Tag Archives: China

why the oil price will continue to be weak

October 22, 2014 By in Energy, Industry Analysis, Mining, oil and natural gas, Recent Market Action, shale oil and gas, Strategy Tags: , , , , , Leave a comment

supply and demand

In the short term (read:  for now and for some vague time into the future), demand for oil is pretty constant, no matter what the price (i.e., demand is inelastic).   People need to fuel their cars and heat their homes.  Industry needs to generate electric power and keep factories humming.

The supply of oil is similarly inelastic, for two reasons:

–major oilfields are mammoth, expensive, multi-year capital projects.  Engineers get underground oil flowing toward wells at what they calculate to be the optimal rate to drain the entire deposit.  Changing that rate once the oil is moving can mess things up so that lots of oil gets left behind–meaning having to do expensive and time-consuming extra drilling to recover it.

–a macroeconomic look at OPEC’s oil-producing countries, especially in the Middle East, is a real eye-opener.  These nations typically have large young populations and more or less no economic activity other than oil.  In my cartoon-like view, they have tons of high school graduates entering the workforce each year and nothing to offer them but make-work “jobs” funded by oil money.  Keeping the political status quo ultimately requires that the oil keep flowing.  According to the Wall Street Journal, the budget breakeven oil price for Iran, for instance, is $140 a barrel and Saudi Arabia’s is $93.  (This isn’t an immediate do-or-die thing, though.  Countries can use savings, borrow or sell assets to bridge a budget gap for a while.)

recent history

Over the past decade or more, supply and demand have been close to being in balance, with China’s strong economic growth giving prices an upward bias.

China is now trying to halt the proliferation of low value-added, energy-wasting industry, so this source of extra demand is fading.  More important, the advent of oil extraction from shale in the US has raised world oil supplies by about 6%, or 5 million barrels a day over the past five years.

Given that demand is relatively constant, the only way to get buyers for this extra oil is to cut prices.  This is what’s happening now.

revisiting the 1980s

There’s lots of ugly history of colonial exploitation of Middle Eastern oil producers in the 1970s and before.  Let’s skip over that, in this post at least.

During the 1970s, OPEC pushed the price of a barrel of oil from under $2 to around $25.  By the start of the 1980s, the association was clearly divided in to two camps.  One wanted to maintain the highest possible current price (which had risen to around $35 for the easiest oil to refine).  The other, led by Saudi Arabia, the largest OPEC producer, feared users would find substitutes for oil, diminishing the long-term value of their vast untapped reserves.  It wanted prices at, say, $15 – $20 a barrel.

Saudi Arabia decided to force its will on the other camp by unilaterally raising production to stabilize prices.  However, a long and deep global recession soon began (partly caused by higher oil prices, mostly by the Fed’s decision to raise interest rates sharply to choke off runaway inflation in the US).

Saudi Arabia then reversed course and began to cut production, again to defend its preferred price level.  Other OPEC nations agreed to reduce production as well, but by and large never did.  Prices eventually bottomed at about $8 a barrel.

The point, though, is that the Saudi attempt to act as the “swing” producer by raising and lowering its output in order to stabilize prices, didn’t work out.  All that happened was that Saudis absorbed a huge amount of the pain of the price decline, allowing its OPEC rivals to prosper, in a relative sense at least.

today

I think Saudi Arabia learned from its experience in the early 1980s that unilaterally reducing production doesn’t work.  Besides, unlike in the early 1980s, it needs its current coil income to balance its budget.

Shale oil production will continue to grow, if nothing else simply from projects begun a few years ago.

As a result, I think the oil price will drift lower, either until a healthier world economy increases demand, or until lower prices force high-cost oil producers to shut down.  We’re a long way from the latter happening.

Bad for oil producers–in fact, energy producers of any stripe, great for everyone else.

looking for patterns

October 21, 2014 By in Constructing a Portfolio, Current Market Thoughts, economics, Portfolio management, Recent Market Action, Stock ideas Tags: , , , , , , , , , 2 Comments

Yesterday I wrote that the recovery that follows a sharp stock market decline is an important time to look for changes in the kinds of stocks that investors are eager to buy and the ones they’re happy to dump overboard.  I’m not sure why take place at these market inflection points, but the very often do.

Step one in trying to detect new patterns is for each of us to examine our own holding to see what’s happening with them.  We’re not just looking for under performance/outperformance during the downdraft.  We’re basically looking for two kinds of outliers:  stocks that underperformed on the downside and are continuing to underperform (bad!); and for stocks that outperformed on the way down and that are continuing to outperfrom now (very good!).

Step two is to widen our search to try to get a feel for what the overall market is thinking.  The way of doing this that I find most useful is to try to imagine the general economic situation the world is in and what kinds of stocks should be winners/losers if my picture is right.  Then I look at the stocks themselves to see whether their price movements confirm my thoughts or not.  Then I adjust if needed and repeat.

The most difficult situation is one where I’m 100% convinced I’m right but the stocks say otherwise.  This is rarely the case, in my experience.  At least someone has already picked up on a major investment theme before me.  But that’s okay.  A trend may last for years.  If I’ve missed the first three months it’s not a big deal.  Besides, being the only one in the restaurant has a kind of eerie feel to it.  If I’m thoroughly convinced I’m right, I’ll probably take a small position and prepare myself to add more quickly as other diners come through the door.

what I’m looking for now

The world is still in a slow recovery from the Great Recession.  The US is doing fine, given dysfunction in Washington.  China has structural change issues that have it growing at a “mere” 6% – 7% or so.  On the other hand, the warts in Abenomics in Japan are showing themselves and the EU is starting to look a lot like Japan of the 1990s.

Four big macro changes over the past, say, six months:

–China has been much more persistent than I had thought possible in trying to steer its economy away from low value-added export-oriented manufacturing toward higher-end businesses aimed at a domestic audience.  This changes the composition of growth, but is good, in my opinion.

–The EU is flirting with recession again.  The biggest culprit is France.  This is bad.

–Energy prices are falling–a lot.  This is bad for energy producers, great for everyone else.

–I had expected world growth developments to express themselves mostly (exclusively?) through changes in stock prices, with the US going up and the rest going sideways.  Instead, the principal expression has been through changes in currency values. This makes a difference.  A higher dollar slows economic gains in the US in much the way an increase in interest rates would; the fall in the euro acts as a (desperately needed) stimulus for the EU.

So, I expect…

1.  Slow GDP growth means secular growth stocks will do well, cyclical value stocks (much) less so.  Long Millennial/short Baby Boom ideas may be the best.

2.  Companies with costs in euros or yen but revenues in dollars stand to be big winners from recent currency moves.  So too companies with assets in the US.  Assets or earnings in the EU or Japan are now worth less in dollars than they were earlier in the year.

3.  The energy situation has a lot of moving parts (more tomorrow).  The clear winners are energy users.  The clear losers are the oil-producing countries where the deposits are controlled by national oil companies (think: Latin America, Africa).

Once I publish this, I’m going back to see if the markets are running with these ideas or not.

 

 

 

Hilton selling the Waldorf Astoria for $1.95 billion

October 8, 2014 By in Asian economic development, China, economics, Industry Analysis, Lodging Tags: , , , , , Leave a comment

The day before yesterday, Hilton (HLT) announced it had agreed with Anbang Insurance Group of China to sell the Waldorf, the flagship of the Hilton chain, to the five-year-old mainland financial conglomerate for $1.95 billion.  Hilton will retain an unusually long 100-year management contract to run the hotel (terms not disclosed).  The Hilton will also undergo a substantial facelift “to restore the property to its historic grandeur”  (no details on how much or who’s paying).

When I began following the US hotel industry as an analyst in the early 1980s, US hotel firms were just beginning to transform themselves from owners of hotel properties into managers of hotels owned by others.

Why do so?

–Historically, ownership of hotels has been a low-return enterprise that ties up immense amounts of capital.

–In my experience, hotel management contracts involve the manager taking large slices of the property’s revenues, cash flow and profits–leaving the owner with tax benefits (e.g., depreciation) and the possibility that the property will increase in value.

As I see it, hotel owners fall into one of several categories:

–local businessmen who want the prestige of saying they own the town’s name-brand hotel/motel, and who prize potential tax writeoffs highly

–billionaires who want the same thing, only with iconic properties

–flight capital, where the owner’s interest is less with potential return than with the presumed safety of having “just in case,” non-portable assets located abroad

–national champions, that is, institutions that either officially or semi-officially represent their home governments and who are signalling their country’s rising status.

 

I see Anbang as falling into the last of these categories.  Its justification to itself likely also includes geographical diversification and its perception that real estate investment opportunities on the mainland are not as attractive as the Waldorf.  IN its defense, Anbang can arguably also make more imaginative use of a city block in a prime section of Park Avenue than Hilton has been able to.

All in all, though, recent Chinese deals for Manhattan real estate mostly call to mind the top-of-the-market foray of Japanese firms into Manhattan in 1989 (think:  Rockefeller Center, which turned out pretty badly for Mitsubishi Estate).

recalling Tiananmen Square

October 3, 2014 By in Asian economic development, China, emerging markets, Hong Kong, Tiananmen Square Tags: , , , , , , , 1 Comment

I was fast asleep at home in the US in early June 1989 when a Hong Kong broker woke me up to tell me troops had opened fire on the crowds that had been occupying Tiananmen Square in Beijing.  That should let you know that I observed what was going on fback then from afar–as well as through the lens of a stock market investor.

Although I think there’s always the possibility of a mistaken escalation of the student demonstrations now under way in Hong Kong into Tiananmen-like violence, I see a number of important differences between the two situations.  Among them:

–Tiananmen Square took place in the heart of China’s capital, not in a politically marginal SAR

–1989 was a time of considerable political/economic unrest in China, with the economy unable to create jobs and, in consequence, hundreds of thousands of unemployed workers roaming around the countryside looking for work.  This was very scary for Communist Party leaders.

–during the months it took the Tiananmen situation to come to a head, many of the students who had originally occupied the square left, and were replaced by older unemployed workers, whose motives were less political and more economic.

–local units of the Peoples Liberation Army (PLA) were ordered to use violence on demonstrators to remove them from the square.  They refused–and were replaced by units from distant areas that had few cultural and ethnic ties with the demonstrators

–the careers of the soldiers–especially the commanders–who obeyed the orders to fire on the crowd were ruined

–world outrage at Tiananmen resulted in significant diplomatic and economic sanctions against China.  Private companies reallocated their capital away from China; highly skilled foreign workers, a key source of potential technology transfer, rethought their plans as well.

 

In sum:  I think media suggestions that the current student pro-democracy demonstrations in Hong Kong are the new Tiananmen are way off base.

I can see potential worries, though.  Clearly, Tiananmen taught the authorities not to use violence against demonstrators.  However, teenage student leaders may genuinely not realize where they live–that, just as there’s no crying in baseball, there’s no democracy in China.  It may also be that opponents of the current administration in Beijing would regard a political incident in Hong Kong as a way of derailing its anti-corruption campaign.  So there is a non-zero chance of a tragic accident.

What I’m doing:  I’ve found myself buying odds and ends on the Hong Kong stock market over the past few days, since the Hang Seng is down almost 10% from its pre-demonstration high.  I may nibble a bit more.  Ultimately, though, while I believe the current situation is very un-Tiananmen-like, I’m not going to bet the farm on my (limited) ability to analyze political events.  So I’m going to make up a shopping list, but wait for clear signs that the situation is being defused before doing much more.

 

 

Chinese economic growth: the big picture

September 23, 2014 By in Asian economic development, China, economics, emerging markets Tags: , , , Leave a comment

the problem Deng faced

In the late 1970s, Beijing came to realize that central planning would no longer work (assuming it ever did).  The economy had become too big and too complex.  So China had to adopt at least some Western free market principles.

The country had two main, related, economic objectives:

–to expand quickly enough to maintain employment and absorb the large numbers of young people looking for a job for the first time, and

–to reduce the importance/power of highly inefficient money-losing state-owned enterprises, which during the early Deng days represented over three-quarters of the country’s GDP.

China had to accomplish these goals without a modern central bank able to temper economic cycles, and without a lot of control over the day-to-day actions of the regional governments being ordered to create economic growth.

 

The result was an overall Chinese economy that grew very rapidly, using the time-honored developing country strategy of favoring export-oriented manufacturing.  Because Beijing lacked better controls, the economy tended to lurch between periods of speculative excess and of near-recession.

The SOEs were never supposed to fail–that would have created the kind of high unemployment that led to Tiananmen Square.  Rather, they were either to modernize or slowly fade away and be replaced by private enterprise.  Foreign investors quickly realized that the SOEs were an excellent economic policy timing tool.  When the SOEs were prospering, policy tightening by Beijing could not be far behind.  When they were approaching death’s door, Beijing would ride to the rescue.

what’s changed

Not any more, however.

China has reached the point where additional low-wage, sub-scale, highly polluting export-oriented materials or manufacturing operations provide absolutely no economic or political benefit.  So Beijing is not going to provide stimulus that would rescue some of the existing capacity and spawn more.  Waiting for stimulus to happen is a mistake.  Equating no stimulus with economic doom is one as well.

I find it encouraging not only that Beijing is trying to transition toward becoming a domestic demand-oriented economy, but also that it appears to feel comfortable that it can do so without negative political repercussions.  Yes, growth may be slower, but it will be more solidly based.

The investment conclusion I come to is to look for mid-sized domestic-oriented Chinese companies whose stocks have been punished during the current period of global investor disenchantment.