacity utilisation in the December Monthly business survey has probably not helped, nor would recent financial market uncertainties. That said, we remain hopeful that AUD depreciation will eventually assist investment in trade exposed industries. Dwelling investment has been a little softer than expected in recent quarters, yet record high numbers of dwellings in the construction pipeline suggest the positive contribution to growth is likely to continue – although the cooling housing market will likely stem the flow of new projects.

 

A link to the full report is posted in the Subscriber's Area. 

A firmer tone on Energy markets represents a tailwind for Australia as LNG shipping capacity comes on line. In fact with the rationalisation of China’s steel industry Australia needs Energy to play a significant role in exports to make up for the loss of revenue from coal and iron-ore. If we take that a step further it is reasonable to expect the Australian Dollar to be more heavily influenced by moves in the oil price than was previously the case. 

Buffett’s company has also bought renewable Energy through long-term contracts. Last year, NV Energy signed up to purchase power from a giant First Solar installation outside Las Vegas for $38.70 per megawatt-hour. Analysts said at the time that it was one of the cheapest rates on record. Commissioners cited projects like that for why it made no sense to continue encouraging net metering in Nevada. If the goal is to put more solar on the grid, it’d be far cheaper for NV Energy to procure it.

This, of course, is of little consolation for the Nevadans who’ve already blanketed their roofs with solar panels. The public outcry seems to have registered with NV Energy. On Jan. 25 it said it would ask the commission to allow existing net-metering customers to stick with the old system for two decades in some instances. “A fair, stable, and predictable cost environment is important to all our customers,” Paul Caudill, the utility’s president, said in a statement. The commission will soon rehear that portion of the case.

Even if the utility’s proposal is accepted, it may not go far enough for the solar industry. The December decision could be challenged in court—or taken straight to voters. SolarCity and other groups are trying to get the issue on the November ballot.

Caught in limbo are people such as Dale Collier. The day after the commission hearing, he showed off a 56-panel system on his home in the Las Vegas suburb of Henderson. It cost him about $48,000 to install in 2011. SolarCity hadn’t yet set up shop in Nevada, so he paid for it by refinancing his house. The system took his NV Energy bill down to about $80 a month from the $330 it used to average, he says. One year, he got a $1,355 check from NV
Energy because his solar power was helping the utility meet its renewable Energy requirements. “It was the smartest thing I’d ever done,” he says. “Now, it’s the stupidest thing I’ve ever done.”

Collier had planned to retire from his job flying small cargo planes. But he doesn’t want to stop working until he has a better handle on his monthly bills from Buffett’s utility. “If it goes totally haywire, I’m going to look at batteries,” he says. “I’d love to just go off the grid totally, and tell them to f--- off.”

 

The acrimonious battle between legacy utilities and distributed supply represented by solar has come to a head in Nevada. There is a great deal at stake and emotions are running high, not least because people have invested a lot of money and risk a profit turning into a loss.

If we look at the situation with a clear perspective the upkeep of the electrical grid is not free. Both utilities and consumers use it to buy and sell electricity. Therefore it makes sense that both should contribute to its upkeep. That was the central argument proposed by NV Energy and it’s hard to argue with. 

Based on conversations with our partner financial advisors, one of the most troubling and confusing aspects of recent market volatility is the close connection between the oil market and the stock market.  If oil prices fall during the trading day, then equity prices almost inevitably follow oil lower.

Falling oil prices are typically seen as beneficial to global consumers, and equity prices outside the Energy sector historically tend to be largely immune to or even benefit from cheap oil.  The few times in history that oil and stock prices have fallen in tandem were driven by the onset of a global recession.  Thus, despite robust US job gains, improving new home sales, and the positive impact of lower gas prices on their personal finances, investors are increasingly fearful that the close correlation between oil and equities is once again signaling a recession and the potential for a market crash similar to 2008.  We strongly disagree.  

This is a well-argued, sensible report by Michael Jones.  I strongly recommend it to our subscribers.

A PDF of the report is posted in the Subscriber’s Area.

The stronger dollar is driving South American buyers away from the 23,000 condos in the pipeline for Miami’s downtown area, said Peter Zalewski, owner of South Florida development tracker CraneSpotters.com. Buyers signed about one-fourth fewer pre-construction contracts last year than in 2014, according to Anthony M. Graziano, senior managing director at Integra Realty Resources Inc., which tracks condo data for the Miami Downtown Development Authority.

In nearby Sunny Isles, Florida, faraway currency fluctuations are endangering the sale of a $3.7 million condominium. A Colombian woman who put down a 50 percent deposit is fretting over how she’ll cover the other half over the next year, said her agent, Mauricio Rojas. The Colombian peso, dragged down by the commodity slump, has lost about 30 percent of its value since she signed the contract in December 2014.

In Houston, the plunge in oil prices to a 12-year low is killing the luxury boom. Sales for homes priced at $500,000 or more dropped 17 percent in December from a year earlier, according to the Houston Association of Realtors.

 

The strength of the US Dollar represents a headwind for the luxury real estate market, at a time when many foreign buyers have seen the value of their domestic currencies decline from what were in many cases historic peaks. Rationalisation in the Energy service sector is an additional headwind for places like Texas, Pennsylvania and North Dakota. However that’s not what piqued my attention today. 

With oil prices dropping and E&P companies cutting their spending, the answer to our question of what is the sound of another shoe dropping is becoming clear. It is the sound of pink slips landing on employees’ desks. Living within one’s cash flow has taken on greater meaning for companies today. Unfortunately, the major operating costs are employees, especially when there isn’t much to do. Reducing costs to stay within cash flow means laying-off employees. Last Thursday afternoon, Houston and the oil patch were shocked by Southwestern Energy’s (SWN-NYSE) announcement that it was terminating 1,100 employees, or 44% of its labor force, as it deals with low oil and gas prices. The third largest natural gas producer indicated it had no drilling rigs operating and was reducing its capital spending plans for the year. 

The next day, leading oilfield service provider Schlumberger Ltd. (SLB-NYSE) announced plans to reduce its workforce by 10,000 in response to low commodity prices and low oilfield activity. Since the third quarter of 2014, Schlumberger has cut 34,000 employees, representing 26% of its workforce. The company also stated in its fourth quarter earnings release that it doesn’t see an increase in oilfield activity until 2017. This view is rapidly being embraced by the industry and shaping all staffing and capital spending decisions. 

Leading forecasting groups – the International Energy Agency, OPEC, IHS, Wood Mackenzie – are embracing the view that the current low oil prices will force the industry to further cut its activity during the first half of 2016 and that natural attrition in production will drop global oil supplies, despite the addition of possibly 300,000-500,000 barrels a day of oil exports from Iran this year. These groups also see demand continuing to grow, although uncertainty about the health of the Chinese economy is becoming a significant wildcard in the forecasts. On balance, these forecasters see the imbalance of global oil supply and demand, which has existed for the past two years, will return to a more balanced condition by the second half of 2016. A balanced market will allow bloated global petroleum inventories to start shrinking, which sets the stage for higher oil prices in the third and fourth quarters of 2016 and still higher prices in 2017. It will be the combination of continued oil demand growth, matched by a stable supply outlook and declining inventories, that drives an upturn in oilfield activity in the first half of 2017. The challenge for the Energy industry will be getting back those employees receiving pink slips now.

A link to the full report is posted in the Subscriber's Area.

The same subscriber added the following anecdote: 

Interestingly enough, the massive layoffs of the 1980's have not YET repeated themselves in the Texas Panhandle, where vast numbers of conventional wells continue to pump. One specialist contractor in drilling supervision said (to my brother over the weekend) that he was still as busy as he could handle, and my nephew just hired on to a drilling company as a roustabout. Interesting anecdotal information - not perhaps strongly suggestive of anything in particular, of course.

After a week of turmoil, there was relief in the markets and for everyday investors on Friday. The FTSE 100 finished the week higher, giving a desperately needed fillip to the country’s depleted ISAs and pension pots; and the price of oil recovered a little. In the past, a rebound in the price of crude would have been seen as a blow, at least outside Scotland – but these days, we seem to have started cheering each time it goes up.

Why? Have we lost the plot, or is it right for the UK, paradoxically now a major net oil importer as a result of the demise of the North Sea industry, to hope for a stabilisation of the price of oil? The answer is that oil’s slump remains good news, on balance, for consumers and manufacturers. With oil production contributing far less than before to our GDP, the direct downside on that front is small.

But there are counterbalancing factors, reasons why it makes sense for the financial markets to worry, even if the ultra-pessimists are wrong.

So why is it different this time? There are five main reasons. The most interesting is that many analysts are worried about a looming Energy and commodity debt crisis. Firms borrowed to invest, including for fracking and shale; but it seems that this credit could turn out to be the new subprime mortgages. The worry is that as the Energy and commodities bubble continues to burst, a tidal wave of bad debt could engulf the financial system, in a repeat of the crisis of 2008.

This is a far cry from the crisis of 2008 for the USA, in my opinion.  We are only talking about the US Energy sector, which is certainly not insignificant but the general public benefits from low oil prices.  In 2008 the entire US financial system and housing market was adversely affected by ‘liar loans’ and collateralized mortgage obligations (CMO’s).

This item continues in the Subscriber’s Area.

As chairman of investments at Guggenheim Partners, Scott Minerd thought he had a realistic view on how big an economic challenge climate change poses.

Then, at a Hoover Institution conference almost three years ago, he met former U.S. Secretary of State George Shultz. Minerd recalled him saying: “Scott, imagine that you woke up tomorrow morning, and the headline on the newspapers was, 'The World Has Discovered a New Ocean.’” The opening of the Arctic, Shultz told him, may be one of the most important events since the end of the ice age, some 12,000 years ago.

And while Shultz’s spokesman couldn’t confirm the conversation, there’s no doubting the melting of the Arctic ice cap, and the unveiling of resources below, presents mind-boggling opportunities for Energy, shipping, fishing, science, and military exploitation. Russia even planted its flag on the sea floor at the North Pole in 2007.

Energy and shipping have been first up. Norway made its national fortune drilling in northern waters, and Arctic fossil fuel exploration has become a more prominent part of U.S. Energy policy. Melting ice means that in summer months, cargo can travel approximately 5,000 km from Korea to New York, rather than the 12,000 km it takes to pass through the Panama Canal. Warming waters also open up access to commercial fish stocks, making the Arctic a growing source of food.

The headline and text of Eric Roston’s article clearly view the opening of the Arctic for commercial ventures as a huge opportunity.  Well, trade routes through the Arctic will be convenient for some but technological advances already ensure that we have more than enough oil, gas and minerals.  This is confirmed by today’s low prices for these resources.  That may change some day but I think the continued and even accelerating advance of technology will provide the industrial resources, or even better substitutes, that the world will require. 

The melting of Artic ice is also further confirmation of climate change in the form of global warming.  This will have some very negative consequences, most likely starting with an increase in the rate of rising sea levels.  The article mentions fishing but not any of the negative consequences.  The last thing our dwindling fish stocks require is the plundering of their last refuge as factory ships sweep up critical supplies.       

Another dive in the oil price: new fresh lows in global equity markets. That's been the dominant pattern for 2016, and it shows no sign of abating.

The trend continued last night, with tumbling crude oil prices dragging down global equity markets. The key US market – West Texas Intermediate – fell 7 per cent per cent, hitting its lowest level since 2003, while the global benchmark – Brent crude – fell 5 per cent to $US27.33 a barrel, a 12-year low.

Indeed, this pattern has become so entrenched that so far this year there's been around a 90 per cent correlation between movements in the key US share market index, the S&P 500 and changes in the oil price (a 100 per cent correlation means that the two move in perfect unison). Which is remarkable given that the US share market usually shrugs off moves in the oil price.

So the big question is why, all of a sudden, the two are now moving in virtual lock-step.

Most analyst agree that global equity markets started showing a hyper-sensitivity to the oil market when the price of crude first approached, and then fell through, the $US30 a barrel level.

Investors have started getting seriously worried that the lower the oil price goes – and the longer it stays down – the greater the threat that many debt-laden oil producers won't be able to meet the interest payments on their debts. As a result, we're likely to see a sharp spike in defaults, and even bankruptcies.

Already, with the oil price continuing to edge further below the $US30 a barrel mark, a high proportion of North American Energy companies are losing money. And with every move lower in the oil price, the likelihood of large-scale defaults and bankruptcies rises. What's more, it's only a matter of time before credit-rating agencies start the process of downgrading triple-B, and even A-rated Energy companies.

As a result, the problems in the oil market have been infecting the huge high-yield US debt market (commonly referred to as junk bonds) for some time., even though the Energy sector only accounts for a relatively low share – around 10 to 12 per cent – of high yield indices.

Given investors’ current mind set it is hard to imagine stock markets rallying against the background of new lows for crude oil prices.  However, the lower Brent falls, the more sharply it is likely to rebound.  Moreover, oil is already experiencing a severe bear market. 

This item continues in the Subscriber’s Area.

We will see a higher default rate in the junk-bond market. Junk-bond issuance used to represent about 1% of GDP. Then it rose to 2%. It was something of a stimulant to the economy. Also, the stock market has been buyback-driven to an extent, and higher borrowing costs will make that more problematic.

Investment-grade bonds also have been dropping in value. The LQD [ iShares iBoxx $ Investment Grade Corporate Bond ETF] consistently dropped in price through 2015. When interest rates rose, it was challenged by interest-rate risk. When the world looked problematic, it was challenged by credit risk. It seems like there is almost no way to win. When investment-grade credit is downgraded, it falls into junk territory, which makes it un-ownable for a large number of institutional investors. The credit market is sending a message, and the stock market, at least until recently, was whistling through the graveyard. When junk bonds fall 20% in price and the stock market sits at a high, something is wrong with the picture. These markets are moving like alligator jaws. Ultimately, they will move together.

 

A link to the full report is posted in the Subsriber's Area.

There are undeniable problems in the Energy sector and this is all the more important because it has been one of the primary sources of new debt over the last five years. With prices where they are today, the prospect of an uptick in the default rate is non-trivial. That’s a problem, particularly for bond ETFs, because they cannot arbitrarily sell and will need to wait for a downgrade or other mandated event to occur before they liquidate. This means they will invariably be late. 

There is no immediate connection (other than for companies doing business there) between the slowdown and the price decline in the oil patch, on one hand, and the general creditworthiness and desirability of high-risk debt on the others. And yet, over the last few months, pronounced changes occurred in the market for distressed debt:

After a period of very stable prices – ever for “iffy” debt 0 some securities have “gaped down” in the last few months (i.e. fallen several points at a time rather than correcting gradually). In particular, investors have become highly intolerant of bad corporate news. 

For the first time since 2008-09, the debt of some companies outside of Energy and mining has fallen from 80 to 60 and others from 50 to 20. 

There is a general sense among my colleagues that investors have gone from evaluating securities based on the attractiveness of their yield (with companies fundamentals viewed optimistically (to judging them on the basis of the likely recovery in a restructuring (with fundamentals viewed pessimistically).

The capital markets have begun the swing from generous toward tight, as is their habit. Thus, whereas they used to find it easy to refinance debt I order to extend maturities or secure “rescue financing” now it’s hard for companies – especially those experiencing any degrees of difficulty – to obtain capital. 

On December 7, Oaktree held a dinner in New York for equity analysts who follow out publicly traded units. Bob O’Leary, a co-portfolio manager of our distressed debt funds, planned to be among the hosts. But he called me on December 3 with a question I hadn’t heard in a long time from my distressed colleagues. “Would you mind if I don’t come? There’s too much going on for me to leave the office“. The change in investor attitudes had created investment opportunities where they hadn’t existed just a few months before – in some cases out of proportion to the change in fundamentals. 

Developments like these are indicative of rising pessimism, skepticism and fear. They’re largely what Oaktree hopes for, since – everything else being equal – they make for vastly improved buying opportunities. But note that we may be just in the early stages of a downward spiral in corporate performance and credit market behaviour. Thus, while this may be “a time” to buy, I’m far from suggesting it’s “the time”. 

 

This is balanced piece and it’s really worth taking time over the weekend to read it in full. 

In August I described the price action following the volatility across ETFs as a massive reaction against the prevailing trend and therefore confirmation of Type-2 topping characteristics. Following such an event investors invariably ask if anything has really changed and whether the widespread experience of being stopped out of positions will have a lasting effect. At the time I drew parallels with the flash crash in 2011 because that was the last time investors had experienced a similar event albeit now from a higher level. 

U.S. stocks surged from three-month lows as Energy and health-care shares paced a rebound, with the Standard & Poor’s 500 Index recovering after the steepest selloff since September.

Equities spiked higher, reversing an early drop that sent the Nasdaq Composite Index toward a 14-month low. Energy companies jumped as crude rallied, with Exxon Mobil Corp. and Chevron Corp. gaining more than 3.4 percent. JPMorgan Chase & Co. added 1.7 percent after its quarterly profit beat estimates amid lower expenses. Merck & Co. and Pfizer Inc. increased at least 2.2 percent to pace health-care’s rise.

“This is the relief rally we’ve been waiting for,” said Bruce Bittles, chief investment strategist at Milwaukee-based Robert W. Baird, which oversees $110 billion. “Pessimism had grown to such a level that enough cash had been raised on the sidelines to sport at least a short-term rally. Better-than-expected earnings could be something for the bulls to grasp and provide this rebound some sustainability.”

“We’ll have to digest all these earnings numbers and then we’ll have a clearer picture, but if you look around the world, there’s not many positive drivers,” said Benno Galliker, a trader at Luzerner Kantonalbank AG. “Play it safe, that’s the message at the moment.”

The recent equity selloff is an “emotional response,” obscuring expansion in both the American economy and corporate profits, Abby Joseph Cohen, president of Goldman Sachs Group Inc.’s Global Markets Institute, said today. The fair value for Standard & Poor’s 500 Index is 2,100, she said.

The main U.S. equity index has declined more than 10 percent from its record set in May, and is 2 percent above the bottom of an August swoon, which was also triggered by anxiety over the impact of China’s weakness on worldwide growth. The gauge has slumped 8.1 percent since the Federal Reserve raised interest rates last month for the first time since 2006.

The comment, “… there’s not many positive drivers”, has certainly been true.  For that to change, I maintain, we need to see China steady and the price of crude oil move higher on short covering and supply reductions.  The same can be said for industrial metals.

This item continues in the Subscriber’s Area.

While oil prices flashing across traders’ terminals are at the lowest in a decade, in real terms the collapse is even deeper.

West Texas Intermediate futures, the U.S. benchmark, sank below $30 a barrel on Tuesday for the first time since 2003. Actual barrels of Saudi Arabian crude shipped to Asia are even cheaper, at $26 -- the lowest since early 2002 once inflation is factored in and near levels seen before the turn of the millennium.

Slumping prices are a critical signal that the boom in lending in China is “unwinding,” according to Adair Turner, chairman of the Institute for New Economic Thinking.

Slowing investment and construction in China, the world’s biggest Energy user, is “sending an enormous deflationary impetus through to the world, and that is a significant part of what’s happening in this oil-price collapse,” Turner, former chairman of the U.K. Financial Services Authority, said in an interview with Bloomberg Television.

This is why oil prices are likely to start moving higher as the year progresses.  There are limits to how far some oil producers can devalue to offset lower benchmark prices in USD, without causing even bigger problems in terms of their import costs of other goods and domestic inflation.

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“Markets have a deep skepticism that we’ll ever see a pickup in inflation,” Stanley said in an interview. But market participants are implicitly assuming Energy commodity prices will continue to fall as fast as they did in late 2014, when Energy prices dropped more than 20%. “The bulk of the movement took place roughly a year ago,” Stanley said.

The Fed expects headline and core inflation to drift higher in 2016 to about 1.6%, and Stanley believes that forecast is the key to what the Fed will do this year. If inflation doesn’t begin to move higher soon, it’s likely that the Fed won’t raise rates more than one or two times. But if inflation surprises the Fed, as Stanley believes it will, then the Fed would be more aggressive.

“It wouldn’t shock me if inflation is higher than the Fed thinks it will be, and they may go one or two more times than is baked in,” he said.

Although markets are intensely focused on the global economy, Stanley argues that the domestic economy is what matters most. “The U.S. is a relatively closed economy,” with global trade accounting for only about 15% of the economy.

“The global economy won’t be entirely healthy, but it won’t deteriorate, deteriorate, deteriorate,” he said.

As for the U.S. economy, Stanley sees a relatively healthy household sector, with rising incomes and an improving housing market, continuing to do better than the business sector, with its soft investment spending.

 

A point both David and I have made, particularly in the Subscriber’s Audio, is that the sharp declines in commodity prices will have a transitory effect on inflation figures because they cannot continue to fall at the current pace indefinitely. Once prices stabilise the effect on inflation statistics will wash out in a couple of quarters and the rising cost of services and wages will be more apparent. There is also the possibility that rebounds in commodity prices, from very oversold levels, will have an inflationary impact. I believe that is why the Fed continues to believe inflation will be higher later this year. 

Investors wanting to take out insurance on Saudi Arabia’s debt have to pay as much as they would for Portugal, a nation still saddled with a junk credit-rating five years after an international bailout.

The cost of insuring the kingdom’s debt more than doubled in the past 12 months to a 190 basis points, or $190,000 annually to insure $10 million of the country’s debt for five years, as of 4:14 p.m. in Riyadh, the highest since April 2009, according to CMA prices compiled by Bloomberg. That’s almost identical to contracts linked to debt from Portugal, whose rating is seven levels below Saudi Arabia’s Aa3 investment grade at Moody’s Investors Service.

Saudi Arabia’s finances are under pressure as it fights a war in Yemen at a time when crude prices are languishing at the lowest level in almost 12 years. The country, which counts on Energy exports for 70 percent of government revenue, sold domestic bonds for the first time since 2007 last year to help fund a budget deficit that may have been the widest since 1991. Net foreign assets dropped for 10 straight months through November, the longest streak since at least 2006, to $627 billion.

Saudi Arabia faces a perfect storm of problems, many of their own creation.

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Some encouraging news from the advanced nuclear sector. I am pleased to see that Terrestrial Energy (disclosure: I own shares) has successfully raised the equivalent of USD 7m in equity. Albeit modest, it is an important step forward. The company is making steady progress in its task to finalize its Molten Salt Reactor design, while the next step is to work with Canadian authorities with the aim to license the technology. Commercialization in the first part of the 2020’ies is still some years ahead, but this technology should, as I hope and believe, prove to be an important tool to reduce carbon emissions in the future.

Thank you for this update and the MIT review articles which gives additional insights on the development of new nuclear. Perhaps the greatest challenge facing the nuclear industry is that despite the fact technology continues to improve quickly, regulatory change is moving at a glacial pace. With sufficient government backing there is credible scope for new nuclear to flourish but it is dependent on political will to make it happen.

The creator of the “lower for longer” scenario, BP plc’s (BP-NYSE) CEO Robert Dudley was interviewed at year-end by a reporter with the BBC during which he began to qualify his view. “A low point could be in the first quarter [of 2016].” Given developments in the global oil market during the first few days of 2016, this looks like a good call. Mr. Dudley went on to say, “But 2016’s third and fourth quarters could witness a more natural balance between supply and demand, after which stock levels could start to wear off.” If that proves to be the case, it implies that oil prices should begin rising during the second half of 2016. However, there remains the overhang of global oil inventories that continue to swell due to the global overproduction. According to the International Energy Agency’s (IEA) latest total (crude oil plus refined products) inventory figures for the OECD countries as of October 2015, there were 2,971 million barrels in storage. Crude oil inventory totaled 1,181 million barrels. As shown in Exhibit 14, the amount of crude oil in storage grew dramatically last year.

A different way of looking at the crude oil inventory situation is to measure it on the basis of days of inventory in storage. Exhibit 15 (next page) shows this data for 2012 through August 2015. While one might think that 30-31 days of forward inventory cover is not meaningful, if we compared the July data when 2015 was at 30 days and the prior three years that were at 27 days, those three additional days represent nearly 300 million extra barrels of oil. To eliminate that additional supply, global oil demand needs to increase by nearly one million barrels a day, or 1% growth in existing oil demand, which just happens to be the long-term average increase in global oil consumption experienced since the 1980s. While consistent with the oil market’s long-term growth rate, reducing the oversupply assumes that supply stops growing, which we know may not happen due to the return of Iranian production plus efforts of other producing countries to boost output to offset lower oil prices.

 

A link to the full report is posted in the Subscriber's Area. 

With deteriorating geopolitical considerations and no sign yet that supply has peaked, the futures market for Brent Crude is in contango right across the curve. For prices to rise a catalyst will be required. That may take the form of a major bankruptcy in the highly leveraged unconventional oil and gas sector or a marked deterioration on the geopolitical front. Both are possible and this is particularly poignant considering the fact that oil prices are accelerating lower and have already had a large decline. 

According to Bank Indonesia (BI) governor Agus Martowardojo, forex reserves shrunk to $105.9 billion after the central bank used some of the funds to intervene in the currency market in an effort to prop up the ailing rupiah. The government also disbursed some of the funds to pay external debts.

"We are grateful that our foreign exchange reserves are now $105 billion, compared to $111 billion last year. It is an ample amount to finance external debt or obligation payments and to pay for imports," he told reporters in Jakarta on Friday.

The rupiah's stability, Agus added, had become a central bank priority and would be maintained in 2016. "We feel that foreign reserves are another instrument that we must manage, in addition to exchange rates and interest rates," he said

Indonesia’s President Widodo has made some legislative and regulatory progress in reforming the economy and clamping down on corruption which has been largely ignored because of the fall in commodity prices and the influence of a weakening Chinese economy. As a major oil producer Indonesia has not been immune to the Energy markets and the Rupiah accelerated to a low near IDR15,000 against the US Dollar last September. Intervention by the central bank to stem the decline saw it jump by 10% in the space of a month and it has been notably steady of late; particularly in an environment where currency volatility has been making headlines. 

As a keen amateur historian I was very interested in the piece by Allister Heath on Thomas Malthus. I would like to play the role of Devil’s advocate here and suggest that things might not be quite so rosy regarding our future comfort on the planet. Malthus was plainly wrong in not considering the incredible capacity of humans to innovate and develop technologies regarding supplies of essential commodities. In one respect however he may still be correct in his basic proposition, namely population growth of our species outpacing our resources at some point. In 1800 there were about 1 billion people on the planet. Today 7.3 billion rising to 11 billion in 2050. While it is true rabbits cannot control their birth rates and we can. The fact is we don't. The control that women have over their bodies is reserved for a privileged few in well-educated western style economies. For vast areas of the globe women are, for cultural or religious reasons totally subservient to men, having no control whatsoever over their bodies. I have just been reading the latest statistic concerning teenage pregnancy here in South Africa. Whereas there were 60 thousand teenage pregnancies in 2011, last year this figure was more than double. Many of these girls are under 15. The whole matter of population of course, impacts directly on climate change and our use of fossil fuels. The development of China over the last 30 years has changed everything. All our talk of green Energy is all very well but China still relies on fossil fuels for 85% of its Energy needs. On official statistics it burns 3.5 billion tonnes of coal as compared to the US one billion tonnes Last year extreme weather events made headlines again, the main one being a record breaking El Nino currently wreaking havoc in the UK and here in South Africa causing a year long drought and record high temperatures. I think we have at least to consider the possibility of global warming entering an acceleration phase.

Many thanks for your interesting and thoughtful email, covering many points.  

Regarding the forecast of 11 billion people in 2050, which I have also heard, I am wary of such extrapolations that far into the future.  It could be right, for all I know, but if we consider the possibility of global warming entering an acceleration phase, as you suggest, subject to severity that could easily reduce populations.  More likely, I hope, education and greater prosperity, leading to a larger middleclass in the world’s poorer regions would also reduce or at least slow population growth.

Regarding air pollution, I have long maintained that we need a little luck, mainly in terms of time, to successfully curb this problem before it is seriously out of control.  Thereafter, technology is the key and fortunately the world is increasingly focussed on this challenge. Great strides have been made and China’s government is now engaged in the effort to reduce CO2 emissions. So I am hopeful, but far from complacent.   

Crystal balls at the ready! This is the time of year when we economists like to give the benefit of our supposed wisdom and you, the readers, indulge us by appearing to believe that we know what is going to happen. Since economists are normally a pretty gloomy bunch, this represents the triumph of fear over experience. By contrast, I find myself fairly optimistic about the year ahead – albeit tempered by the usual dose of worries.

On the global front, the most important influence on our economy will probably continue to be the price of Energy. I reckon that it is likely to stay roughly at the current level, although it may trend up a bit.

Two consequences follow from continued low Energy costs. First, across pretty much all of the developed world the rate of inflation is set to rise from the near-zero rates that have prevailed recently.

Second, whereas last year saw the predominance of the negative effects of low Energy prices over the positive ones, this year that balance should reverse. The losers from low prices will already have done most of their cutting, while the gainers may still increase their spending.

I doubt whether China is again going to provide the main source of anxiety this year. I suspect that the slowdown has pretty much come to an end and there may even be scope for economic growth to pick up a bit. In America, I expect the recovery to continue bowling along at its recent solid though unspectacular pace.

In recent years the euro-zone has been a running sore for the world economy. Although it did a bit better last year, I suspect that its growth rate will fall back in 2016. Certainly no one should suppose that its fundamental economic problems are fixed.

In some ways 2016 is going to be a watershed year. Having flirted with deflation, most developed economies will now experience a return to more familiar territory and policymakers – except in the euro-zone and Japan – will return to the once familiar quandary as to how far and how fast to put up interest rates in order to fend off the danger of inflation.

Readers of the financial press are subjected to a plethora of 12-month financial forecasts at this time of year.  They are not without some merit, including consensus views which can be a warning for contrarian thinkers. 

This service does not release its own annual forecasts because Eoin and I comment on the markets every day, including medium to longer-term forecasts in the Friday ‘big picture’ Audios.  However, I am always interested in Roger Bootle’s forecasts regarding him as a practical economist with a good track record.

Nevertheless, I suspect Roger Bootle and most of the rest of us who are not perennial bears will find today’s market action somewhat unnerving.  Moreover, a weak start to the year can often weight on sentiment for a longer period.  

Subscribers may recall my checklist of four points which concerned me when I responded in both writing and Audio to the optimistic outlook from The Weekly View: 2016 Outlook Highlights: Shifting Gears, which I posted on 22^nd December and also discussed in the Audio for that day. This item is updated and reviewed today, including in response to a subscriber’s email citing concerns expressed in today’s FT. 

 This item continues in the Subscriber’s Area.

The Nevada Public Utility Commission voted unanimously in favor of a new solar tariff structure on Tuesday that industry groups say will destroy the Nevada solar market, one of the fastest-growing markets in the country.

The decision increases the fixed service charge for net-metered solar customers, and gradually lowers compensation for net excess solar generation from the retail rate to the wholesale rate for electricity, over the next four years. The changes will take effect on January 1 and will apply retroactively to all net-metered solar customers.

The broad application of the policy sets a precedent for future net-metering and rate-design debates. To date, no other state considering net-metering reforms has proposed to implement changes on pre-existing customers that would take effect right away. Changes are typically grandfathered in over a decade or more.

 

Renewable Energy and distributed generation are two of the greatest threats to established utilities in the sun-belt. If people can generate their own electricity at home, sell excess onto the grid at a favourable rate and only take from the base load provider when necessary, they are put in a highly advantageous position relative to the utility. On the other hand utilities are accustomed to a highly regulated market but not to competition. 

7. Better Batteries
Solar and wind power have seemingly limitless potential, but since they're intermittent sources of Energy, they need to be stored. That’s why there’s a race to build a better battery. The lithium-ion standard bearer, introduced by Sony two-plus decades ago for personal electronics, can be pricey—especially for large uses—and flammable. So every few weeks comes an announcement of a new idea.

Harvard researchers unveiled a flow battery made with cheap, non-toxic, high-performance materials that they say won’t catch fire. “It is a huge step forward. It opens this up for anyone to use,” says Michael Aziz, Harvard University engineering professor and co-author of a study in the journal Science. (Find out how this flow battery works.) Also this year, MIT and DOE announced promising advances that could make batteries better and cheaper.

The battery push has gone beyond the lab. In May, Tesla’s Musk unveiled battery products that he plans to mass-produce in his $5 billion Gigafactory in Nevada. The products include the sleek, mountable Powerwall unit that SolarCity, a company he chairs, is putting in homes. This month, in the first such offering from a U.S. utility, Vermont’s Green Mountain Power began selling or leasing the Powerwall to customers. (Here are five reasons this battery is a big deal.)

Other companies are challenging Musk. Pittsburgh-based Aquion Energy, a spinoff from Carnegie Mellon University, began selling its saltwater battery stacks last year. German storage developer Sonnen said this month that it’s ramping up production of its lithium-ion battery at its facility in San Jose, California, for use in U.S. homes.

 

Symbiosis is popular in nature but it is becoming increasingly clear that it also has a role to play in sustaining the pace of technological innovation. Renewable Energy technologies such as wind and solar are progressing rapidly but they will always suffer from intermittency without corresponding innovation in storage for both consumer and industrial uses. This has been painfully slow to follow because it takes time for capital invested in research to deliver results and yet the signs are promising that the next really big enabler with occur among chemical companies. 

It is one of life’s mysteries that being wrong about everything has never been much of a barrier to success. Take Thomas Malthus, the British theologian: his big idea was that the number of human beings would necessarily grow faster than the supply of food, leading to calamity. There was little difference, in his mind, between people and rabbits: both were doomed to over-breed, over-consume and starve.

Yet this theory, expounded in 1798 in An Essay on the Principle of Population, one of the most influential books ever written, and now also routinely applied to oil and other resources, is bogus. Unlike rabbits, who are powerless to control their environment, the more we need, the more we eventually find a way of producing: the availability of food and oil are determined by technology and economics, not by some law of nature. Modern techniques (such as fertilisers, genetic selection or fracking) mean that agriculture and the extraction of commodities have become hugely more efficient.

The average British field yielded just over three tons of cereal per hectare per year in 1961; today, it is twice that. Thanks to the spread of free markets and knowledge, the world has never produced so much food, and the number of hungry people worldwide has dropped by 216m since the early Nineties, according to the United Nations.

Ditto oil production: in 2000, the Energy Information Administrationestimated that the world contained just over one trillion barrels of untapped oil; since then, proved reserves have shot up by 60pc, increasing every single year despite booming consumption from Energy-thirsty emerging markets.

Malthus wasn’t just far too pessimistic about supply: he was also wrong about demand. Rabbits can’t control their birth rates; we can. As more countries embrace markets and globalisation, thus ensuring that their economies develop, global birth rates keep on falling. As to Energy consumption, it is just a matter of time before improved battery technology and ever-cheaper solar power finally lessen our dependence on the internal combustion engine and oil. We will eventually be able to feed and fuel the world’s population using significantly less land and fewer hydrocarbons than we do today.

Jesse H Ausubel, an academic at the Rockefeller University in New York, has calculated that an area the size of the Amazonian forest could be returned to wildlife when the average farmer around the world becomes as productive as their US counterparts. Ausubel calls this the Great Reversal: nature’s chance to restore land and sea to their original use. It is an intriguing and exhilarating prospect, made possible by the wonders of capitalism, innovation and human ingenuity.

The abject failure of Malthusianism was, in fact, one of the defining trends of 2015, especially in the oil market; it will continue to be one of the central forces of 2016, impacting everything from how quickly the Bank of England puts up interest rates, to the stability of the Middle East. The price of Brent crude oil, which briefly reached $147 a barrel in 2008, is now down to around $37. Some analysts even believe it could fall briefly to $20, especially if more Iranian supplies than expected hit the global markets.

People are susceptible to Malthusianism because running out of what we need and want – food, companions, shelter, money – is a primal instinct. Fortunately, it motivates most people on a needs must basis.  However, it can also overwhelm some with feelings of anxiety and loss. 

As investors with a sense of history, we know that most markets have not only survived but also thrived after much more worrying events than we are witnessing today.  We also know that the world improves more often than not, in terms of GDP growth, technological innovation and life expectancy.  This is reflected by stock markets over time, to the benefit of sensible, worldly investors who buy low and sell high.   

A PDF of Allister Heath's article is posted in the Subscriber's Area.

Bloomberg News reporters in 128 cities will cover the stories that matter most in 2016. Here's a selected calendar of key events for the year.

January 

Taiwan holds an election and may choose its first female president.

U.S. begins production of liquefied natural gas for export from Cheniere Energy's terminal in Louisiana, the first since 1969. 

World leaders gather for the World Economic Forum in Davos, Switzerland. Follow our special report.

Vietnam's Communist Party Congress convenes to make leadership changes and set policy.

UN monitors may conclude that Iran has implemented all steps required under July nuclear accord, allowing the U.S. and Europe to lift sanctions.

A few of these dates will be important for stock markets.  Inevitably, however, it will be the surprise developments and perhaps a black swan or two which become the events of the year.  Despite all the uncertainties and concerns that people have felt and expressed throughout 2015, I think 2016 will provide a number of opportunities.  Eoin and I aim to identify many of these, helped by our vast Chart Library, plus the interests and experience of our subscribers.

Happy New Year! 

The most destructive oil crash in a generation is giving ship owners a billion-dollar windfall.

With the Organization of Petroleum Exporting Countries abandoning output limits in a drive for market share, ships that carry as much as 2 million barrels a trip are in demand to haul crude from the Middle East to Asia and North America. While oil prices fell about 35 percent in 2015, average earnings for these carriers jumped to $67,366 a day, the most since at least 2009, according to Clarkson Plc, the world’s largest shipbroker.

“The stars are aligned for us right now,” Nikolas Tsakos, the chief executive officer of Tsakos Energy Navigation Ltd., said in an interview at Bloomberg’s New York offices, adding that falling oil prices will likely stimulate demand and cargoes next year.

Tanker analysts are predicting the rate boom will persist for many of the same reasons oil forecasters are bearish. OPEC shows no sign of reversing its market strategy, and Iran has outlined plans to ramp up its exports once economic sanctions against the country are lifted. At the same time, the U.S. just repealed a four-decades old limit on its exports.

With on-land inventories already at record levels, this could mean more barrels will eventually be stored on ships, further increasing profit, said Tsakos.

The biggest tanker operators who manage fleets from Europe are Euronav NV, based in Antwerp, Belgium, DHT Holdings Inc., Frontline Management AS, which runs Norway-born billionaire John Fredriksen’s tanker fleet, and Tsakos Energy in Greece. All have seen their shares rise this year while most Energy producers have fallen.

Clearly cheaper Energy costs open the routes of international commerce, while also making business more attractive and competitive for many corporations and middleclass people around the world. 

This item continues in the Subscriber’s Area.

Dr Alsweilem, now at Harvard University's Belfer Centre, said the Saudi authorities have taken a big gamble by flooding the world with oil to gain market share and drive out rivals. “The thinking that lower oil prices will bring down the US oil industry is just nonsense and will not work.”

The policy is contentious even within the Saudi royal family. Optimists hope that this episode will be a repeat of the mid-1980s when the kingdom pursued the same strategy and succeeded in curbing non-OPEC investment, and preparing the ground for recovery in prices. But the current situation is sui generis.

The shale revolution has turned the US into a mid-cost swing producer, able to keep drilling at $50bn a barrel, according to the latest OPEC report. US shale frackers can switch output on and off relatively quickly, acting as a future headwind against price rises.

The Energy intensity of global GDP is falling rapidly. Renewable technology and Energy efficiency have both made huge strides. The latest climate accords in Paris imply some form of carbon tax that will ratchet upwards over time, slowly changing the cost calculus for oil use.

“There is an overwhelming feeling among many in Saudi Arabia that this crisis is just cyclical and that it will reverse soon, so everything will be OK. But the danger is that what is happening is structural, and that means a country like Saudi Arabia can’t just sit still,” said Dr Alsweilem.

The Saudi government may have unveiled an austerity package of spending cuts and increased taxes, and be looking to slash electricity and water subsidies for the wealthy. But Riyadh has to tread with care. The country’s cradle-to-grave welfare system is what keeps a lid on dissent and binds the country’s fissiparous tribal polity.

Prince Mohammed bin Salman, the 30-year old deputy crown prince now running the country, is trying to push through radical reforms, firing princelings from sinecure positions and bringing in an elite team of technocrats to transform Saudi Arabia’s archaic oil-based economy.

He is drawing on a McKinsey study – ‘Beyond Oil’ - that sketches how the country can break its unhealthy dependence on crude, and double GDP by 2030 with a $4 trillion investment blitz across eight industries, from petrochemicals to metals, steel, aluminium smelting, cars, electrical manufacturing, tourism, and healthcare.

I do not know if Dr Khalid Alsweilem, the former head of asset management at the Saudi central bank, has much influence with King Salman.  However, 30-year old and highly influential Prince Mohammed bin Salman may understand, given the concluding paragraph above. 

However, Saudi governments remain compromised by their Faustian pact with the contemporary Wahhabis who have spread their intolerant faith far beyond the Middle East, in an effort financed by Saudi billions as the price of crude oil mostly rose from the 1970s until mid-2014.  With that stream of funding now inevitably reduced, one might hope that intolerant Wahhabism was now in decline, although the outcome may be less reassuring.  

This item continues in the Subscriber’s Area, where more charts and another article are posted, in addition to a PDF of AE-P’s article.

California’s proposed rule that a driverless vehicle must contain a steering wheel and a brake pedal for emergencies, goes against the grain of the technology industry that has been leading the development of these vehicles and cannot imagine a situation where the specified equipment would be necessary. It is akin to the continued existence of the emergency brake, a seldom used feature on a car, or directional signals, which many people seem to consider as unnecessary. The mandated equipment will certainly alter a passenger’s experience from that of a 21st Century, space-age vehicle to merely being a passenger riding in a modern automobile.

And   

Stretching out the transition time to a totally driverless vehicle fleet will also delay some of the anticipated economic and Energy benefits envisioned. The world of a complete fleet of autonomous vehicles would allow them to be smaller and lighter, reducing the Energy needed to produce them and power them. The absence of accidents would reduce the economic impact of injuries, physical damage and deaths, along with limiting or even ending the need for personal automobile insurance and the costs of accident litigation. If driverless vehicles could operate without human drivers, many families might also eliminate the need for second or third cars by being able to overlap their use of one vehicle, even though it would mean that vehicle would drive considerably more miles per year than the typical family’s current vehicles do. Net-net there should be an Energy savings. Lastly, fewer vehicles would mean less need for expanded highways and parking spaces, freeing up urban land for alternative uses. California’s stance on driverless vehicles would seem to be slowing down the shift to our transportation nirvana and actually extending the petroleum age.

 

A link to the full report is posted in the Subscriber's Area.

California’s laws on what need to be inside an autonomous vehicle, including a driver for example, are likely to represent a brake on the sector’s progress. However as anyone who actually drives a car knows there is a difference between what the law says and what the experience of driving is. 

With the exception of a small number of outliers the worst performing shares this year have been in the Energy sector. This is particularly true of the S&P 500 where 11 of the 15 shares down more than 50% are Energy related. Those are pretty scary declines and sentiment is about as bearish as I have seen with news flow compounding that view as one would expect. 

US STOCKS: We believe the bull market in US stocks will remain in place, but we only expect single-digit annual returns. We anticipate a prolonged but slow expansion, which is shifting gears as wages start to grow.  This is better for economic growth than for earnings, as higher wages pressure already high margins and the strong dollar remains a headwind for global companies.  We expect mid-single-digit returns from the S&P 500, as we believe current valuations put a restraint on the upside potential. Within our portfolios, we currently like homebuilders and bank stocks; we recently added oil services to increase our Energy holdings, which we underweighted in 2015.  In contrast, we are avoiding utilities and REITS, which are highly sensitive to interest rates.  We are cautious on retailers and healthcare stocks.

So, how does this forecast tally with subscribers’ views and our own outlook?

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Mergers haven't taken off in the oil patch this year largely because potential targets have been banking on a rebound and potential buyers have been expecting further falls. The spike in yields for borrowers in the Energy sector, along with the growing acceptance that oil and gas prices likely face another year on their back, should mean those opposing views finally converge in 2016, prompting some deals.

What's more, this chart suggests the advantage should lie with large, strategic buyers like the oil majors for two reasons.

First, one way potential targets have been shoring up balance sheets is to sell assets rather than the entire company.

But a thriving asset market requires buyers being able to raise capital at reasonable rates, be they other E&P companies or private equity firms looking to snap up bargains. Asset sales have slowed already this year, with just $29 billion worth in North America, compared with $107 billion in 2014, according to data compiled by Bloomberg.

Second, with the cost of capital rising and cash harder to come by, any deals struck will require at least the promise of synergies and will favor those buyers able to use their own stock as a credible acquisition currency. One reason Anadarko's approach to Apache met with such scorn was that it scattered rather than tightened the company's focus. The majors, diversified anyway, bring the benefit of bigger balance sheets, which both alleviate any credit pressures weighing on the target and provide a clearer path to developing a smaller E&P company's reserves. Paying with shares also means that selling shareholders get to participate to some degree in the eventual recovery in oil and gas prices.

 

Major oil companies have slashed exploration budgets with the result they have more capital to pick up promising assets as prices decline. Private Equity firms have amassed sizable war chests to invest in troubled Energy companies but have so far been slow to make large purchases. Meanwhile sellers are hoping for a rebound so they can get a better price. With everyone appearing to bide their time a catalyst is required to encourage deal making.