Monthly Archives: February 2015

the US Employment Situation, January 2015

February 6, 2015 By in economics, employment, Employment Situation report Tags: , , , , , Leave a comment

the best laid plans…

I’d intended to write about the oil industry today, no matter what the results of the monthly Bureau of Labor Statistics monthly Employment Situation report released this morning.  How good/bad could it be?, I thought.  If anything, there might be a negative impact from layoffs in the oilfields.

Turns out, the January 2105 ES is really good, so I’m writing about that instead.  Different varieties of oil stocks on Monday.

large job gains

The economy added 257, 000 jobs in January, +267,000 in the private sector and -10,000 in government.  That’s significantly more than economists had been forecasting, although I’ve come to think that forecasters don’t tend to put their best efforts into coming up with these numbers.  It’s also the latest in a long string of  monthly gains that are way above the +125,000 or so needed to absorb new workers leaving school and entering the workforce for the first time.

very large positive revisions

More important, the revisions to prior months’ job gain estimates are positive   …and enormous.

November 2014 new positions were originally reported as +321,000.  That figure was revised up to +353,000 last month.  The just-released final figure is +423,000.

December 2014 new positions were reported as +252,000.  That has been revised up this month to +329,000.

Add revisions to the January new job total and the economy turns out to be employing a whopping 404,000 more people than we thought a month ago.

unemployment rate up

The unemployment rate rose slightly in January to 5.7%, despite the jobs gains.  That’s because the labor force grew by over a million workers during the month.  This is also good news.  It implies that large numbers of unemployed people who had stopped looking for work–and thus dropped out of the workforce–now think there’s a good chance they can find a position and are back job hunting again.  The return of discouraged workers is another positive sign that had been missing up until now in the rebound from recession.

salary news still mixed

Wages grew by 2.2% over the past year.  December had shown a drop of $.05 an hour in average wages; January recovered that and added another $.07 to $24.75.

So far S&P 500 stock index futures have gained about six points in the pre-market–a tepid, but positive, response.  I think this news deserves better.

effects of lower oil prices

February 5, 2015 By in Energy, Industry Analysis, Mining, oil and natural gas, shale oil, shale oil and gas, Strategy Tags: , , , , , , , 2 Comments

At $50 a barrel oil vs. $100 a barrel:

1.  High-cost alternatives hydrocarbon like liquefied natural gas (LNG), where projects require billions of dollars in spending on infrastructure–cryogenics at the wellhead, special refrigerator ships for transport–become much less compelling.  Tar sands, too.

2.  Green energy substitutes like wind and solar, which already require heavy government subsidy to encourage adoption, are less attractive, as well

3.  The real asset value of oil companies is in their proved reserves.  A lower price hurts this value in two ways.  The first is the obvious one, that the selling price of output is lower.  But there is a second.  In order to be counted as reserves, barrels of oil must be economically recoverable at present prices.  So quantities may shrink, too, as the price declines.  One can imagine, say, a tar sands company that has one hundred million barrels of reserves worth $20 billion at a $100/bbl price   …but 0 barrels worth $0 at a $40 price.

4.  The natural gas price in the US has fallen, but not by a much as oil.  This puts US petrochemical plants, which use natural gas as a raw material, at a relative disadvantage vs. their European and Asian counterparts that use naphtha, a petroleum product.  In absolute terms, the US companies are still in better shape, but to the extent that their historical price advantage has long ago been factored into stock prices, their equities have been relative underperformers.

5.  I spent six years as an oil analyst, covering both the big internationals and domestic explorers, and another while managing an Australian portfolio at a time when over half the market consisted of natural resources stocks.

Admittedly, my expertise is dated.  Nevertheless, some things don’t change.  Hearing and reading Wall Street “experts” on oil publicizing their opinions, I’m struck by how much loss of basic knowledge about the oil industry there has been within the investment community over the years.  This really shouldn’t be so surprising.  I’ve seen the same phenomenon in the mining industry.  In both cases, there have been very long stretches of time when the relevant stocks have been dormant and, consequently, it has been very hard for a sector specialist to make a living selling his analysis.

More on industry sub-sectors tomorrow.

 

oil: how the price dynamic has changed

February 4, 2015 By in Current Market Thoughts, Energy, Industry Analysis, oil and natural gas, shale oil, Strategy Tags: , , , , , , , Leave a comment

Value Line vs. O”Neil

My first Wall Street job was with Value Line, a firm which has seen better days but which dominated the retail market for investment information in the 1970s – 1980s.  It still publishes the Value Line Investment Survey, a newsprint weekly that over a 13-week cycle provides historical data, analyst commentary (generally not good nowadays) and a computer-generated comparison of relative investment attractiveness (based on PE and earnings growth) for a universe of around 1800 stocks.  As I recall, the Survey cost about $250 a year back then and had about 80,000 subscribers.

Analysts and portfolio managers who worked for the company couldn’t understand why the price was so low.  We all thought the publication should sell for at least double the going price.  Since the main costs of publication were for printing and postage (sadly, not for salaries), the company could triple or quadruple its profits by charging $500.  The publication was surely worth it.  Yet the firm’s owner adamantly refused to budge.  A real head scratcher.

Then we found out why.

A rival emerged in the form of William O’Neil and Company, a suppliers of very detailed price charts and other technical information to individuals and institutions. O’Neil launched a chart-based weekly service covering the same universe of stocks, cpriced at $125 a year.  No analysis, but similar historical data, loads of technical information and highly detailed charts that put Value Line’s to shame.

The publication lasted about a year and then folded (I Googled O’Neil just before writing this.  The firm appears to have revived the idea and to now be selling a similar service.  I didn’t investigate, though.)

Why?

I remember figuring at the time that O’Neil needed at least 5,000 subscribers to be cash flow positive (this was a long time ago, so my numbers may be way off.  Their accuracy isn’t necessary for my point, though.).  If it got there, it could gradually add features and increase marketing   …and start to grow itself into a serious competitor to Value Line.  O’Neil couldn’t get north of 2,000 with its service, however, and quickly got tired of bleeding red ink.

Suppose the VLIS had been priced at $500 instead of $250?  O’Neil could have priced his service at, say, $250   …or even $350 and still offered a generous discount.  At 2,000 subscribers he would have been in the black–and growing into an increasingly sharp thorn in Value Line’s side.

The clear economic response to this development would have been for VL to cut its price to $250 to make O’Neil unviable.  But that would have been psychologically very hard to do.  It would have created internal morale problems as belt-tightening took hold.   And it might also draw the attention of the Justice Department.  Waiting two or three years, hoping (in vain) for the competitive dynamic to change, would only compound the problem.

pricing umbrella

That was my introduction to the concept of a pricing umbrella, the idea that high margins creates a fertile, sheltered environment in which competition can grow.

why it’s bad

Two negative consequences:

–competition can gain critical mass, and

–even if it can’t, if newcomers have made significant capital investment they will continue to operate–at a loss–to extract whatever cash they can from their failing businesses.

OPEC’s umbrella

More or less, this is the messy situation that OPEC has created in the oil market.

Under the protection of a $100 a barrel price, unconventional, technology-based competitors have emerged, mostly in the US so far.  This happened about half a decade ago.  The newcomers were initially able to extract oil profitably at $80 a barrel (as opposed to less than $10 for Saudi Arabia).  But they’ve improved their techniques to the point that many can make money at $40.

results of the oil price halving

In the near term, highly financially leveraged high-cost oil producers will be forced by their creditors to stop spending on new projects.  They will continue to produce from existing wells until they run dry, however.  It’s just that all their cash flow will be devoted to repaying debt.

The long-term problem for OPEC is that the new technology–whose development high prices stimulated–won’t go away.  As/when prices rebound to, say, $60 a barrel, hydraulic fracturing will begin to expand aggressively again.  I think shale oil output will rise relatively quickly, as solvent oil development firms take over in-the-ground infrastructure left idle by their bankrupt brethren.

At some point, the oil price will bottom.  I don’t know whether that point is now or not, but I’ve been thinking that something like $40 a barrel will be the floor.  On the other hand, I don’t see the market returning to the status quo ante within any reasonable amount of time.

How this affects oil stocks tomorrow.

what the utility “death spiral” is

February 3, 2015 By in Industry Analysis, Utilities Tags: , , , Leave a comment

I’ve been hearing and reading a lot lately about a potential electric utility “death spiral.”  So I thought I’d write, in simplified terms, what this is all about (by the way, the Economist magazine has an excellent recent survey of the electricity generating industry worldwide).

utility 101

Governments have generally decided that capital-intensive public service businesses, like provision of water, electric power, natural gas shouldn’t be open to all potential entrants.  Instead, the government chooses a single provider.  In return for being awarded a monopoly in a given service area, the company in question agrees to government regulation of its charges.

For every utility I know of (cable tv being, arguably, an exception), regulation takes the form of limiting the utility to a maximum allowed return on its net investment in plant and equipment.  Net here means after subtracting accumulated depreciation charges.  In most countries, the return is set annually.

setting rates

The rate fixing process boils down to this:

–the government utility regulator specifies an allowed return on plant for a given year, say 5%.  If the utility has net plant and equipment of $40 million, the  total allowed profit is 5% of that, or $2 million.

–the utility submits an estimate of the number of units it will sell in the coming year and what the cost per unit will be.  Let’s say it figures it will provide 20 million units to customers and that it will cost $.20 a unit to do so.  The utility is allowed to add a profit element (i.e., $2 million/20 million units = $.10 a unit) to its costs to arrive at the total per unit charged to customers.  In our case, this is $.30/unit.  [The reality is a little more complex:  bulk customers or industrial users who agree their service can be interrupted in periods of peak usage may get discounts; peak period users may be charged a premium.  That doesn’t make a difference for the “death spiral,” though.]

electricity

Let’s say the service in question is electricity.  Let’s also say the population is stable (there’s a life cycle aspect to utility profits, but that’s another wrinkle we won’t worry about yet).

the spiral begins

Over time, people buy appliances that conserve power.  New construction is better insulated, so air conditioning doesn’t have to run so much.  New light bulbs run cheaper.  Home power monitoring systems optimize and reduce electricity consumption even more.  On top of this, responding to government subsidies, some people put solar panels on their roofs.

Suppose all of that cuts electricity usage in the service area by 20% (very high, but just to make the point), to 16 million yearly units.

The new calculation of the electricity company per unit profit becomes:  $2 million/16 million units = $.125/unit.  The per unit charge becomes $.325, or 8% higher than before.

The 8% increase causes more people cut their power consumption, either by investing in new, less power-hungry devices, finding substitutes (those solar panels no longer look quite so ugly) or simply by heating/cooling the house less.  Let’s say the price response reduces annual demand in the service area to 14 million units.

What happens at the next annual price setting?  The new per unit allowed profit is:  $2 million/ 14 million units = $.143/unit.  So the cost of electricity rises by another 5.5% to $.343.

That causes another round of conservation/substitution   …which drives the per unit charge even higher   …and prompts another round of conservation.

That’s the death spiral.

Is it real?  Maybe in some places in the EU.  In the US it seems to me there’s a tipping point out there someplace that we haven’t yet reached.  I don’t spend time dreaming about my next utility stock purchase, however.

other stuff

If the service area is growing, with new customers arriving every day, the potential problem is a worry for the distant future.  If the service area is shrinking, on the other hand–like if retirees are departing for warmer/cheaper climes–the issue is on the table today.

From an investor point of view, two further non-death spiral complications:

–when the service area matures, the regulator typically sees no further need to maintain a high allowable return on plant to make raising new capital easier, so the return percentage is pared back

–without new capital spending, net plant shrinks as accumulated depreciation …well, accumulates.  This is another minus for mature service areas, since smaller net plant = smaller allowable profit.

Both of these factors mitigate the spiral effects.  Neither makes the utility in question prettier to Wall Street eyes.