Have oil prices gone as low as they’re going to go? Market activity indicates there are some bottom fishers out there, especially funds and traders looking to cover shorts. It’s weird to predict a short-covering rally in oil and other resources. But one may be in the cards now that a fair bit of liquidation has taken place.
Our friend and commodity guru in Chicago thinks there is a geopolitical explanation for oil’s move. In his latest letter to clients Steve writes, “The Sunni world is terrified of the rising Shiite power represented by Iran. Starving the latter of petrodollars (or in Iran’s case petroeuros) is in Saudi Arabia’s best interests [Saudi Arabia’s leadership being Sunni]. Condi Rice’s trip the Mideast is about garnering support of the Sunni Arabs against Iran. Yesterday Saudi Oil Minister Ali Naimi was reported as saying no new emergency OPEC meeting was needed to combat low prices. Could this be the latest phase of a US / Saudi deal which brokers continued American presence in Iraq – and perhaps the troop ‘surge’ we’ve all been reading about — for lower crude oil prices? Stranger things have happened.”
We’ve posted more of Steve’s analysis on the blog. A disclaimer, however. None of us really knows what’s going on in the Middle East. But it’s hard to explain the oil price in terms of reduced global demand. Demand for energy has never been higher. It’s prompting a global search for different fuels.
For example, Energy Resources of Australia (ASX: ERA) reported record quarterly production at it Ranger mine in the Northern Territories. The wet weather (at least somebody is getting rain) didn’t prevent the mine from producing 1,662 tonnes of uranium in the last quarter of 2006. Even so, full- year production was down twenty percent from 2005.
Production down, uranium prices up. Coincidence?
Uranium is nuclear fuel for electric utilities…you know…the ones that generate power in most advanced industrial economies. Uranium prices ended at US$72 last year. $100 can’t be far away. And as uranium analyst Marin Katusa from Casey Research explains in an article we’ve posted, uranium represents only 5% of a utility’s total cost in generating power.
Dusting off our left lobe, we think that means that uranium is relatively inelastic in terms of price. The utilities that use it don’t blanch at higher prices. Uranium could conceivably double and still not be prohibitively expensive for the utilities which rely on it for power.
Perhaps this is why ERA is one of forty companies hoping to earn exploration rights to the Pamela and Angela uranium deposits in the Northern Territories. By the way, according to yesterday’s Herald Sun, there are six Chinese companies in the queue as well. Who will win the concessions? Watch this space.
Uranium is just one fuel in demand and under supply pressure. Woodside Petroleum (ASX: WPL) has got to feel good about the growing demand for liquid natural gas (LNG). The company reported a 44% rise in fourth quarter sales today. That stacked up to a $1 billion in oil and gas sales for the three-month period. For the year sales and production were up 39% and 14%, respectively.
It’s good to produce more oil and gas when prices are high. But Woodside, if you recall, was forced to cut its estimates of 2006 production in last year’s third quarter from 76 million barrels of oil equivalent to 72. The problems then were lower-than-expected shipments of oil from its Enfield oil project. But there are storm clouds on the LNG horizon, too….
“Chevron Corp and Royal Dutch Shell are delaying construction projects from Australia to Nigeria, threatening to drive natural gas prices higher for years to come,” reports a Bloomberg article yesterday. “None of the world’s biggest energy companies approved developments last year to increase production of liquefied natural gas, which helps heat homes and run power plants from Tokyo to Boston. The main reason is the cost to build LNG plants has tripled in six years, according to Bechtel Group, Inc.”
There is certainly plenty of incentive to build natural gas and LNG facilities. “Natural gas prices are three times higher than in during the 1990s and consumption of the fuel will outpace the 1.6 per cent annual gain in energy demand for the next twenty-five years, according to the International Energy Agency. Gas is also becoming more popular because it emits 29 percent less carbon dioxide than coal burned in power stations.
We’ll get to coal in a minute. But do you notice this recurring theme of huge cost over-runs in the efforts to expand mining and energy capacity? We harken back to a December 22nd article by Trevor Sykes in the Australian Financial Review: “Even if all the big mining companies were competing frantically and bringing on mines as quickly as they could, the are still several significant constraints on mine supply. Productions costs are rising sharply. For any project that has to get off the ground from scratch, the rise has probably been 50 to 60 per cent over the costs of two years ago.”
Sykes continues, “BHP’s Ravensthorpe nickel mine in the south of Western Australia began on a cost estimate of $700 million. BHP has announced the cost has blown out to $2.2 billion….All new mining projects are facing such blow-outs. Higher costs of energy are a root cause, increasingly not only the fuel costs of construction, but also as an input into the steel of other materials used in construction. These higher costs will inhibit the number of projects coming on stream-and hence increase the value of existing producers.”
We hasten to add that one man’s cost blow out is another man’s profit bonanza, which is one reason we’ve added a mining services company to our list of recommendations in Outstanding Investments. So even if the majors feels the pinch, the so-called pick and shovel companies that make building new mines capacity expansion possible will have bumper-crop years. At least that is the idea.
In the meantime, cost-blow outs delay the on-stream production of energy the world needs right here and now. According to Bloomberg, “Chevron, the U.S.’s second-biggest oil company, last year abandoned its timetable for approving the Gorgon LNG project in Australia. Developing the fields, which hold $400 billion of natural gas, would cost $10 billion and increase world supplies by 7 per cent. The driller and partners Shell and Irving, Texas- based Exxon Mobil are studying ways to reduce construction costs.”
The gas is where it is. Shell is even looking for more of it. “Energy giant Shell is back in the Australian exploration business with a vengeance,” reports today’s Australian. Shell executive Wouter Hoogeveens said, “We have invested in a range of new permit areas, farming-ins, and have also purchased the rights to gas in the Crux field. In November we began drilling in the Browse Basin, 450km northwest of Broome.”
“This effort is designed to find the extension of the Icthys field, which Japanese group Impex estimates contains 12 trillion cubic feet of gas that could result in a new LNG project by 2012.” With new projects like that on the horizon, even rising production costs will not stand in the way of future development. Rising production costs do have an impact, of course.. It simply means the underlying commodity prices will have to rise, that or lower profit margins for the oil and gas companies. Which do you think is more likely, the oil company eating the higher cost or passing it on to you and me?
Uranium, oil, gas…even coal is getting harder to produce in the quantities that the world-especially China-demands. “The NSW coal industry has been plunged into conflict over ship queues that have doubled to more than 50 vessels at Newcastle port and added millions of dollars to coal miner’s costs.” Mining behemoths like Rio Tinto (ASX: RIO), Xstrata (LON: XTA), and BHP (ASX: BHP) are faced with congestion at the region’s limited number of coal terminals and rail heads. And with coal, there is no such thing as jumping the queue.
We detect another theme: capacity constraints. In another story on the same page we learn that, “Rio also warned that the Pilbara was experiencing ‘ongoing acute shortages of mining inputs that continue to put pressure on costs.”
As a famous Bolshevik revolutionary once asked, “What is to be done?” Fuel demand from conventional hydro-carbons would surely fall if we all drove Pierce Arrow cars powered by Nikola Tesla’s mysterious electric motor. But until then, the situation remains MESI. The world requires More energy, more Efficiency, better Substitutes, and greater energy Innovation.
Markets are messy too, and work indirectly. For example, with falling oil prices, substitutes for oil become less economic and less attractive as investments. Bloomberg’s Shruti Singh reports that, “Sugar, used in food and to make ethanol, has dropped 45 percent from a 24-year high of 19.73 cents a pound in February as global production rose, demand slowed and crude oil dropped from a record. Oil today touched the lowest since May 2005.”
Sugar as a substitute for oil has lost its appeal. But if you view falling oil prices as the cue ball in a game of billiards, there are many reactions that result directly from its fall, though the reactions are not strictly equal and opposite. Falling sugar prices are a chance to buy sugar assets cheap, or so must be the thinking of pirate equity groups allegedly interested in Australian firm CSR. CSR operates in four segments: building products, aluminium, sugar, and property.
The stock surged in recent days on speculation it’s the target of pirate raid. But just which assets are the swashbucklers after? “Being a traditional company,” says Austock analyst Michael Heffernan, “CSR is the type of company most private equity firms would be interested in buying…It also has some lazy assets and private equity firms would be able to make them work harder.”
We can think of a few lazy assets we’d like to work harder, too. But making them do so is another question. Still, it just goes to show you, private equity casts its voracious eye far and wide…and it wouldn’t surprise us a bit if that wandering eye started to land on undeveloped energy assets or energy substitutes that could be made to work harder. After all, a commodity’s potential energy is its ability to do some kind of work for its master, to move earth, heat a home, or light a city. If private equity can get Australia’s potential energy assets to “work harder,” we’re all for it!
However it’s not just the pirates who see the latent and undeveloped potential of Australia’s energy assets. Welcome to New South Shanghai.
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