Wednesday, April 25, 2012

For Frack's Sake

And relax. BBVA results not the shocker disasternistas were hoping for, the cult of AAPL continues to fleece its disciples and it is looking more as though that was NOT the big one re Europe. TMM can’t help but think this has got a july 2009 feeling about it. We had the QE sugar rush from mar09 to jun09, then the market sold off because no-one believed it. But then the earnings season was good and the market ripped higher, never looking back. OK it may be a bit premature, but with all the noise subsiding and the market blaming the quiet on “waiting for the FOMC” which to be frank no one really cares about, TMM are more inclined to believe that the markets are “shagged out after a long squawk”. Whatever the reason, we will be invoking the “do not short a quiet market” rule and expecting more up drift.

Whilst it is quiet we will have a look at something we believe is about to change the world much more than any Apple iteration – the changing shape of energy supply. TMM would like to start today’s post with an interesting chart showing energy costs per Gigajoule for major fossil fuel sources in the US. White is Power River Basin coal, orange is henry hub gas, yellow is oil and pink is international coal (Newcastle spot).

As you can see, the big story of energy prices going to the moon over the last decade remains very much intact but gas has been doing something very unusual – after spiking hard it has gone into a massive decline and is almost as cheap as powder river basin coal on a per GJ basis. The cause of this is the fracking revolution in gas production which has massively increased the US’ fossil fuel reserves. It is already being keenly felt in power markets where US coal companies are being killed by the increased competitiveness of gas fired power generation as the portion of the day in which it makes sense to burn gas is longer and more profitable, reducing those peak time margins that coal fired power plants make much of their profits from. For coal equities this is hardly news – Cliffs Natural Resources, Alphadyne and Arch Coal have not been feeling the vim and vigor of a resurgent US economy. Similarly the US’ strategic exposure via oil imports to the Middle East and less than friendly regimes like Venezuela is waning judging by the chart below. Crude import percentage from Saudi in white, Canada in orange and Venezuela in yellow (Note the post Libya ramp in Saudi imports – that won’t be around for long).

TMM can’t help but feel that the money for the “war on terror” could have been better spent, but the US appears to have been a classic case of “better lucky than smart” in that regard since they have secured a reduced exposure to middle eastern madness through oil sands. Now, not that oil is mattering as much as it used to – below are vehicle miles travelled in the US in orange, inferred gasoline demand in green and average MPG of sales in white.

Not hard to see what is going on here: a period of high oil prices has pushed consumers into buying much more efficient vehicles and vehicular travel has peaked. Much like any business if unit sales and prices are down revenues are down a lot. TMM are wary of hockey sticks though so we thought we would do the comparison of a new efficient hybrid, say a Prius C and a Corolla. In summary – it’s ugly, and the google docs link is here. You need $2 gasoline to even think twice about not buying the hybrid. In addition, companies like Ford are offering vehicles in gasoline, electric and LPG versions. No points for guessing how gasoline stacks up in the lifetime cost analysis there. Simply put, the vehicle mileage hockey stick is going further, a lot further unless WTI halves. It would be particularly disturbing if people widely moved to plug in electric cars which essentially allow you to do what the power grid does – determine which fuel is cheapest to burn then burn that. In that case you would expect oil and gas to converge on a per GJ basis which would be a catastrophe for WTI.

In summary a few very important things are happening in energy, but particularly so in the US:

  • Energy prices are falling for gas, with knock on effects for other markets in which it is substitutable. Similarly, vehicle fleets are becoming more efficient and gasoline demand in DM is probably in a structural bear market on that alone. This has major implications for US inflation most of which has been from food and energy in recent years despite motor fuel being only ~5% of CPI basket and heating and utilities being another 5%. It may be the case that even if housing recovers and “rent equivalent cost of ownership” (~40% of the basket) stabilizes that the US has a very benign inflationary environment for structural reasons. Buy all the gold you want, but if people’s gas bills cease to exist or go into a nominal decline then that will take the bite out of a lot of quantitative easing in commodities.
  • The historic segmentation of the energy markets into transport fuels and utility fuels is starting to blur and is likely to continue to do so. For that reason, the pricing per GJ for each should converge over time. You may not be able to make everyone in the US buy an electric car tomorrow but the ability of WTI to command a big premium over henry hub will weaken over time.
  • US energy imports are falling fast and will continue to do so as the vehicle fleet turns over. This is going to have major implications for US defense spending – how much does the US care about the Middle East, ex oil? TMM would note that if the straits of Hormuz are closed, China has more to lose from it than the US. In addition, it has major implications for US tax receipts if people buy LPG cars or electric ones. US utilities pay cash taxes in the US, Saudi Aramco does not. The major problem of the US from a macro standpoint, its twin deficits and high debt may be reduced materially by these trends and the historically cheap USD may be the best buy in FX for the next decade.
  • Make it in America? The US and particularly the Democrats have developed some kind of romantic attachment to manufacturing and politically astute CEOs like Andrew Liveris of Dow have picked up on this theme and have called for the US to have an industrial policy, aka, handouts for corporate along the lines of China. TMM see this for what it is – getting something for nothing and think it is largely unnecessary for most businesses. It is highly unlikely the US is going back to making garments or in any way competing with the scale efficiencies of southern China when it comes to cheap labor, especially as China’s factories increasingly replace labor with capital. Where it can compete however is in areas that are skills or technology intensive (when in doubt, buy out Asia’s best and brightest with grants) and anything that is energy cost intensive. Liveris notes that labor is <12% of COGS at Dow and Energy is 25% or more. TMM think that $2 gas makes a much bigger difference than looser labor laws or tax holidays.  

The Downside….
There is another side to all this aside form extolling the virtues or hope of a resurgent America, and that is the effect it will have on those on the long side of the commodities trade. For the likes of the Middle East and Russia TMM have this to say:

Saudi and Russia in particular have developed fiscal arrangements (Saudi’s covered well here) such that their economies “don’t work” at much less than $90 WTI. Russia is not that much better and is more dependent upon gas, something that the European buyers they have held to ransom for so long might not want to buy if they can frack their own as Romania is currently exploring. For that reason TMM are hard pressed to think of currencies they dislike more than the rouble – all the terms of trade frothiness of Australia with a boatload of political risk and a much bigger credit bubble as can be seen below. 

Even in the case of Australia all those lazy RBA terms of trade and commodity price projections may go awry if China manages to produce a lot of fracked gas – China SOEs have never been ones to shy away from renegotiating off take of commodities if it suits them though that is likely a late 2010s / early 2020s problem. Some countries have the political wherewithal to take such a crunch in terms of trade (Brazil, Australia) others might not make it and require some institutional change when they can’t deliver their side of the autocracy / milk-and-honey trade.

Of course the real crunch comes against renewables. Whilst cost differentials have been narrowing between traditional fossil fuels and solar and wind,.  will the energy addicts be able to resist dirt cheap carbon emitting gas for the benefit of the environment? TMM think not as austerity drives people to short term survivalist individualism rather than long term community spirit though that is arguably in the price these days. The larger shock is that by the time we start running out of gas energy prices might be following solar's quasi Moore's law - which wouldn't hurt any of TMM's power bills.


Greyleaf said...


Dumb question on the Google doc cost comparison spreadsheet. The Prius cost(PV) is $35.6k, vs Corolla's at $30.8k, at $4/gallon gasoline price. Doesn't this mean Prius is still a bit expense?

abee crombie said...

natural gas revolution! but how do you play it? MLPs are my best guess, the GP partnerships.

Agreed most of US problems solved if it can get a coherent energy policy together, but that is asking a lot.

interesting food for thought: OPEC oil demand has been a major source of demand over past several years. but would that have been the case with lower oil prices.

Also high WTI prices are needed to keep Gas at sub $3 as all the rage today is in NGLs (tied to oil price)

Anonymous said...

Long India, short Canada trade?

Amplitudeinthehouse said...

Watched a doco not long ago about Fracking, nothing good was depicted..just one court case after another in the USA where regional communities we"re ( and some succeeded)in trying damn hard to kill off hydraulic fracturing projects.Showed some case studies, not good.

Moreover, it gave the impression that projects like this we're popping up like brown shoots in the doubt we'll hear more.

ps...Amplitudeinthehouse says,thanks for the some original brain teasing, it's not often he gets away from the mind numbing extrapolation that feeds into the local community that he is currently surrounded by, be it from movies, movie adaptions from novels, cartoons,local newspapers and any written bio ( preference to those formely guest of HM). many thanks.

Nic said...

Great, great post, Team MacroMan.
I'm feeling the July2009 thing too.
If Iran back down ...

Leftback said...

Fracking good post, Nemo. The problem with natty in the US is that (as usual) the infrastructure isn't worth shit. [e.g. Our trains and rail stations look like they did in the 1950s.] There are hardly any CNG filling stations over here, although some of the vehicle fleets and regional buses have converted.

So, among the reasons Natty is so incredibly cheap in the US are:

a) we have got a lot of it,
b) we are producing a ton of it,
c) we didn't burn much this mild winter
d) we are running out of places to store it and
e) we mainly use it to run our barbecues

A change in gasoline tax policies would start the ball rolling in the right direction. With UK style petrol taxes we would all be driving LPG vehicles already. But with US politicians still bent on fellating the oil industry we will be waiting a while.

Welcome back, Nemo. LB assumes that the remainder of TMM are hung over after Boozy Tuesday and perhaps might be Chelsea fans still coming to terms with the smash and grab job pulled off overnight in Cataluña? Amazing game.

Here is a counterpoint to yesterday's AUD/CAD discussion:

Trouble Down Under

It still comes down to China growing at 3% versus the US growing at 1%.... [otherwise referred to in official government statistics as 8% and 2.5%]

Leftback said...

Translating Bernanke-speak:

Bernanke: Balance sheet tools are on the table

They will do MBS purchases or Twist 2 if they see fit.

Bernanke: Inflation will moderate later this year

The US economy sucks ass but we will not do QE3 yet.

Bernanke: FOMC is comfortable with 2014 guidance

We tied the hawks up and they are in the closet under the stairs.

Bernanke: Too soon to declare victory, raise rates

Raising rates would be like shooting myself in the head.

Bernanke: Many views on what are ultra-low rates

No other views actually matter, just mine.

Bernanke: Fed policy is in the right place

Without me we would be in a Great Depression.

Bernanke: Funds rate would be negative if possible

The US economy is a steaming pile.

Bernanke: Fed still working on transparency

Fed still working on opacity.

Anonymous said...

Greyleaf/Tom - Change the electricity price per kWh in the CF model to match the price in the savings matrix to see stated results

RedRut said...


All great points! If anything nat gas will become cheaper and possibly even 0 (as it did in the early 90s) as capacity is almost full.

The transition from oil to gas is definitely something that may occur but this could be a 20 - 30 year thing

Corey said...

Despite the economic sense of fracking and what will probably become an eventual acceptance - it makes too much sense not to, in the near term it depends as much on politics as anything else. A very sensitive issue already, as one of your earlier, since removed comments alluded too. Of course those are issues for another blog, but one has to be well aware of the risks from an investment standpoint. As an example the pass through status that MLPs currently enjoy may go the way of the Canadian Royalty trusts if el presidente gets his way. Lots of unknowns in an election yr. As for the rest, lets just say I'm feeling Blue.

charles said...

You are mixing up hybrid and plug-in hybrid.

A plug-in hybrid, which enables to perform 60% of journeys on electric power, has a very expensive Li-ion battery pack that can be used for a limited mileage.

AS a consequence, you won't find a plug-in hybrid @ 21,000$. The reference here puts the price tag at 32,760$.

Put that number in the spreadsheet, and the corolla becomes attractive again...

Demand destruction will cap fuel prices before technology IMHO

Leftback said...

We are clearly back in the world of central bank arb, where weak US economic data releases increase the perceived probability of further easing, and supports USTs and equities. As long as this dynamic stays in play, all those strong dollar/vigorous US recovery trades are not gonna work. US Q1 GDP tomorrow may do nothing but cement this tendency.

Nemo Incognito said...

Folks for clarification I am talking about hybrids here which now, in Prius C format are silly cheap.

Plugins are still pricey and fwiw I think we'll see the high end of the market (think Tesla) go electric and the plug in side will be neither here nor there. I think its an intermediate step which is as necessary as the laser disc (Remember those LP sized DVDs?). But nonetheless if you have people buying a Prius C over a fiesta or a corolla that is huge and will righteously trash the market.

If you want to do a Prius C versus corolla set all driving to gas and use the mileage number. only need the power input if you are charging up at home. I've done side by sides for a bunch of price points and cars and I think Tesla is right.... luxury end will switch before the punters though mileage is ripping there too.

Charles said...

Nemo, you are loosing me here.

This was a post about tracking and how electrically powered cars were going to enforce the GJ arbitrage between liquid fuel and electrical generation.

And now you say "set all driving to gas" ?

BTW, it has been ages that the european middle class drive 50+ MPG compact diesel cars, and I didn't really see the trashing of the oil market.

Barring some revolutionary development in battery technology, american cars improvement in MPG (which will be merely a catch-up to european standards) will just leave some fuel on the table so that the chinese can drive their cars (and as they don't have a lot of money, they will go for the cheap high MPG no hybrid fancy car).

I don't see oil at 50$ on a sustained long term basis because long hydrocarbon molecules are really a very efficient way to solve the problem of mobile energy storage. At a 4 or 5$ price point, there is potential for various synfuel scheme to take over from dwindling natural supplies.

This being said, the trump card is the price of greenhouse gases release. If at zero, synfuel from NG and coal will thrive ; if not, batteries may have a fighting chance but still could still be ultimately defeated by climate friendly synfuel processes (when Saudi energy minister talk about atmospheric carbon capture in their speeches, I don't think it is to put the CO2 into the ground, they probably have more in mind to turn it back to fuel using solar or nukes)

Anonymous said...

Jeff Gundlach's 72 chart presentation kind sums up the debt story:

Also note chart#31

Top for AAPL?

Anonymous said...

Great post. Thanks.

Cheers from Osaka...


Steve said...

Hey TMM, how about getting a GDP thread going? I'd be interested to hear what people think.

LB it looks like you nailed it, it's the QE baby.

Steve said...

And while we're at it, BOJ adds 100 gazillion, JGBs rally, and JPY falls??

David said...
This comment has been removed by the author.
Amplitudeinthehouse said...

Macro Bullet Points EOW

-Stopped out Dow

-BB taken to task ,why not duplicate's the currency stupid..but

-Euro fudge factory new-orders rise to all-time high.

-PMI alternate to lagging indicators for this week.

-Betty does the rounds ( well take look , no else wants do it)

-APPL says to the 80's Nifty 50..EAT YOUR HEART OUT!!

Trade Ideas

We'll be back.

abee crombie said...

Take your bets, when will German 2 year yields reach 0?

Natty had a nice move the yesterday.

Seems to me the equity buying of past few days was of the laggards getting a little bounce. We still need some follow through but you would have to say advantage bulls at this point.

I never have understood the yen.

Leftback said...

If Italy were to execute all of the structural reforms, would that be called: "The Full Monti"?

Leftback said...

JPY stronger b/c markets expected an even bigger dollop of bond buying, possibly up to 1 squazillion yen, and b/c USD weaker on soggy GDP data.

USDJPY still executing a retrace of the huge move off the all time low at the end of January. Expect something in the 78s-79s again (a 50.0-61.8% Fib retrace) on renewed USD weakness, before BoJ acts again some time this summer?

Leftback said...

For fans of shampoo, Spanish 10y yields are making, you know, that formation....

Steve said...

Further to LB's point if someone went to a costume party as the head of the ECB he would be dressed in Draghi

abee crombie said...


is 1 squazillion bigger than 1 brazilian

for all the talk of end of eurozone/spain etc, Corporate bonds holding in very well.. I just dont get bund and schatz..

Steve said...

If we get the full Monti we might see a Brazilian

Nemo Incognito said...

Big moves today in the most crowded trades.... AUD in particular and a decent run of AUDCAD. While TMM like the "long dollar" stuff we do trade it.... shorting a non-existent China fraud this ain't. No heroes in macro etc.

And on Spain, quite. TMM were discussing recently that you basically need to put a few of the crappy caixa idiota types under to show them cold steel while leaning on a deposit guarantee. The strong ones are already buying back their covered bonds. Bifurcation? TMM's more educated friends in financials think so.

As for rest of Ibex you have to wonder how much lower Telefonica can go. Stub value of the spanish biz is a 2.5x EV/EBITDA proposition once you strip out Latam and that is circa SK Tel in 2002 type valuation territory - normally a huge lift.

abee crombie said...


Polemic said...

Abee.. yes our friends at BCA kindly tweeted that they dedicated that post to us...

They like cad/aud and we like aud/cad

2 views make a market..

Unknown said...

TMM, one other aspect to the US energy equation you forgot: US domestic oil production. It has recently reached levels not seen since around 2000, and it is headed higher. Current production is around 6.1 million barrels/day, and it is easily going to 7 million barrels/day within the next 2-3 years or so. Eight million barrels/day is not out of the question either, and some are beginning to speculate it could match its 1970 high sometime within the next 10 years.

EIA Data

Nemo Incognito said...

Unkown - you are right. Shale gas often comes with some liquids which has led to a big increase in oil production. TMM aren't sure that is as long term a trend as gas but it sure is helping in the interim.

Anonymous said...

While I agree the ruble is good to short, the short is not that obvious as the rather manipulative Russian credit to gdp graph implies, with taking 96 as the base where, Russia didn't have a financial sector at all.

Russia's sov debt to gdp is 10% and private companies (many of them quasi sov) are around 100%, consumer credit is around 10-20%.

Considering the above, don't see much sense in presenting the data in the format you did, as one could start thinking Russia is heavily overleveraged in contrast to peers, while in reality it has still one of the lowest credit to gdp ratios

Amplitudeinthehouse said...

If your out-there, TMM...maybe some insights in regard to HF shorting Core-EZ bonds...any latemail?

- Reverse way of betting on Euro-Bonds if-when implemented?

Apart from yields being at historical lows.

The world is going to find out this week if the US averages have finally succumbed to the illusion of promised prosperity through QE past-present-but but but....