Taipan Online: Hotline

One month after Memorial Day marked the official start of the summer, Americans are braced for another summer season of gasoline price pressure. The national average price per gallon sits at around US$2.20.

Then, up pops T. Boone Pickens, director of the BP Capital Management hedge fund. Armed with a can of fuel, he pours it straight on to the fire.

At the time, the fellow had no idea that a devastating hurricane would destroy much of the Gulf Coast and leave New Orleans flooded and in ruins – so perhaps his prophecy should be marked with a big, fat asterisk.

Pickens stated that Americans would be paying US$3 for a gallon of gasoline “within a year.”

As it turns out, that was one heck of a conservative prophecy.

The fallout from the hurricane has wreaked total havoc with the oil market and gasoline costs. If Americans were grumbling about gas prices back then, many are positively livid today, amid widespread rumors of unscrupulous price gouging.

Considering I’ve been in England since August 25, it’s tough for me to say with absolute clarity whether this is true or not. What I will say is that my friends and colleagues back in Baltimore have told me about enormous lines at gas stations, deep fluctuations in price between gas stations located mere miles apart and of prices rising so fast that stations can’t even keep up with the cost posted on the boards outside. Gasoline prices in Atlanta ballooned to over US$5 a gallon. Hmm…sounds like some funny business to me.

But consider the statistics:

The Gulf region is responsible for about one quarter of America’s oil and gas production (1.5 million barrels of oil per day and 12.3 billion cubic feet of gas).

And with operations at many of the region’s refineries suspended and 40% of production shut down in the immediate aftermath of the hurricane, it’s hardly surprising that crude oil prices wasted little time in leaping to US$70 a barrel and higher, as traders hedged their bets on the “buy now, profit later from existing strong demand and very tight supply” theory. Heating oil costs also lurched past US$2 per gallon, while natural gas prices leapt a massive 20%.

All told, this hurricane season has wiped out about six million barrels of crude oil production and there’s no telling how long Gulf oil and gas production will take to get back up to full speed.

Even before the hurricane hit, Energy Information Administration figures showed the forward-looking 21-day supply at the lowest in two years.

“SUPER SPIKE?”

Quoted in USA Today, Red Cavaney, CEO of the American Petroleum Institute, predicts a “significant and protracted” gasoline crisis, with the consensus being that prices will climb and settle at a national average of around US$3 per gallon. But that could easily be a conservative estimate. Some projections are closer to US$4. Yikes. Glad I’m within walking distance of the office.

But what do others do? Stashing the car in the garage for months and suspending your life isn’t an option. So as unappetizing as it is, many folks simply won’t have much choice but to pay those costs.

But here’s another question: How? With many Americans already spending more than they earn and saddled with a boatload of debt, thanks to the credit culture and paycheck-to-paycheck lifestyle, there are going to be some seriously stretched wallets across the nation. Even worse…the personal savings rate crashed to its lowest level since 1959 in July. It’s arguably the case that assets like housing and financial portfolio appreciation are creating wealth – or at least making some Americans feel wealthier and might dull the pain of rising pump prices.

Although the Gulf region accounts for one third of America’s oil and one fifth of the country’s natural gas, Philadelphia Fed president Anthony Santomero brushes off the effects of the storm, blithely saying the Fed can still pursue its “measured pace” interest rate policy because the economy is big enough to withstand the aftermath.

Maybe. But tell that to folks paying out the wazoo for gasoline.

As an aside, if you think gas prices are high in the US, spare a thought for my poor fellow Brits over here, where pump prices are more than double what they are in the US.

Over the past few days, the national average price for a liter of “petrol” has risen by two pence to a shade over 94.

Let me break that down for you in terms of gallons. There are approximately four liters in a gallon. That means a gallon costs about 376 pence, or £3.76. At the current exchange rate, that’s US$6.93 per gallon.

With just one of the eight refineries in Louisiana and Mississippi online again and 80% of Gulf oil production still suspended, little relief is in sight for American and British drivers.

I should note that a massive 47 of that 94 pence per liter disappears into government coffers by way of “excise duty” (i.e. taxes). VAT (value added tax) accounts for another 13p. Just 23p goes towards production costs.

Needless to say, there are some bitter motorists over here. The RAC Foundation is calling on Chancellor Gordon Brown to introduce a system that reduces petrol taxes if crude oil prices hit a certain level. Yeah, big chance of that! Since 1995, petrol prices have doubled, but the amount of tax per liter has dropped from 73% to 66%, which suggests that rising oil prices account for the bulk of price inflation.

But I digress…

IT’S THE SUPPLY, STUPID

But there’s something else at work now, too. With refinery production curtailed and transportation problems afflicting a vast area of the Gulf Coast region, supply disruptions, not demand, have caused the latest gasoline spike. As my colleague Brit Ryle notes: “That supply shortage necessarily means that demand will now fall, at least a little. So when refiners get back on line and gasoline is plentiful, prices will come down because of the increase in supply.

“And new supply is what we need. Exxon estimates there are 7 trillion barrels of heavy oil, oil sands and shale-oil reserves in the world. Cambridge Energy Research Associates forecasts a 7-million-barrel-a-day surplus by 2010. Of course, only time will tell if there’s any merit to claims such as these, but maybe it’s the possibility that current supply and demand dynamics are transitional that keeps oil traders’ trigger fingers itchy.”

This comes as global energy consumption is already at a 20-year high.

But don’t panic. According to BP, the world’s second-largest oil and gas company, we’re not running out of energy resources just yet. The group says the world has enough oil to last at least another 40 years, while current gas reserves should last until 2071 and coal resources for another 164 years. With increased investment and new technologies, those figures could rise, according to BP’s chief economist Peter Davies.

Davies is also the fellow behind BP’s Statistical Review of World Energy 2005, which says global energy consumption rose 4.3% last year - the biggest-ever jump in volume and the largest percentage growth since 1984. The figure was higher than the ten-year average in every world region.

The soaring usage is hardly surprising, given America’s higher energy demand and that from rapidly growing economies like China, India, South Korea, Chile, Argentina, Malaysia and Singapore. Several of these countries are heavily dependent on oil imports to drive their economic growth.

Take China, for example. Last year’s blockbuster GDP growth of 9.5% was largely possible because of a hefty 15% spike in energy consumption. BP reports that since 2001, China’s energy demand has ballooned by a huge 65% and now accounts for almost 15% of total global demand.

WANT SOME WAFFLE? TRY OPEC

So it seems odd that with all those countries’ demand doing nothing but rise, the OPEC oil cartel trumpeted “a slightly more optimistic view of the world economy for the coming year” just one month ago.

How lovely. Trouble is…OPEC’s “slightly more optimistic view of the world economy” isn’t actually very optimistic at all - at least not according to its latest demand estimate. The group forecasts that global oil demand next year will rise by about 1.6 million barrels per day (bpd) - an upward revision of 30,000 bpd.

Unsurprisingly, the US will lead the way, with China accounting for one-quarter of the world’s demand. In anticipation, OPEC already plans to crank out one million bpd day more in 2006. But the boys are going to have to produce more oil than originally thought because production from non-OPEC nations is expected to be lower than forecast. Good job crude production climbed 3.4% last year - the highest rate since 1978.

AMERICA’S GAS PROBLEM

Unfortunately, BP’s rather bullish forecasts above can’t hide the grim reality that heating oil prices this winter are set to squash the budgets of many consumers.

A report in USA Today says that as oil prices and supply concerns rise, heating oil prices in New York alone have leapt 60% from a year ago. That’s on top of last winter, when average heating oil costs jumped 30% to US$1,200.

WHAT NEXT FOR U.S. ECONOMY? DO I HEAR 3%?

On a wider scale, the disaster has obvious and far-reaching implications for the US economy. But despite Hurricane Katrina’s devastation, it’s important to remember that the economy had thankfully built up a decent head of steam. Second-quarter GDP growth rolled in at 3.3%, a pretty healthy level under trying circumstances.

Before the hurricane struck, the economy had been expected to grow by a healthy 3.5% this year. But with energy prices already rising fast beforehand (now exacerbated in the aftermath) and August’s job report showing a lower-than-expected 169,000 new jobs, GDP is likely to take a hit.

For example, what does the US economy do about the many destroyed businesses and thousands of displaced workers throughout the South? The lost consumer spending? The lost tourism revenue in places like New Orleans? With damages expected to total more than US$100 billion, some economists are already hustling to revise down third-quarter GDP estimates.

Don’t be fooled. The recovery and repair efforts won’t “stimulate the economy,” as some giddy economists would have you believe. Yes, some companies (construction, utilities, etc.) might beef up their bottom lines, and it will take a huge amount of manpower to restore the place. But there’s no way this will replace lost business activity, corporate wealth, personal assets, consumer spending and tourism revenue. Remember, this is not necessarily new economic growth or new money being created - it’s simply a matter of replacing the enormous amount of economic activity and wealth lost in the hurricane. So anyone who trumpets any kind of positive economic spin for the region is really only clutching at straws.

The economy is big and robust enough to withstand major shocks, as it has done many times before. Besides, we live in a truly global economy these days, which will help pick up some slack for a while until the South gets back on its feet. But in the meantime, it will mean some short-term pain. You could see 0.5% sliced from GDP and 3% full-year GDP growth.

SELL YELL

The hurricane has unfortunately claimed a victim in the Taipan portfolio. Ian Cooper tells me that “while Chinese transport firm Yellow (YELL:NASDAQ) has yet to hit our -25% stop loss, we’re not going to sit around and wait for it to do so.

“If you remember, YELL was Chris DeHaemer’s play on falling oil prices in the August Taipan issue, so if you bought it then, sell it now.

“The company just lowered guidance for the quarter, citing ‘disruptions caused by Hurricane Katrina and problems integrating new procedures at its Roadway Express division.’ A third quarter earnings range of US$1.40 to US$1.45 is now expected – below earlier estimates calling for a range of US$1.60 to US$1.65.”

“But it’s not all bad. Chris is also recommending you hold your position in Chinese Internet firm Netease (NTES:NASDAQ). First recommended back on August 27, 2004 at US$35.88, it closed Friday at US$76.86 – a 114% gain in just over a year.”

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Enjoy your weekend.

Martin Denholm

Executive Editor, Taipan

P.S. Late-Breaking Profit Update from Ann Sosnowski over at the WaveStrength Group:

“Beer got a nice push Thursday and Friday, after football season started. I watched the Patriots and Raiders battle it out on Thursday night and kept track of how many Anheuser-Busch Companies Inc. (BUD:NYSE) commercials I saw as opposed to Molson Coors Brewing CLB (TAP:NYSE) commercials.

“I counted at least four BUD commercials in the first half of the game, not including all of sponsorships peppered between.

“I counted two TAP commercials (which I think were more entertaining!) After halftime and one endorsement of TAP as the official NFL sponsor.

“If you’ve read your September Taipan issue, you’ll know that I recommended a position in TAP stock, as well as some longer-term call options. This was based on the premise that as the official sponsor of the NFL, their stock would naturally rise with the start of the football season.

“So far, so good. Right now, you should be sitting on options gains of 24.24% and a stock gain of 4.26% in a little over a week. TAP’s call options rose US$0.30 on Friday alone!”

MMM

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