The Rude Awakening
Wall Street, New York
Friday, May 24, 2007 ------------------------- - Whether weather will or whether weather won't - a commodity forecast from our guru on the ground,
- A moment of nostalgia - the grand old days of Big Oil,
- 3 good reasons for an energy divergence and much more…
------------------------- Eric Fry, reporting from a hotel room overlooking Manhattan's Bryant Park… For nearly two months, oil stocks have been rallying, even though the prices of crude oil and natural gas have been languishing. Why would this be so? Why would oil stocks rally, even though crude oil is falling? Your editors at the Rude Awakening can imagine three possible explanations: 1) Just because.
2) Oil stocks are "anticipating" higher oil and gas prices.
3) Crude oil has almost nothing to do with oil stocks…for the moment. Of these three possible explanations, we favor #3, followed closely behind by #1. (Explanation #2 - the classic, all-season explanation for stock market divergences - seems unlikely to pertain in this instance). 
Liquidity is calling the shots in the global financial markets, not underlying fundamental realities. ("Liquidity," as defined in yesterday's edition of the Rude Awakening, refers to the vast pool of cash, credit and derivatives that animate financial asset prices worldwide). In other words, cashed-up, derivative-toting hedge fund managers are patrolling the world's financial markets, hunting down "alpha" (excess return) wherever they can find it. And these well-heeled alpha-hunters are usually gunning for returns that are short-term and relative - NOT the long-term, absolute returns that made billions of dollars for guys like Warren Buffett. Alpha-hunters don't care much about underlying fundamentals. But they care a lot about short-term
momentum. Since oil stocks exhibit positive momentum, these stocks have become prize game. Hence, according to our newly minted theory, oil stocks are soaring even though crude oil is not. These divergences usually end badly. Over the long term, most oil exploration and oil services stocks deserve to be darlings. But even so, we never like to see oil stocks soaring when oil and gas prices are not. It just doesn't feel right…like polyester underwear. When oil stocks soar well above the prices of oil and gas, they are usually soaring off a cliff. For evidence of this tendency, you may examine the August 30, 2006 edition of the Rude Awakening,m Road Scholars, in which we noted a similar divergence between oil stocks and oil. As fate would have it, oil stocks tumbled shortly thereafter. We would not dare to predict a repeat performance, but neither would we rule it out. So let's call oil stocks long-term valuable, but near-term dangerous…and a bit volatile. Crude oil is not, however, the only commodity that threatens volatile trading action over the coming weeks and months. So does corn and wheat and most of the other grains, according to Kevin Kerr, editor of the Resources Trader Alert. Kevin shares some of his latest thoughts in the column below. ----------------------------------- Weather Roulette
By Kevin Kerr Let's play weather roulette. We have no choice in the matter, really. So we might as well play. Every year about this time, Mother Nature starts to whip up storms in the Gulf of Mexico, and farmers in the Midwest begin to worry about getting enough rain. This year is no different, weather-wise. But it feels a lot different, commodity-wise. Grain prices are already sky-high. So any setbacks during the summer could produce dramatic action in the trading pits of Chicago. In general, I am bullish on grain prices…not because of what I know, but because of what I cannot know: the weather. Since demand is very firm in most grain markets, the main price influences should be on the supply side. That's where the weather comes into play. Already this year, adverse weather trends delayed corn plantings in the Midwest. I saw it firsthand. In late April, I went out to Illinois and Indiana to see some farms for myself. I visited during what is traditionally the busiest planting week, but due to all the cold, wet weather, barely anything was going on. Farmers were getting very anxious, as every day the crops didn't get in the ground meant a bigger chance of lower-than-average yields. As we now enter summer, new challenges arise. A lot is on the line, after all. Many of these hard-working growers have bet the farm (pardon the pun) and planted corn from "post to post." For many of the farmers, the input costs to get the crops in the ground have been staggering. Seed costs, fuel costs, new equipment, planting delays, fertilizer…the list goes on and on. All of these expenses seem justified because of the "promise" of a big payday when that golden crop is harvested and driven to the nearby ethanol plant. But this is a dream that could become a nightmare for many farmers if the weather does not cooperate When I looked out over the vast corn and soybean fields, I saw many of the larger farms had irrigation systems - you know, those massive, sprinkler-like things that roll down the fields. Many smaller farmers, though, don't have that equipment. When July temperatures spike, and if La Nina fulfills her promise, irrigation will be an around-the-clock necessity. Those irrigation machines don't simply turn on like the garden hose in your backyard - they run on fuel. A lot of it. This is an expense that could add a ton to the bottom-line cost for this year's crops. Meanwhile, down in the land of Dixie, they're actually trying to grow corn too, in cotton states like Georgia. It sounds crazy, as the climate is completely wrong, but the allure of cashing in on that ethanol bonanza is strong - almost like a new gold rush. How nuts has it gotten? I read early in the year that an old orange juice processing plant in Florida was being converted to an ethanol refinery.
Equally crazy, it's actually possible to get government subsidies to grow corn in Nevada - yes, Nevada. The fight over water is going to become so intense in the Midwest, Southeast and Southwest, and this will be an absolute disaster for the country. The average ethanol plant uses 100 million gallons of water a year. Farmers irrigating all those fields use millions of gallons of water, as well as a ton of fuel to run the systems. Already, major fights over water rights are starting, and the battle lines are being drawn. If temperatures climb to record levels this summer and water supplies become even scarcer than they already are, the outlook for farmers is grim. This is a problem that cannot be solved. Yes, we have low oil production in the U.S., so someone came up with ethanol to supplement conventional fuel. The situation with water is very different. You can't build a factory that can create a substitute for water out of switch grass or anything else. This is a problem that will get a lot worse before it possibly gets better. Our colleague Chris Mayer has written many good articles on this subject, and many of his water-related stock recommendations have done very well. Byron and I may be adding a water-related stock to the Outstanding Investments portfolio very soon. In the meantime, we'll be watching the weather…literally. --- Kevin Kerr's Resource Trader Alert --- The Maniac Trader strikes it rich again… The Global Commodities Crunch Take Off Those who heeded his call banked 400% in just 34 days on this "sterling" options play - one of the 10 Triple Digit winners he picked in 2006… Join the Maniac's rampage and YOU could rake in even more than this - and faster - as the global commodities crunch escalates. Find out if you qualify to become part of this elite trading circle right here: Kevin Kerr's Resource Trader Alert ------------------------------------------- Exxon Who?
By Byron King After three days at the 2007 Offshore Technology Convention (OTC) in Houston, Texas, it is apparent that this is not your father's oil business. Almost everything has changed, and almost nothing is the same. Big Oil is history, or at least the Big Oil of myth and legend - as taught in the salons and parlors of American academe and the so-called "think tanks" of the American political establishment. The old "Seven Sisters" (the top tier of the international oil companies, aka IOCs) are down to four and control less than 10% of the world's oil reserves. The newly rising and assertive national oil companies (NOCs) control over 70% of the world's reserves and have an entirely different political and economic agenda than do the IOCs. This means a lot of things, foremost among them that the West no longer has its previously built-in hometown advantage in the scramble for the oil that is necessary to power its "knowledge-based" economy. IOCs no longer have a lock on technological prowess in the oil patch, as even a casual glance at the offshore developmental efforts of NOCs such as Brazil's Petrobras and Norway's Statoil will demonstrate. And in a world awash in capital, the NOCs have little difficulty in arranging financing for almost anything that they desire to accomplish, as was demonstrated recently by Angola's Sonangol and its decision to construct its own refinery complex to capture more of the downstream value of that nation's oil. As for the future, simply note that the Sonangol people are meeting with some representatives of Russia's Gazprom next week in Luanda. To discuss what? Think big, dear readers. Going forward, the world will, of course, continue to find, produce and consume oil. But oil will be scarcer, and it will be the expensive stuff from far away, from under harsh waters, from deep within the rocks of the Earth. How far away? How expensive? Consider that Russian oil giant Rosneft is planning to develop Arctic oil prospects so far out to sea that they will require underwater pipelines of 600 kilometers in length, about the distance from New York, N.Y., to Cleveland, Ohio, but under both water and sea ice. And just to lay down pipelines in the seabed of the Arctic, Dutch builder Heerema Marine Contractors is building a construction vessel that sports a lifting system that can hoist over 15,000 tons, or about the weight of a navy cruiser. The price? Over $1 billion. You will not pay for that kind of investment with cheap gasoline at the pump. That is, if the NOCs of the future will even sell you the gasoline from their new refineries and not ship it to some other country with a stronger economy and more robust currency. Stay tuned… Joel's Note: Scary, huh? What happens if, as Byron previously suggested, the United States is left off the guest list when the future's powerful and mighty nations host their grand oil ball? Maybe things will vastly improve…Bush will display some heretofore unrevealed oratory prowess and sweet talk the oil producing countries back to the dinner table. Maybe he will not. One thing that is certain is that this is going to be a very interesting decade as power (in the form of both politics and raw energy) pendulum to and fro. Byron covers these topics with an unrivaled passion in the field and is eager to bring you the news as only a geologist with a keen macroeconomic bent can. Following is a quick read that should provide some general background to the current energy climate with a view to the future. It called the Oil Wars of 2007 and you can take a read here: Outstanding Investments - Oil Wars of 2007
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