I was going through the world's largest gold deposits, then seeing which firms own them, -- interestingly you can search the mines here: http://www.minefund.com/mineral-deposits/richest-deposits.php I'd like a large deposit, so that the co can set up operations and then have a long mine life, plus the resource firm's main source of value is its mining assets.
Anyway, what is interesting is that Thompson Creek, mainly a Molybdenum producer, owns the 47th largest gold deposit in the world, Mt Milligan in Canada, with 6 million ounces of gold proven, also contains about 1 M tons copper (comparison, Codelco, Chile's gov't owned copper miner world's largest has 77M tons copper)(which is to say, it won't set records in copper, but the copper is a source of value). 22 year mine life, will come online in 2013, so current forecasts don't include earnings from this forecast to 2012 (current forecast is selling at 13x 2012 earnings). Production will be 194,000 ou gold, which is around a small to mid tier producer -- you'd see this at around $1Bn in market cap by itself at least.
This doesn't include Molybdenum, which is the main asset, interestingly Moly prices haven't moved up too much, despite the fact that iron ore, copper, now nickel -- most base metals are up -- see http://www.infomine.com/chartsanddata/chartbuilder.aspx?z=f&g=127676&dr=5y Moly prices were at $30-35, now at $15, but at an uptrend.
Nice net cash position, market cap of only $2Bn, nice chart (stock looks flat, no breakout yet).
Corporate presentation here: http://www.thompsoncreekmetals.com/i/pdf/Presentation_February_24_2011.pdf
I really like the "hidden" asset of the Mt Milligan gold and copper mine. However note, the grades are on the low side for the mine, -- grades of around 0.4 g/ton for gold -- you want to see at least 1 g/ton, and copper grades of 0.14% copper -- you want to see grades of 1% copper. However, the reserves are very big, I noted one of the most successful gold miners, Newcrest in Australia, has one main mine, Cadia, which has a grade of 0.5 g/ton but 27 M ounces total., Now Newcrest is worth almost $30Bn, due to the fact that they have all the operations set up, even as the mine as a relatively low grade (can just process and process ore).
TC should be able to do the same, perhaps on a bit of a lower scale, but a 6 M ou mine is not small at all (again gold mines of over 1M ounces are very rare).
Anyway, once the market either anticipates the gold mining operation Mt Milligan coming online, or higher moly prices, TC should do better than a relatively low $2Bn market cap.
It's not showing up as a gold producer yet since it is classified as Moly, so that's why I think it hasn't moved too much. (most gold producers are up a ton over the past year and a half). It's sort of like KHGM, which is the world's 6th largest copper producer, but also has the 5th largest reserves of silver (always classified as copper, doesn't get a benefit yet too much from silver) (KGHM has already up a ton so probably isn't too much of a buy here).
Feasibility Study of Mt Milligan:
I found an NPV for a feasibility study of Mt Milligan (located about 500 miles north of Vancouver): http://www.terranemetals.com/i/pdf/2009-10-09_PreTaxMatrix_2.pdf
The chart gives different prices of copper and gold, and different discount rates. The maximum prices for copper are $3.50 per lb (now $4.33) and $1000 for gold (now $1400 ou). At $3.50 copper and $1400 gold, the NPV is $C3,134M at a 5% discount rate, $C2,156M at a 8% discount rate.
Of course you'd increase that value is the value of copper is $4 and gold $1400.
So I think the stock will do really well once revenues come in from Mt Milligan. (and as long as commodity prices stay strong).
Checked the message board for TC, and the explanation for the low stock price is possible bankruptcy, from a potential meteor strike (this is a joke). The messages are very frustrated with the stock, blaming it on management, for some reason (need to figure out why). So perhaps it will be a while before it moves. But it appears the value is there.
Tuesday, March 8, 2011
Wednesday, February 23, 2011
Petrobras -- Economics of Deep Sub-Salt Operations Hinges on Cash Costs per Barrel
Petrobras´ market value is nearing $250Bn which is fairly high but if (the key) is ´the cash costs of the deep sea oil per barrel. PBR is spending at least $174Bn to develop this (one of the largest capital projects in history, ever).
I did a quick calcuation of the payback period of the deep sea oil costs. The estimate is that initially the deep sea will produce an additional 2 million barrels of oil -- quick calculation, assuming a profit per barrel of $40 after direct operating costs = $29.2Bn of profit per year, or a 5.96 year payoff period -- this is at the high end of aceptable levels of payoff, in which oil and gas firms want payoffs to be below 5 years.
If the profit after operating costs is $60, the payback period drops to 3.94 years. Need to find better data on direct operating costs. If it is only costing PBR $20 to hire workers, equipment, power, water, foodservice etc then this isn´t bad at all (since the deposit is likely very large and will last for decades)(the price of oil should be in the $70-90 range for a while).
One more note: I did find data that at least at Tupi the gas/oil ratio is 15-20% -- majority oil (perhaps the pressure maintains the longer hydrocarbon chains). In geological theory, the deeper the deposit, the hotter and the more the longer hydrocarbon chains will have been broken to form natural gas, but PBR seems quite confident the deposit is mainly oil (of course natural gas is cheaper currently and less profitable and also is much more difficult to transport from offshore locations).
I did a quick calcuation of the payback period of the deep sea oil costs. The estimate is that initially the deep sea will produce an additional 2 million barrels of oil -- quick calculation, assuming a profit per barrel of $40 after direct operating costs = $29.2Bn of profit per year, or a 5.96 year payoff period -- this is at the high end of aceptable levels of payoff, in which oil and gas firms want payoffs to be below 5 years.
If the profit after operating costs is $60, the payback period drops to 3.94 years. Need to find better data on direct operating costs. If it is only costing PBR $20 to hire workers, equipment, power, water, foodservice etc then this isn´t bad at all (since the deposit is likely very large and will last for decades)(the price of oil should be in the $70-90 range for a while).
One more note: I did find data that at least at Tupi the gas/oil ratio is 15-20% -- majority oil (perhaps the pressure maintains the longer hydrocarbon chains). In geological theory, the deeper the deposit, the hotter and the more the longer hydrocarbon chains will have been broken to form natural gas, but PBR seems quite confident the deposit is mainly oil (of course natural gas is cheaper currently and less profitable and also is much more difficult to transport from offshore locations).
Polyus -- High Reserves but Some Operating Problems
I did some more research on Polyus and they had some mixed operating performance in 2010 -- their biggest mine, currently Olimpiada showed a decrease in production of almost 30%, from 839,000 ounces in 2008 to 584,000 ounces in 2009 -- apparently the problem is that two other mines are close by, and Polyus is allowing ore from the other two mines to be processed at the processing center at Olimpiada, which caused problems with the exaction of ore. The solution appears to build a separate processing center (which can crush the ore, and exact the gold by a bath of high-grade acids and chemical solutions) but it doesn´t appear that the firm has this in the works.
Another concern was that the production was up 10% y/y to 1.39M ou (approx) but the profit didn´t increase, mainly due to higher costs -- I´m not sure I did note that the mines are spread around the country in mainly three locations, which are extremely far away from each other (well over 1000 miles), so the co isn´t getting any syngeries from the operations.
Polyus is having serious problems with its acquisition of KazahkGold, and is going to divest this -- about 2 years after acquiring it -- the owners of Polyus and the ruling family (Nazerbyev) of Kazakhstan really got into an argument. On the negative side, KazahkGold was the one asset so far that is significantly increasing production
Current forecast is for 1.5M ou, which one analyst takes to mean that the problems at Olimpiada will continue. The capital expenditures appear to be (according to UBS) well under maintance levels -- strangley, the CEO (who is also the owner to the New York Nets) wants to sell the firm, not develop it.
The basic idea is to find Gold miners which are the most undervalued on reserves. Below is a useful chart by UBS that shows potential undervaluation by reserves, since Gold is not really concentrated in one geographical area, there are many firms and it does appear that Polyus is undervalued, although perhaps not by a whole lot (in the chart below, Anglo Gold, Harmony and Gold Fields appear to be the cheapest on an EV/Reserves and Resources). I´ll look into these -- (although I´m not sure how these miners stack up against individual gold mines, I did like the fact that Polyus had one very large mine in the works -- will research).
Another concern was that the production was up 10% y/y to 1.39M ou (approx) but the profit didn´t increase, mainly due to higher costs -- I´m not sure I did note that the mines are spread around the country in mainly three locations, which are extremely far away from each other (well over 1000 miles), so the co isn´t getting any syngeries from the operations.
Polyus is having serious problems with its acquisition of KazahkGold, and is going to divest this -- about 2 years after acquiring it -- the owners of Polyus and the ruling family (Nazerbyev) of Kazakhstan really got into an argument. On the negative side, KazahkGold was the one asset so far that is significantly increasing production
Current forecast is for 1.5M ou, which one analyst takes to mean that the problems at Olimpiada will continue. The capital expenditures appear to be (according to UBS) well under maintance levels -- strangley, the CEO (who is also the owner to the New York Nets) wants to sell the firm, not develop it.
The basic idea is to find Gold miners which are the most undervalued on reserves. Below is a useful chart by UBS that shows potential undervaluation by reserves, since Gold is not really concentrated in one geographical area, there are many firms and it does appear that Polyus is undervalued, although perhaps not by a whole lot (in the chart below, Anglo Gold, Harmony and Gold Fields appear to be the cheapest on an EV/Reserves and Resources). I´ll look into these -- (although I´m not sure how these miners stack up against individual gold mines, I did like the fact that Polyus had one very large mine in the works -- will research).
Sunday, February 20, 2011
Polyus' Gold Reserves: Under-Appreciated
Polyus Gold may have significantly larger reserves of gold than is credited to the stock by the market currently. Polyus Gold (ADR: OPYGY) is the gold mining spin off from Nolisk Nickel. Polyus has the world's second largest gold mine by reserves, Natalka, at 40.8M ou of gold in place -- this compares to all of Barrick's Gold's reserves of 138M ou.(Barrick is the world's largest gold miner).
Gold miners report proved (90%) and probable (50%) reserves all together, unlike oil which typically report only proven (90%). Barrick reports it has 138M ous of reserves of gold, when you look at the 40-F, it has 30.3M ou of proven gold, 109.4M ou of probable http://www.sec.gov/Archives/edgar/data/756894/000110465910017012/a10-4461_1ex99d1.htm
In comparison, Polyus reports reserves in the Russian classification system, which is A,B,C1 and C2. According to Nikolai Vlasov, chief geologist, Peter Hambro Mining plc, A,B,C1 are roughly equivalent to proved and probable. http://www.imcinvest.com/pdf/Russian_reserves_8.pdf
Polyus reports in its 2009 Annual Report 77M ou of A,B,and C1 gold reserves. Polyus also reports international standard reserves, mesaured of 14M ou and 66.3M ou of indicated. (total 80.4M)
Note that measured means that the reserves exist with high certainty (90%) but are not yet proven, in so far that they have not been proven to be economically mined through a feasibility study and http://www.polyusgold.com/eng/news/reports/audit/
According to Polyrus' investor's relations, Natalka's mine life to 2073 (very large mine), average cash costs per ounce of $51.3 (should be very profitable)(this is the mine info). The mine will double Polyus' current output of 1.38M ou per year of gold towards 2020, in 2014 it will increase by 48%.
In comparison Barrick (market cap: $50.9Bn) produces 7.4M ou. Newmont (market cap $28.8M) produced 5.3M ou in 2009, reserves of 92 M ou.
Polyrus I'm not sure the market cap, one source is saying $10Bn, another around $5Bn -- it is really attractive at $5Bn. I will double check this.
You can find a comparison of the world's richest gold mines here: http://www.minefund.com/mineral-deposits/richest-deposits.php There are only 6 mines with reserves of 30M ou or above,and only 8 with total reserves of 20 M ou or above. Barrick does not own any of these top 8 mines, but has interests in many smaller mines -- it appears Barrick has consolidated many individual mines, to form the world's largest gold miner.
Natalka will come on-stream in 2013 - actually late 2013. The shares haven't moved up too much -- except for after the financial crisis.
Overall I can tentatively say that Polyus is comparable in size to Barrick, in so far that it is a major miner of gold (the Russian reserve show that Barrick has 80% more gold than Polyus) -- but the market cap of Barrick is far higher, $50Bn verses $10Bn. Of course this reflects geopolitical risk (mining in Russia) -- next steps would be to compare average costs per ounce -- it seems most gold miners would have higher than Polyus' cash costs since the mines will be located in many different locations (a single, large deposit will lower cash costs per ounce since the set up costs of the electricity, water, housing, roads, equipment etc can be depreciated over a longer mine life). Further next steps are to analyze political risk.
Gold miners report proved (90%) and probable (50%) reserves all together, unlike oil which typically report only proven (90%). Barrick reports it has 138M ous of reserves of gold, when you look at the 40-F, it has 30.3M ou of proven gold, 109.4M ou of probable http://www.sec.gov/Archives/edgar/data/756894/000110465910017012/a10-4461_1ex99d1.htm
In comparison, Polyus reports reserves in the Russian classification system, which is A,B,C1 and C2. According to Nikolai Vlasov, chief geologist, Peter Hambro Mining plc, A,B,C1 are roughly equivalent to proved and probable. http://www.imcinvest.com/pdf/Russian_reserves_8.pdf
Polyus reports in its 2009 Annual Report 77M ou of A,B,and C1 gold reserves. Polyus also reports international standard reserves, mesaured of 14M ou and 66.3M ou of indicated. (total 80.4M)
Note that measured means that the reserves exist with high certainty (90%) but are not yet proven, in so far that they have not been proven to be economically mined through a feasibility study and http://www.polyusgold.com/eng/news/reports/audit/
According to Polyrus' investor's relations, Natalka's mine life to 2073 (very large mine), average cash costs per ounce of $51.3 (should be very profitable)(this is the mine info). The mine will double Polyus' current output of 1.38M ou per year of gold towards 2020, in 2014 it will increase by 48%.
In comparison Barrick (market cap: $50.9Bn) produces 7.4M ou. Newmont (market cap $28.8M) produced 5.3M ou in 2009, reserves of 92 M ou.
Polyrus I'm not sure the market cap, one source is saying $10Bn, another around $5Bn -- it is really attractive at $5Bn. I will double check this.
You can find a comparison of the world's richest gold mines here: http://www.minefund.com/mineral-deposits/richest-deposits.php There are only 6 mines with reserves of 30M ou or above,and only 8 with total reserves of 20 M ou or above. Barrick does not own any of these top 8 mines, but has interests in many smaller mines -- it appears Barrick has consolidated many individual mines, to form the world's largest gold miner.
Natalka will come on-stream in 2013 - actually late 2013. The shares haven't moved up too much -- except for after the financial crisis.
Overall I can tentatively say that Polyus is comparable in size to Barrick, in so far that it is a major miner of gold (the Russian reserve show that Barrick has 80% more gold than Polyus) -- but the market cap of Barrick is far higher, $50Bn verses $10Bn. Of course this reflects geopolitical risk (mining in Russia) -- next steps would be to compare average costs per ounce -- it seems most gold miners would have higher than Polyus' cash costs since the mines will be located in many different locations (a single, large deposit will lower cash costs per ounce since the set up costs of the electricity, water, housing, roads, equipment etc can be depreciated over a longer mine life). Further next steps are to analyze political risk.
Frontier Gold: Is the Andewa Deposit Legit?
Frontier Resources (FNT.AX) has move from sub-..10 to mid .30's in a week -- the main reason is the announcement of exploratory drilling information at the Andewa prospect on the island of New Britain in Papua New Guinea.
Frontier has 7 deposits in Papua New Guinea - the main source of value is Andewa in the Island of New Britain- the firm is implying that there is gold deposits between 14 to 66 g/ton in this region which stretches for about 7 km, at a good seam -- in comparison Barrick Gold, the world's largest gold producer averages about 2 g/ton, so this would be 7-33x more concentrated.
Actually Frontier also has 2 projects in Tasmania, but again the best potential is the Andewa project in PNG. (actually the Bulago deposit is also promising, see below)
I sort of don't believe the numbers. I was searching through the world's richest gold mines and all have gold per ton numbers below 3 g/ton see:http://www.minefund.com/mineral-deposits/richest-deposits.php
This would be by far the most rich gold find in the database --well so far I've searched Barrick's deposits (in their annual report, and the Polyrus Gold (Russia) deposit which is #2 on the list and this averages 1.5 g./ton.
The newest release has some geological data but not nearly enough to establish reserve numbers - so far this is all in the beginning stages.
The firm is really small, having to raise capital even for exploratory drilling. (they had to raise $A1.1M to survey the region -- Frontier will certainly have to raise capital to develop the project. Actually the deposit looks like it is close to the coast, so could be served by water transport, see a map of the projects in the 2010 Annual Report, p. 3: http://www.frontierresources.com.au/
Previously in 3/10 Frontier announced another 67 g/ton deposit, this time on the main island of PNG, in the Bulago deposit, but this didn't generate much excitement -- I don't know why all of a sudden the latest report has really made the stock go off, but the previous ones did not. (more word of mouth, or a better geological survey, actually I don't know).
Anyway I'll be researching more and will try to find out if the find in legit.
Frontier has 7 deposits in Papua New Guinea - the main source of value is Andewa in the Island of New Britain- the firm is implying that there is gold deposits between 14 to 66 g/ton in this region which stretches for about 7 km, at a good seam -- in comparison Barrick Gold, the world's largest gold producer averages about 2 g/ton, so this would be 7-33x more concentrated.
Actually Frontier also has 2 projects in Tasmania, but again the best potential is the Andewa project in PNG. (actually the Bulago deposit is also promising, see below)
I sort of don't believe the numbers. I was searching through the world's richest gold mines and all have gold per ton numbers below 3 g/ton see:http://www.minefund.com/mineral-deposits/richest-deposits.php
This would be by far the most rich gold find in the database --well so far I've searched Barrick's deposits (in their annual report, and the Polyrus Gold (Russia) deposit which is #2 on the list and this averages 1.5 g./ton.
The newest release has some geological data but not nearly enough to establish reserve numbers - so far this is all in the beginning stages.
The firm is really small, having to raise capital even for exploratory drilling. (they had to raise $A1.1M to survey the region -- Frontier will certainly have to raise capital to develop the project. Actually the deposit looks like it is close to the coast, so could be served by water transport, see a map of the projects in the 2010 Annual Report, p. 3: http://www.frontierresources.com.au/
Previously in 3/10 Frontier announced another 67 g/ton deposit, this time on the main island of PNG, in the Bulago deposit, but this didn't generate much excitement -- I don't know why all of a sudden the latest report has really made the stock go off, but the previous ones did not. (more word of mouth, or a better geological survey, actually I don't know).
Anyway I'll be researching more and will try to find out if the find in legit.
Wednesday, February 9, 2011
If the economy doesn't grow, will it collapse?
An interesting question has been posed, mainly by pundits concerned with peak energy but also by economist and fund managers -- whether the economy will shrink dramatically if the economy does not offer the promise of growth. This subject or question can be rephrased in several ways, such as "if the economy doesn't grow, will it collapse?" or, as Bill Gross of PIMCO theorized in his August 2010 Investment Outlook "...Not only growth but capitalism itself depends on a growing population," as, Bill Gross states, that a growing population implies steady growth in consumer demand.
However, most articles on this topic state capitalism will collapse without higher demand in the future, without going into detail as to why. Why, in more depth, will shrinking demand -- and also importantly lower expectations of demand -- lead to dramatically lower GDP numbers? This is to say, why can't capitalism exist in a steady state (no growth)?
John Maynard Keynes would answer this question based on the relation of investment to consumption demand as components of GDP, as explained in Chapters 5 and 6 of his General Theory of Employment, Interest and Money. The largest component of GDP is consumer demand. In the US consumer demand ranges from a high 60% of total GDP to low 70%s of GDP. Investment ranges around 15% of GDP (the other parts of GDP according to GDP = C+ I + G +(E-I) are net exports and governmental spending, which total in the US approximately 15% of GDP).
The investment component of GDP is related to the consumption measure, in so far that businesses will not invest in new capital and equipment unless they expect a steadily increasing market (demand) for their products and services.
So, if the businesses expect future demand to be lower, they will dramatically cut back on investment - why would a business invest in more capacity if it doesn't expect to have higher sales? This means that the 15% of GDP represented by investment will drop significantly faster than the 70% of GDP represented by consumption. John Maynard Keynes referred to the attitude of businesses to invest famously as "animal spirits" -- this phrase was recently picked up by George Acklof and Robert Shiller in their book with the same title, published in 2009. (Keynes exact discussion of animal spirits argued for a non-rational contemplation of future investment, verses other schools of economics that argued that investment was rational, but for this purposes of this post, we will not go into detail on this, the discussion however is important for implications on the future equilibrium of aggregate demand and aggregate supply in terms of GDP)(and actually is a bit beyond the understanding of the author :).
A Malthusian version, where peak energy or peak food results in high prices and therefore lower consumption, would also impact future investment, and also carry a re-enforcing cycle between consumer demand and investment (however the details of the exact transmission mechanism from higher prices to investment could be different than expectations of lower demand from for example higher saving rates, which is not analyzed here, in so far peak energy would be a production issue, not at first a demand issue).
The relation between investment and consumer demand can be explained as a self-reinforcing cycle. We can see many examples of re-enforcing cycles in nature, such as theoretically higher temperatures, which melt snow caps, which then do not reflect as much solar radiation, which then leads to higher temperatures, which further melts snow caps etc (this is theoretically proposed by scientists such as the late Steven Schneider of Stanford University). In a GDP measure, lower consumption could reinforce a lower investment, which in turn could reinforce lower consumption, leading to a downward cycle which means significantly lower GDP at the final equilibrium.
The idea here is relevant in so far that sustained declines to consumer demand, from a declining population (in Bill Gross's concerns, outlined above) to lower levels of consumer credit, to deleveraging of consumer debt, to average declines in expenditures from declining capital gains from property, can all lead to significantly lower GDP than at first calculated based on reduction in demand, through the relationship of demand with investment.
The analysis appears to be supportive of emerging economies such as China and Brazil (at first glance) in which businesses are more confident of future demand, in terms of a positive, self-reinforcing cycle between consumer demand and investment by business. (both Petrobras and Vale of Brazil have announced record breaking investment budgets for 2011 and beyond, for example at over $US70Bn and $US20Bn, respectively).
However, the analysis does not initially (in the author's opinion) support slower growth economies that are deleveraging, such as many EU countries, and the US. Businesses in the US and certain countries in the EU may not be as confident of future demand increases, due to deleveraging of consumers in these countries, and other factors.
As a final note, this relation of demand and investment explains some rational of John Maynard Keynes insistence on governmental, stimulus spending, which would find its way, through Keynes' multiplier (which is incidentally currently being debated in the economics profession, in terms of its size and impact on the overall economy), which, in turn, would support demand and then support investment, as businesses would be more likely to invest in an expanding economy.
However, most articles on this topic state capitalism will collapse without higher demand in the future, without going into detail as to why. Why, in more depth, will shrinking demand -- and also importantly lower expectations of demand -- lead to dramatically lower GDP numbers? This is to say, why can't capitalism exist in a steady state (no growth)?
John Maynard Keynes would answer this question based on the relation of investment to consumption demand as components of GDP, as explained in Chapters 5 and 6 of his General Theory of Employment, Interest and Money. The largest component of GDP is consumer demand. In the US consumer demand ranges from a high 60% of total GDP to low 70%s of GDP. Investment ranges around 15% of GDP (the other parts of GDP according to GDP = C+ I + G +(E-I) are net exports and governmental spending, which total in the US approximately 15% of GDP).
The investment component of GDP is related to the consumption measure, in so far that businesses will not invest in new capital and equipment unless they expect a steadily increasing market (demand) for their products and services.
So, if the businesses expect future demand to be lower, they will dramatically cut back on investment - why would a business invest in more capacity if it doesn't expect to have higher sales? This means that the 15% of GDP represented by investment will drop significantly faster than the 70% of GDP represented by consumption. John Maynard Keynes referred to the attitude of businesses to invest famously as "animal spirits" -- this phrase was recently picked up by George Acklof and Robert Shiller in their book with the same title, published in 2009. (Keynes exact discussion of animal spirits argued for a non-rational contemplation of future investment, verses other schools of economics that argued that investment was rational, but for this purposes of this post, we will not go into detail on this, the discussion however is important for implications on the future equilibrium of aggregate demand and aggregate supply in terms of GDP)(and actually is a bit beyond the understanding of the author :).
A Malthusian version, where peak energy or peak food results in high prices and therefore lower consumption, would also impact future investment, and also carry a re-enforcing cycle between consumer demand and investment (however the details of the exact transmission mechanism from higher prices to investment could be different than expectations of lower demand from for example higher saving rates, which is not analyzed here, in so far peak energy would be a production issue, not at first a demand issue).
The relation between investment and consumer demand can be explained as a self-reinforcing cycle. We can see many examples of re-enforcing cycles in nature, such as theoretically higher temperatures, which melt snow caps, which then do not reflect as much solar radiation, which then leads to higher temperatures, which further melts snow caps etc (this is theoretically proposed by scientists such as the late Steven Schneider of Stanford University). In a GDP measure, lower consumption could reinforce a lower investment, which in turn could reinforce lower consumption, leading to a downward cycle which means significantly lower GDP at the final equilibrium.
The idea here is relevant in so far that sustained declines to consumer demand, from a declining population (in Bill Gross's concerns, outlined above) to lower levels of consumer credit, to deleveraging of consumer debt, to average declines in expenditures from declining capital gains from property, can all lead to significantly lower GDP than at first calculated based on reduction in demand, through the relationship of demand with investment.
The analysis appears to be supportive of emerging economies such as China and Brazil (at first glance) in which businesses are more confident of future demand, in terms of a positive, self-reinforcing cycle between consumer demand and investment by business. (both Petrobras and Vale of Brazil have announced record breaking investment budgets for 2011 and beyond, for example at over $US70Bn and $US20Bn, respectively).
However, the analysis does not initially (in the author's opinion) support slower growth economies that are deleveraging, such as many EU countries, and the US. Businesses in the US and certain countries in the EU may not be as confident of future demand increases, due to deleveraging of consumers in these countries, and other factors.
As a final note, this relation of demand and investment explains some rational of John Maynard Keynes insistence on governmental, stimulus spending, which would find its way, through Keynes' multiplier (which is incidentally currently being debated in the economics profession, in terms of its size and impact on the overall economy), which, in turn, would support demand and then support investment, as businesses would be more likely to invest in an expanding economy.
Tuesday, July 29, 2008
What is Going On in the Oil Markets? OPEC Appears to be in Control
Oil prices are generally very volatile, but this year has been an exceptional roller coaster. What is going on in the oil markets currently? Note that over the long term, oil prices tend to be determined to a greater degree by fundamental factors (supply and demand) verses technical factors (financial speculation). This article will focus on fundamental factors, making the assumption that supply and demand factors fundamentally determine oil prices.
In the author's view, the effective consensus view on oil prices from approximately 2002 onward prior to July, 2008, was that demand would increase significantly going forward, while supply would stagnate, leading to continued high, and even higher, oil prices. The new "market consensus" since the beginning of July 2008, appears to be, in the author's opinon: slightly higher supply (we are finally seeing a supply response) and only slightly higher demand (developed countries' oil consumption will go down, developing countries oil consumption will go up, but at a lower rate). The new consensus appears to imply a slightly higher supply than demand, going forward, resulting in significant downward pressure on the current and future price of oil.
The reassessment since July 2008, has mainly been driven by two new pieces of information, which are being digested -- world supply in the past few months increased, albeit slightly (by approximately 500,000 bpd from a world average production of 86M bpd, also note that exportable oil has so far not shown increases in supply), and total world consumption slowed significantly, driven mainly by consumption declines in the United States (offset by continued consumption in the developing world, mainly China).
It is argued in this article that this new, as of July 2008, "market consensis" is not exactly accurate -- the supply response in 2008 is not a fundamental change regarding future production, due to the fact that all the increased supply in 2008 has been from OPEC countries, who have an interest in relatively high oil prices. But the demand response in 2008 is likely a fundamental change, meaning that world oil demand will likely slow significantly going forward. The new market consensus is therefore close on demand, but off on supply. If supply is actually being effectively controled by OPEC, but demand is moving at a lower rate, the net result will likely be current pressure on the oil price, but a long term, supported reletively high oil price, in line with OPEC's interests (note OPEC has stated that they are comfortable with long oil prices around $100, if over the short term in the $80's).
The risk to the author's view of the current oil situation -- which is can be summed up by the title "OPEC controling prices" -- is a worldwide economic recession and/or a very large conservation movement in both developing and developed countries, that decreases demand to a higher degree than OPEC effectively can cut supply. In this case, the price of oil would decline significantly.
In the author's view, the effective consensus view on oil prices from approximately 2002 onward prior to July, 2008, was that demand would increase significantly going forward, while supply would stagnate, leading to continued high, and even higher, oil prices. The new "market consensus" since the beginning of July 2008, appears to be, in the author's opinon: slightly higher supply (we are finally seeing a supply response) and only slightly higher demand (developed countries' oil consumption will go down, developing countries oil consumption will go up, but at a lower rate). The new consensus appears to imply a slightly higher supply than demand, going forward, resulting in significant downward pressure on the current and future price of oil.
The reassessment since July 2008, has mainly been driven by two new pieces of information, which are being digested -- world supply in the past few months increased, albeit slightly (by approximately 500,000 bpd from a world average production of 86M bpd, also note that exportable oil has so far not shown increases in supply), and total world consumption slowed significantly, driven mainly by consumption declines in the United States (offset by continued consumption in the developing world, mainly China).
It is argued in this article that this new, as of July 2008, "market consensis" is not exactly accurate -- the supply response in 2008 is not a fundamental change regarding future production, due to the fact that all the increased supply in 2008 has been from OPEC countries, who have an interest in relatively high oil prices. But the demand response in 2008 is likely a fundamental change, meaning that world oil demand will likely slow significantly going forward. The new market consensus is therefore close on demand, but off on supply. If supply is actually being effectively controled by OPEC, but demand is moving at a lower rate, the net result will likely be current pressure on the oil price, but a long term, supported reletively high oil price, in line with OPEC's interests (note OPEC has stated that they are comfortable with long oil prices around $100, if over the short term in the $80's).
The risk to the author's view of the current oil situation -- which is can be summed up by the title "OPEC controling prices" -- is a worldwide economic recession and/or a very large conservation movement in both developing and developed countries, that decreases demand to a higher degree than OPEC effectively can cut supply. In this case, the price of oil would decline significantly.
Oil Prices: Dominated by OPEC Currently
There have been notable developments on both the supply side and the demand side in 2008 in the oil markets -- namely, there is a small overall supply increase in total oil and condensate production in 2008, and on the consumption side, most notabily, oil consumption in the overall world has increased only very slightly (under 500,000 barrels per day) -- with a surprising 5% decline in 2008 in the United States, the world's largest oil consumer, for the past three months (May, June and July).
On the supply side, OPEC is engineering this supply increase, by removing all restrictions by members towards oil production by OPEC members in 2008. The removal of OPEC production quotas, (by a senior OPEC official, reference) has not been reported widely in the media. The king of Saudi Arabia stated in July 2008, that he is "very disappointed" by the increase in the price of oil. This move has been initiated by OPEC in order to support the flagging OECD economies by lowering oil prices, and alleviate pressures on the developing world's economies, according to comments by OPEC officials.
"Prices will continue to soar as the economy flourishes because energy is a vital resource in development. Thanks to the Almighty, our region has a strong oil reserve that can meet future demands."
The apparent paradox of King Abdullah wanting to increase production while supporting a reletively higher price of oil can be solved by Abdullahs observation that (from the July 2008 interview) that: "Our enthusiasm to protect the interests of the international community, in terms of oil, is on par with our eagerness to protect national interests."
It should be noted that since about 2005
"OPEC's unity may keep oil from dropping below $50 a barrel for years to come, energy experts say.``They've learned their lessons,'' said Daniel Yergin, author of the Pulitzer-winning history of the oil industry, ``The Prize: The Epic Quest for Oil, Money & Power.'' ``They like this band from $50 to $60 and they prefer the upper part of the band rather than the lower part,' `We are happy with the level of compliance,'' Mohamed al- Hamli, president of the Organization of Petroleum Exporting Countries, said in an interview in
Further, OPEC has currently removed all restraints on oil production from all countries. OPEC has lifted all quotas as of early 2008 on OPEC production due to the run up in oil prices which threatens the world economy.
"A senior OPEC delegate said Monday that OPEC ceilings and quotas had become largely irrelevant and that OPEC had a "tacit" understanding that those members capable of boosting crude production should supply as much oil as world oil markets needed."
With OPEC producing all out, we get a very small move up in overall oil production. (which actually can be interpreted as a reason for long term concern in terms of oil productive capacity for the world as a whole over the long term -- does OPEC really have potential for significant future output increases if maximum current output increases total output by less than 1 million barrels?)
Which other countries besides SA can increase oil production and oil exports significantly with a moderate probability over the intermeidate term? Almost without exception, they are OPEC member countries. Of non SA production, the two main countries with the most potential are
Note that non-OPEC production is flat, without significant prospects for increases over the intermediate to long term, according to IEA (International Energy Agency) president Faith Birol. The most notable current development is the fact that Mexican oil production declined at over 30% last year without prospects for reversal of that decline this year (that is to say, is continuing to decline at near 30%) and
In summary, overall, on the supply side, the current supply increase is likely a deliberate response by OPEC, and it is likely future supply increases are controlled by OPEC. Going forward, without significant world "demand destruction," it is likely OPEC will continue to move to support a long term, relatively high price of oil.
What is Occurring With Demand? Real Demand Destruction in Developed Countries, Developing Countries Still See Demand Increases
The key question on the consumption side: is it possible that overall consumption of oil can decline going forward? This would require, in the developed world, continued declines year to year. Further, this would require, in the developing world, oil consumption to increase little or not at all.
One more "risk" to the above theory, that OPEC controls the intermediate price of oil. Can the world move away from oil use in the intermediate term, without economic impacts? It is noted that demand in the United States dropped by approximately 5% so far in 2008, Denmark's oil demand peaked back in 1998, and Japan's oil demand hasn't moved significantly since the 1980's, despite economic growth there (more specifically, in Japan, economic growth in the 80's, followed by stagnation in the 90's).
Proposed:
- lower oil consumption is related to either 1) lower rate transport of goods and persons and/or 2) more efficient transport of goods and persons. 1) is more correlated with lower economic activity (recession), while 2), efficiency, is more correlated by mass transport -- both
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