China finds opportunities in oil price drop

This week, Cnooc announced plans to reduce capital spending as the government and large state-owned enterprises respond to the collapse in oil prices. China’s third-largest oil producer said it would cut development spending by 67 per cent and, albeit less dramatically, reduce exploration and production capital expenditure.

At the same time, the Beijing government and refiners such as Zhuhai Zhenrong have increased their purchases of crude oil to record levels. Sinopec, another big state-owned energy enterprise, opened up a tank farm for crude oil on the resort island of Hainan in November.

These apparently contradictory signals reflect changes in the sources of growth in a slowing Chinese economy and show how the government and corporate China are exploiting the collapse to reduce their longer-term vulnerability to price swings in the volatile energy market.

It is easy to understand why Cnooc is cutting back spending. The economy is growing slightly below the level the cadres have commanded and slowed to 7.1 per cent in the final quarter of 2014. Reinforcing that trend is the fact that the energy intensity of Chinese production has gone down. Chinese crude oil demand per unit of gross domestic product has been dropping by 4.3 per cent a year since 2005, according to data from JPMorgan Private Bank.

Moreover, as the sources of growth shift slowly from manufacturing to services and from exports to domestic demand, that drop will probably accelerate, making further oil capex cuts likely — and shareholders happier.

But China is also looking ahead and taking advantage of the speedy and unexpected reversal in the oil price.

The increase in demand for crude on the mainland comes because China is exploiting lower oil prices to dramatically boost its storage capacity for both commercial and strategic reasons. By doing so, it will address one of its perennial weaknesses, its reliance on imported energy, and make itself more competitive.

The move comes at a moment when pessimism about Chinese prospects generally is on the rise. That downbeat attitude reflects chronic excess capacity, an overbuilt property market and concerns about a corporate sector that has borrowed too much, whether in renminbi or appreciating US dollars.

The way China is taking advantage of the declining oil price also suggests that some of the pessimism is unwarranted. The dramatic expansion in commercial and strategic holdings of crude while the price is half of what it was just months ago is only part of the story. The government is also increasing taxes rather than pass on the full benefit of bargain fuel prices to consumers.

Those taxes will go partly to dealing with China’s monumental environmental issues, according to Miswin Mahesh, Barclays’ commodities analyst in London. That spending should be good for China and its neighbours, if the past is any guide.

Up to now, Chinese growth has been good news for the rest of the world. In 1990, China’s contribution to global GDP growth was 5 per cent. Since 2010, the figure has swelled to more than 40 per cent. Its role as a crutch for world growth has become especially important as the growth rate of other emerging markets has fallen. (Last year emerging markets as a whole grew only 4 per cent — the worst figure since 2009 — and this year may even drop slightly below that.)

China’s demand for crude is already lifting the fortunes of shippers and others. Among the biggest beneficiaries of the increase in Chinese appetite for crude is Iran, says Amrita Sen, chief oil analyst with Energy Aspects in Houston and London. Indeed, Chinese demand for oil from Iran accounts for more than India, Japan, and South Korea combined. (All these countries have received specific exemptions from US-imposed sanctions on Iran, and they may also import more than the level the waivers allow.)

Earlier on, before China received permission from the US to procure Iranian oil, the country paid for its Iranian imports in renminbi. But today, Ms Sen says, the Chinese are using dollars. That benefits both sides. Tehran finds dollars more useful than renminbi as there are still controls on what Iran can do with its Chinese currency.

At the same time, China has clearly decided it is better to obtain real assets such as oil with its dollars than to purchase paper securities. Right now, both US Treasuries and the US dollar look attractive, while oil does not. But China always takes the long view — and in the long term neither Treasury securities nor the greenback seem as attractive as they do today — at least as seen from Beijing.

Source: http://www.ft.com/intl/cms/s/0/b083f7b4-ab8d-11e4-b05a-00144feab7de.html#axzz3Qnw9Fh8K

After the Boom in Natural Gas

THE crew of workers fought off the blistering Louisiana sun, jerking their wrenches to tighten the fat hoses that would connect their cement trucks to the Chesapeake Energy drill rig — one of the last two rigs the company is still using to drill for natural gas here in the Haynesville Shale. 

At its peak, Chesapeake ran 38 rigs in the region. All told, it has sunk more than 1,200 wells into the Haynesville, a gas-rich vein of dense rock that straddles Louisiana and Texas. Fed by a gold-rush mentality and easy money from Wall Street, Chesapeake and its competitors have done the same in other shale fields from Oklahoma to Pennsylvania. 

For most of the country, the result has been cheaper energy. The nation is awash in so much natural gas that electric utilities, which burn the fuel in many generating plants, have curbed rate increases and switched more capacity to gas from coal, a dirtier fossil fuel. 

Companies and municipalities are deploying thousands of new gas-powered trucks and buses, curbing noxious diesel fumes and reducing the nation’s reliance on imported oil. 

And companies like fertilizer and chemical makers, which use gas as a raw material, are suddenly finding that the United States is an attractive place to put new factories, compared with, say, Asia, where gas is four times the price. Dow Chemical, which uses natural gas as a material for producing plastics, has assembled a list of 91 new manufacturing projects, representing $70 billion in potential investment and up to three million jobs, that various companies have proposed or begun because of cheap gas. 

“The country has stumbled into a windfall on the backs of these entrepreneurs,” said Edward Hirs, a finance professor at the University of Houston who contributed to a report that estimated that the nation’s economy benefited by more than $100 billion last year alone from the lower gas prices. 

But while the gas rush has benefited most Americans, it’s been a money loser so far for many of the gas exploration companies and their tens of thousands of investors. 

The drillers punched so many holes and extracted so much gas through hydraulic fracturing that they have driven the price of natural gas to near-record lows. And because of the intricate financial deals and leasing arrangements that many of them struck during the boom, they were unable to pull their foot off the accelerator fast enough to avoid a crash in the price of natural gas, which is down more than 60 percent since the summer of 2008. 

Although the bankers made a lot of money from the deal making and a handful of energy companies made fortunes by exiting at the market’s peak, most of the industry has been bloodied — forced to sell assets, take huge write-offs and shift as many drill rigs as possible from gas exploration to oil, whose price has held up much better. 

Rex W. Tillerson, the chief executive of Exxon Mobil, which spent $41 billion to buy XTO Energy, a giant natural gas company, in 2010, when gas prices were almost double what they are today, minced no words about the industry’s plight during an appearance in New York this summer. 

“We are all losing our shirts today,” Mr. Tillerson said. “We’re making no money. It’s all in the red.”

Like the recent credit bubble, the boom and bust in gas were driven in large part by tens of billions of dollars in creative financing engineered by investment banks like Goldman Sachs, Barclays and Jefferies & Company. 

After the financial crisis, the natural gas rush was one of the few major profit centers for Wall Street deal makers, who found willing takers among energy companies and foreign financial investors.

Big companies like Chesapeake and lesser-known outfits like Quicksilver Resources and Exco Resources were able to supercharge their growth with the global financing, transforming the face of energy in this country. In all, the top 50 oil and gas companies raised and spent an annual average of $126 billion over the last six years on drilling, land acquisition and other capital costs within the United States, double their capital spending as of 2005, according to an analysis by Ernst & Young. 

Now the gas companies are committed to spending far more to produce gas than they can earn selling it. Their stock prices and debt ratings have been hammered. 

“We just killed more meat than we could drag back to the cave and eat,” said Maynard Holt, co-president of Tudor Pickering Holt & Company, a Houston investment bank that has handled dozens of shale deals in the last four years. “Now we have a problem.” 

A Master Salesman

Aubrey K. McClendon, chief executive of Chesapeake Energy, had a secret, and he was anxious to share it.

He called Ralph Eads III, a fraternity buddy from Duke who had become his go-to banker. Mr. McClendon explained that he had quietly acquired leases on hundreds of thousands of acres somewhere in the southern United States — he would not say exactly where — that could become one of the world’s biggest natural gas fields. 

But to develop the wells, he needed billions of dollars. 

“I can get the assets,” Mr. McClendon told Mr. Eads, a vice chairman of Jefferies, according to three people who participated in that call, nearly five years ago. “You have to get the money.” 

Get it he did. Mr. Eads, a pitch artist who projects the unrestrained enthusiasm of a college football coach, traveled the world, ultimately raising an extraordinary $28 billion for Mr. McClendon’s “secret” venture in the Haynesville Shale, as well as other Chesapeake drilling projects. 

Other bankers working in the glass office towers of downtown Houston were equally busy. While the skyscrapers are home to global giants like Chevron and lesser-known companies like Plains Exploration and Production, they also house storefronts for Wall Street deal makers who play a vital, though less visible, role in the nation’s surging energy production. 

Mr. Eads, 53, a Texas native, is a prince of this world. His financial innovations helped feed the gas drilling boom, and he has participated in $159 billion worth of oil and gas deals since 2007. 

A Sigma Alpha Epsilon fraternity brother of Mr. McClendon, he headed to Wall Street directly after Duke. He first earned a national profile in 2001, while working for the El Paso Corporation, a natural gas pipeline operator. Regulators accused El Paso of creating an artificial gas shortage in California in the previous year, contributing to a power crisis in the state. Although El Paso eventually settled the complaints for $1.7 billion, Mr. Eads said El Paso was guilty of nothing more than coming up with creative financial transactions.

“I wake up every day thinking about how to finance big things,” he said. 

His tall, lanky frame and bellowing voice make him hard to miss, even in a large crowd. And his deal radar is never off, as he works the room at dinner parties and charity events. 

That is how he met Jim Flores, the chief executive of Plains Exploration, who eventually invited him on a duck hunt. 

After Mr. McClendon’s urgent request for money, Mr. Eads put in a call to Mr. Flores to see if he might be willing to finance part of Chesapeake’s Haynesville project. 

“Aubrey and I have calculated it, and it might be the largest gas field in the world,” Mr. Eads said he told Mr. Flores, noting early results from a single well that showed unprecedented gas flows. 

The type of deal he pitched, nicknamed “cash and carry,” was certainly aggressive and innovative. Plains would pay Chesapeake $1.7 billion to gain ownership of about one-third of the drilling rights that Chesapeake had leased in the Haynesville. Plains would also commit to paying out another $1.7 billion to cover half of Chesapeake’s drilling costs, in return for part of the future profits. 

“It’s going to be a great investment,” Mr. Flores said on the day the deal was announced in July 2008.

But the deal, like others later struck by Chesapeake, benefited Mr. Eads and Mr. McClendon and their companies far more than the people writing the big checks. 

Chesapeake spent an average of $7,100 an acre on the drilling sites it had leased in the Haynesville. Plains paid Chesapeake the equivalent of $30,000 an acre. 

Jefferies and the other firms involved in arranging the deal made an estimated $23 million on this transaction.

Much of the money that Mr. Eads raised for American gas drillers came from overseas oil and gas companies, like Total of France and Cnooc, the China National Offshore Oil Corporation. He told them the American shale revolution was an opportunity they simply could not afford to pass by. 

“This is like owning the Empire State Building,” Mr. Eads said, recalling one of his favorite lines. “It’s not going to be repeated. You miss the boat, you miss the boat.” 

In China, he was in awe at just how much money was available to invest. One senior executive at a major Chinese oil company that Mr. Eads declined to identify, citing the confidential nature of the negotiations, explained that the country wanted to move as much as $750 billion from United States Treasury bonds into the North American energy business. 

Mr. Eads was only happy to oblige, helping to secure $3.4 billion from the Chinese for Chesapeake through two deals. 

Not everyone believed the story line of endless profits and opportunity. Mr. Eads said one oil company executive whom he would not identify had rejected his pitch, complaining, “The reason for the glut is you guys.” The executive said he expected natural gas prices to plummet. 

In private, Mr. Eads acknowledged that his pitches involved a bit of bluster. 

“Typically, we represent sellers, so I want to persuade buyers that gas prices are going to be as high as possible,” Mr. Eads said. “The buyers are big boys — they are giant companies with thousands of gas economists who know way more than I know. Caveat emptor.” 

Investment banking revenue at Jefferies reached $1.1 billion in 2011, a record for the firm, up from $750 million in 2007. Energy deals were cited among the biggest drivers of that surge, which came despite major problems at the firm because of its exposure to European sovereign debt. 

Mr. Eads would not say how much he had been compensated for this bonanza. But Dealogic, a firm that tracks Wall Street transactions, estimated that Jefferies collected at least $124 million in fees from Chesapeake since 2007, a large share of its overall revenue on oil and gas deals, which ranged between $390 million and $700 million during the same period, according to two different industry estimates. 

Even before the recent round of deals, Mr. Eads was a wealthy man. He lives in a sprawling, 11,000-square-foot lakefront mansion in Houston and has a wine cellar with 6,500 bottles. In 2010, he bought an $8.2 million home in the exclusive West End of Aspen, Colo., whose other homeowners have included Jack Nicholson and Mariah Carey. 

Mr. Eads’s success has produced no shortage of jealousy in Houston. 

“A lot of people don’t like him because he got ahead of everyone else,” said Chip Johnson, chief executive of Carrizo Oil and Gas, who made two big deals in which Mr. Eads was involved. “He got the reputation for overselling, but I have a hard time believing you can fool the big companies.” 

“Without him,” Mr. Johnson added, “the country would not have had the huge gas supply as quickly as we did.” 

Others have been more critical. 

“He is like the bartender serving drinks for people who can’t handle it,” said Fadel Gheit, a managing director at Oppenheimer & Company, about Mr. Eads. “And the whole gas industry has gotten a rude awakening, a hangover, with gas prices plummeting. The investment bankers were happy to help with a smile and get their cut.” 

A Train Without Brakes

“Quit drilling,” T. Boone Pickens, the Texas oilman, barked to his fellow board members at Exco Resources, a small, independent drilling company based in Dallas that, like Chesapeake, had made a big bet in the Haynesville. “Shut her down.” 

Mr. Pickens, 84, made billions of dollars as a hedge fund manager and wildcatter drilling for oil and gas. He borrowed heavily to build up the oil and gas reserves of Mesa Inc. in the late 1980s before losing the company during its financial difficulties a decade later, when drooping gas prices hurt its ability to repay debts and pay dividends. He wanted Exco to avoid a similar fate. 

There was only one problem: under the contracts that Exco signed, it couldn’t stop drilling. 

The company followed Chesapeake’s lead and struck its own $1.3 billion cash-and-carry deal with the BG Group, a British gas company. BG paid Exco $655 million in cash upfront and agreed to foot 75 percent of the bill for future drilling in the Haynesville in return for a share in future profits on the gas produced. 

When the arrangement was made, it seemed like a winner all around. Exco had more than 53,000 acres of leases in the Haynesville, but like Chesapeake, it lacked the money it needed to drill on all the land. BG’s financing helped Exco to increase the number of rigs it had working in the Haynesville to 22 from four. 

Nevertheless, the agreement, negotiated by Goldman Sachs, came with some important strings attached: Exco had to keep all 22 rigs drilling for gas, even as the price was dropping. BG wanted to reach certain targets for drilling wells and producing gas in the United States, and it was intent on sticking with the plan, even if its partner now insisted that it made no economic sense. 

“They are great partners, but they have their pedal down around the world, and we are part of that,” Douglas H. Miller, Exco’s chief executive, explained to Wall Street analysts last year.

Mr. Pickens was furious. “We are stupid to drill these wells,” he said in a recent interview. 

But Exco was not alone. Many of its fellow gas companies — including Chesapeake and Petrohawk — had little choice through last year but to keep drilling, no matter how low the price fell or how big a glut was forming. 

It wasn’t just the cash-and-carry deals that were forcing them to drill. 

The land that the natural gas companies had leased, in most cases, came with “use it or lose it” clauses that required them to start drilling within three years and begin paying royalties to the landowners or lose the leases. 

Exco, Chesapeake and others initially boasted about how many acres they had managed to lock up. But after paying bonuses of up to $20,000 an acre to the landowners, the companies could not afford to lose the leases, even if the low price of natural gas meant that drilling more wells was a losing proposition. 

The industry was also driven to keep drilling because of the perverse way that Wall Street values oil and gas companies. Analysts rate drillers on their so-called proven reserves, an estimate of how much oil and gas they have in the ground. Simply by drilling a single well, they could then count as part of their reserves nearby future well sites. In this case, higher reserves generally led to a higher stock price, even though some of the companies were losing money each quarter and piling up billions of dollars in debt. 

Just as in the earlier real estate bubble, the main players publicly predicted success even as, privately, their doubts were growing, court documents show. 

Mr. McClendon suggested in August 2008 to Wall Street analysts that he had fundamentally transformed the once-risky, century-old oil and gas business into something with the reliability of an assembly line.

“We consider ourselves to be in the gas manufacturing business, and that requires four inputs in our opinion — those inputs are land, people, science and, of course, capital,” Mr. McClendon told the analysts. “We think that’s pretty impressive and hope you do as well.” 

But soon after, he told some Chesapeake employees that the company might have made some big mistakes. “What was a fair price 90 days ago for a lease is now overpriced by a factor of at least 2x given the dramatic worsening of the natural gas and financial markets,” Mr. McClendon wrote in an October 2008 e-mail that has since become public in a lawsuit against Chesapeake. 

And as with so many other shale gas players, Chesapeake struck so many complicated financial deals that it couldn’t stop ramping up the gas factory. 

“At least half and probably two-thirds or three-quarters of our gas drilling is what I would call involuntary,” Mr. McClendon acknowledged at one point. 

For him, the drilling binge had some significant financial consequences. During the good times, Chesapeake paid him handsomely in cash and perks. He achieved a net worth of over $1 billion, and he made it to the Forbes list of the 400 wealthiest Americans. He bought homes in Bermuda, Colorado and Hawaii, as well as a stake in the Oklahoma City Thunder basketball team. 

An unusual company program also allowed Mr. McClendon to buy a small personal stake in Chesapeake’s wells. That is expected to reap more than $400 million for him over the 15- to 20-year life of the wells, although it has strained his personal finances for now. An investigation by Reuters detailed how Mr. McClendon had borrowed heavily from Chesapeake business partners to help finance his share of the wells’ costs. That and other issues drew the scrutiny of the Securities and Exchange Commission, shook investor confidence in him and prompted a shake-up of Chesapeake’s board that included the removal of Mr. McClendon as chairman. 

(Mr. McClendon refused requests to be interviewed for this article, and he did not respond to a list of questions.) 

Mr. Eads appears to have fared better. He had seen the coming crash, and, as any master salesman would, found a way to play both sides. He continued to persuade new investors of the great potential in shale while telling his longtime clients to cash out. 

“It is a great time to sell,” Mr. Eads recalled telling Terry Pegula, the founder of East Resources, who had built up his own operation in the Marcellus region of Pennsylvania from one well to 75 over the course of one year. “With all these new plays popping up, I had a real concern gas prices would weaken.”

Mr. Eads then helped arrange what will go down as one of the great early paydays of the shale revolution: the 2010 sale of East Resources, which Mr. Pegula had started with $7,500 borrowed from family and friends, to Royal Dutch Shell for $4.7 billion. 

There were a handful of other such profit takers, including the Houston businessman Floyd Wilson, who created a company in 2003 called Petrohawk Energy with the intention from the start of selling it. Petrohawk drilled its first Haynesville well in 2008. Last year, it sold itself to an Australian energy conglomerate, BHP Billiton, in a $15 billion deal that brought Mr. Wilson and other executives a payout worth at least $304 million. 

But for many gas drillers, there has been only pain. 

Exco, whose production of natural gas was still rising in the Haynesville as of early this year, saw its credit rating downgraded in May. It reported a loss of nearly $780 million for the first half of the year, before write-offs and other adjustments, even after it reduced its work force and rig count. BG, its joint venture partner, reported in July that it was taking a $1.3 billion write-down on its shale gas investments in the United States, including the Haynesville deal with Exco. 

Plains Exploration, which celebrated its first deal with Chesapeake back in 2008, reported a loss for the first quarter this year, but has since shifted heavily away from gas to oil production and is making money again. Warm weather last winter exacerbated the glut to historic levels, reducing prices even further, since so little gas was needed to heat homes in many parts of the nation. 

Chesapeake’s stock price sank this year after it was revealed that Mr. McClendon had taken a personal stake in Chesapeake wells and then used those investments as collateral for up to $1.1 billion in loans used mostly to pay for his share of the cost of drilling those wells. The company is trying to raise $14 billion this year by shedding assets, a goal it has almost reached with huge recent sales of West Texas oil and gas fields and pipelines to Royal Dutch Shell and Chevron. 

To help the company through this difficult patch, Mr. McClendon turned to his old friend, Mr. Eads. Jefferies & Company, joined by Goldman Sachs, offered Chesapeake an emergency $4 billion unsecured bridge loan, at 8.5 percent interest, to give the company a lifeline until it could sell enough assets to keep afloat. (The company says it intends to pay back the entire loan this year from recent sales.) 

In hindsight, it should have been clear to everyone that a bust was likely to occur, with so many new wells being drilled and so much money financing them. 

But everyone was too busy working out new deals to pay much heed. 

The bust has certainly hit the Haynesville hard. Some local landowners, having spent their initial lease bonuses, are now deeply in debt. Local restaurants and other businesses are suffering steep losses now that so many drillers have left town. 

“At this point we’re struggling,” said Shelby Spurlock, co-owner of Cafe 171 in the town of Mansfield. The restaurant is decorated with wall collages of drill worker uniforms from companies that are leaving the area. Once open from 4 a.m. to 10 p.m. and employing four servers, the restaurant has cut its hours and is down to two servers. “Our very existence is in danger,” she sighed. 

Mr. Eads, ever the deal maker, is unfazed. He tells anyone who will listen that the price of natural gas will eventually recover. He is making money, meanwhile, helping struggling companies and opportunistic investors strike deals at the new, lower prices. 

“These shale assets are forever,” he said. “They are going to produce for a hundred years.” 

Source: http://www.nytimes.com/2012/10/21/business/energy-environment/in-a-natural-gas-glut-big-winners-and-losers.html?gwh=4EF02441B478F83613CC96156951883F&pagewanted=all

Dollar bears in for shock if US cuts energy imports

The future of the dollar is more likely to be determined in the shale gas and oilfields of Dakota and Texas than in the sovereign wealth funds of Asia and the Middle East. This is because striking new technological developments are set to transform America’s energy supplies, significantly improving the US balance of payments and the long-term outlook for the greenback.

The US’s current account deficit has been a longstanding drag on the dollar. At the height of the credit boom in 2006, it reached $800bn or 6 per cent of gross domestic product. Though the deficit has halved as the credit crunch has lowered imports, it still stands at 3 per cent of GDP, largely because the US, like the eurozone, Japan, China and India, remains a major energy importer, with annual net foreign oil purchases of $300bn a year. As the US economy slowly recovers, the International Monetary Fund expects the US current account deficit to start rising again. That would lead to foreign central banks accumulating greater reserves of dollars.

But such straight-line forecasts are likely to be challenged as the US’s shale gas and “tight oil” reserves are commercially exploited over the next few years. The US has vast reserves of shale gas but, until recently, energy companies were unable to tap the gas trapped in shale rock. Now, through hydraulic fracturing or ‘fracking’, US reserves of economically available gas supplies have started to rise sharply.

Already the ratio of US gas reserves to annual production has increased from eight years to 12 years. This may not appear substantial when compared to other regions of the world. Qatar, for example, has proven gas reserves well above 100 years of current production. But fracking may allow the US to soon count up to one hundred years of gas reserves relative to current production. That would lead to a major shift in the US’s energy outlook.

In addition the exploitation of tight oilfields through new technology is increasing the US’s domestic oil production relative to imports. This marks a significant departure from the past three decades, when the share of US oil consumption accounted for by foreign supplies rose from around 30 per cent in the 1980s to over 65 per cent by the time the credit crunch began in 2007. In 2010 imports had already declined to 61 per cent of total US oil consumption and are set to decrease further.

More strikingly, the US is starting to export oil again given its increased domestic oil production. Ten years ago, US oil exports were less than 10 per cent of the country’s oil imports. Now they are close to 20 per cent of US imports as local oil output surges. For example, North Dakota yielded more than 500,000 barrels of oil a day at the end of last year, exceeding the production of Opec member Ecuador.

There remain significant environmental concerns regarding the use of fracking to exploit shale gas in commercial quantities. But if America is able to dramatically increase its energy reserves, then it can reduce its reliance on foreign supplies – particularly from volatile regions such as the Middle East.

Over time this would engineer a sharp improvement in the US current account deficit. As the US’s net oil import position accounts for the lion’s share of its balance of payments deficit, increased domestic production has the potential to reduce the US current account deficit from 3 per cent of GDP to lower levels, or even send it into a surplus over the next decade.

The US economy last ran a current account surplus at the start of the 1990s. If the US is able to return to a similar position over the next few years owing to reduced energy imports, it would have three important consequences for financial markets and the global economy.

First, in the foreign exchange markets, the dollar would continue its recovery against the euro and other major currencies that began during the financial crisis of 2008. Consensus forecasts that the greenback will keep on depreciating to rebalance America’s current account deficit will need to be torn up.

Second, the negative relationship between oil prices and the dollar would break down. China and India are still likely to be large consumers of Middle East energy but significantly reduced US foreign oil purchases will limit the growth of the region’s sovereign wealth funds. As a result, their dollar-diversifying activities, heightened when oil prices rise, will be constrained in future.

Third, stronger growth in the US on the back of a more balanced economy would call into question the Fed’s current stance of keeping monetary policy super-loose.

Thus the conventional wisdom of an ever-weakening greenback is likely to become obsolete. Over the next decade, the currency is set to benefit from the US’s reduced reliance on foreign energy. That will be a positive shock for US consumers and companies and a negative shock for long-term dollar bears.

Source: http://www.ft.com/intl/cms/s/0/91501a42-5273-11e1-ae2c-00144feabdc0.html#axzz1mYi1Q0j0

Boeing: Faster, faster, faster

THERE are not many businesses in which the next six years’ worth of customers form an orderly queue, putting down fat deposits and topping them up with further instalments as they wait in line. But that is Boeing’s fortunate position. On January 25th it announced a 21% rise in annual net profits, to $4 billion.

Last September, after three years of delay, Boeing made the first deliveries of its newest model, the 787 Dreamliner. A revamped version of the trusty but ageing 747 jumbo has also arrived, two years late. A few airlines got fed up and cancelled, but most had little choice but to keep waiting. Boeing’s main rival, Airbus, has an even longer backlog—up to eight years at current production rates. And the delivery schedule for Airbus’s answer to the Dreamliner, the A350, has been slipping.

Last year, straining to ramp up production to meet soaring demand, the two big planemakers turned out a record 1,011 airliners between them. But for every plane they delivered, they won more than two fresh orders (net of cancellations), so the queue got longer. On January 25th Boeing won its largest-ever order from Europe: Norwegian Air Shuttle is to buy 122 planes worth $11.4 billion at list prices.

The lion’s share of 2011’s advance orders were for the A320neo, a re-engined version of Airbus’s short-haul airliner, which should enter service in 2015. This year the plane most in demand looks to be the 737MAX, a re-engined version of Boeing’s short-haul plane, deliveries of which are due to start in 2017.

At Boeing’s Renton factory near Seattle the existing version of the 737 is now being turned out at a record rate of 35 a month, after a recent speeding-up of the two assembly lines. At the front of assembly line number one, a plane destined for flydubai, an airline that can’t afford capital letters, is ready to roll. Behind it is the latest addition to Ryanair’s huge fleet of 737s, which has just had its engines fitted. Next, a Korean Air plane which is about to receive rows of seats; then an Azerbaijan Airlines jet, its toilet cubicles lined up alongside ready for installation. The plan is to increase the production rate further, to 42 a month by 2014. Fortunately, there is space to squeeze a third assembly line into the giant hangar.

Likewise, at Boeing’s Everett factory to the north of Seattle and another plant in South Carolina, plans are afoot to churn out more of the company’s bigger jets, including the 787. But the 40-odd unfinished Dreamliners scattered around the Everett campus and elsewhere are a reminder of how such attempts to ramp up production can go wrong. Having first suffered from a worldwide shortage of the fasteners that hold bits of the plane together, the 787 was then held back further by other mishaps, including faulty horizontal stabilisers sent by an Italian supplier. Boeing is struggling to correct the problems on the unfinished planes even as it strives to get its production lines turning out ten fault-free 787s a month by the end of next year.

The head of Boeing’s commercial-airliner division, Jim Albaugh, admits that with hindsight too much of the Dreamliner programme was contracted out to other firms. Some work has been brought back in-house so that it can be more closely supervised. The planemaker has also set up a “war room” that constantly monitors the world’s supply of aircraft parts and raw materials. It has signed a long-term deal with a Russian metals firm to ensure a steady supply of crucial components made from titanium. And it has hired hundreds of “examiners” to visit suppliers, to check that they are building up production to meet Boeing’s increasing needs and chivvy them along if not.

Boeing’s assembly plants are the final stage in a long and hugely complex global supply chain. It has about 1,200 “tier-one” suppliers, which provide parts directly to the planemaker from 5,400 factories in 40 countries. These in turn are fed by thousands more “tier-two” suppliers, which themselves receive parts from countless others. Beverly Wyse, who oversees production of the 737, admits that it has sometimes been a job to persuade all these suppliers to invest enough to meet future demand. To do so, Boeing has had to learn to be more open with them about its production plans, and a bit less paranoid about whether such information might reach the ears of its competitors.

Even with all these new measures in place, Boeing’s plans to boost production of the Dreamliner remain “hugely ambitious”, reckons Richard Aboulafia of Teal Group, an aviation consultancy. He wonders if the planemaker is serious about its target of making ten of them a month, or whether it is just bandying about an unrealistic figure to rev up its suppliers. “Not true,” retorts Mr Albaugh. Boeing has every intention of reaching the goal, he says.

Fasten your seat belts

Still, with the world economy looking wobbly and the euro-area crisis far from over, might suppliers not have good reason to fear that the recent surge in aircraft orders could go into reverse thrust? Myles Walton, an aerospace analyst at Deutsche Bank, believes that both Boeing and Airbus have quietly begun double-booking some of their delivery slots, in case a customer collapses. He reckons they have done enough of this to cope with the worst imaginable recession in Europe.

Perhaps the biggest risk on the horizon would be a sustained surge in the price of oil, which could send airlines into a tailspin of losses and bankruptcy. So far, though, the chief worry for Boeing and its main rival is how to get their products flying out of the door faster.

Source: http://www.economist.com/node/21543555

Can Big Oil Repeat Its Big Year?

Even today, $1.67 trillion is a lot of money. That is the amount wiped off the combined market capitalization of the top 50 energy companies between the end of 2007 and the end of 2011. Breaking it down offers big clues on Big Oil's prospects for 2012.

Every year, PFC Energy, a Washington, D.C.-based consultancy, ranks the top 50 listed energy companies in the world by market value. The latest, due Monday, has a surprise. The biggest gainers in 2011 were the dinosaurs of oil and gas: the supermajors. Their collective value increased by 8%, compared with a 7% decline for the PFC Energy 50 overall. It is only the second time they have led the field in the ranking's 13-year history.

Conventional wisdom holds this shouldn't be the case. Faith in the supermajors—Exxon Mobil, Chevron, Royal Dutch Shell, BP, ConocoPhillips and Total—has waned as state-backed rivals like PetroChina have emerged and smaller competitors have opened up new frontiers like U.S. shale. Seemingly too big to grow but too small to offset the power of petro-states, the supermajors have been priced for decline.

Why did investors fall in love with them again in 2011? First and foremost: security. The S&P 500 ended 2011 down slightly after wild swings. In choppy markets, scale and cash payouts provide comfort. And the supermajors, with a collective value of $1.2 trillion at year end, provide it in spades. The three U.S. ones alone paid out 9% of all S&P 500 dividends and buybacks in the year ended September 2011, according to data from Standard & Poor's and Capital IQ.



So how about that missing $1.67 trillion? It is gone despite the average price of Brent crude being 53% higher in 2011 than in 2007 (and 13% higher than in 2008, year of the super-spike). About half of that market value was lost by listed state-controlled national oil companies, or NOCs, like PetroChina. State support has its advantages, but it also means NOCs serve two masters: markets and mandarins. That makes them riskier investments.

While the NOCs in the ranking lost 44% of their value between 2007 and 2011, the supermajors declined by just 22%.

But it isn't just safety that helped the supermajors lead the charge in 2011. Chevron, Exxon and Shell likely all delivered cash flow per share growth of 30% in 2011, well ahead of the traditional growth stocks of the exploration and production sector, according to Credit Suisse.

Ed Westlake, analyst at Credit Suisse, says the oil majors are more sensitive to oil prices than many investors think. In part, that is because much of their global natural-gas production is sold at prices linked to oil, rather than at the depressed, de-linked levels that prevail in the U.S.

This year, the supermajors are forecast to make $67 billion in free cash flow, according to FactSet Research Systems. That is down slightly from 2011's expectation but still equates to a healthy free cash flow yield of 5.6%.

Goldman Sachs points out, however, that unlike a year ago, supermajor stocks enter 2012 trading at a slight premium to their smaller integrated oil peers. That, coupled with the fact that 2011's cash-flow surge is unlikely to be repeated, means some investors' gains may be redeployed into other energy stocks.

It seems unlikely that the supermajors will register the biggest gains in the PFC Energy 50 2012. That doesn't make them a bad investment. With markets still unsettled—Europe, in particular, remains unpredictable—Big Oil will likely remain a safe haven. Stocks don't always have to be the biggest winners to be reliable repositories of value.

Source: http://online.wsj.com/article/SB10001424052970203750404577173191238523960.html?mod=WSJ_Heard_LEFTSecondNews

Japanese firms shop abroad: Armed with a strong yen

MR TICKLE and Mr Bump are leaping into bed with Hello Kitty. Sanrio, the owner of the bow-adorned feline, said on December 6th that it had acquired the “Mr Men” franchise from Chorion of Britain. The deal, for an estimated ¥3 billion ($40m), brings the Japanese design and licensing firm 86 playful characters who have delighted toddlers in 30 countries and shifted 100m books.

Corporate Japan is on an overseas shopping spree. Japanese firms spent a record $80 billion on some 620 foreign companies in 2011, according to Dealogic, a firm that measures such things (see chart), exceeding the previous record of 466 deals worth $75 billion in 2008. When Japan Inc went shopping abroad in the 1980s, it was a sign of strength. Japanese companies were spreading their wings because they were growing. This time, it is a symptom of weakness.

The past year in Japan has been wretched. An earthquake and tsunami in March wrecked factories and disrupted supply chains, creating shortages of all sorts of crucial components. Radiation fears hurt exports. A strong yen walloped profits. Floods in Thailand interrupted the distribution of electronics and car parts. Corporate-governance scandals cast a black cloud over blue suits nationwide.

The Japanese population is ageing and shrinking. The economy is sluggish. Consumption is lacklustre. So Japanese firms find it nearly impossible to expand domestically. At the same time, thanks to crises elsewhere in the rich world, the yen is extraordinarily strong. It has appreciated by 45% against the dollar in the past four years. And having learned thrift during their own banking crisis a decade ago, Japanese firms are flush: big listed companies are sitting on a cash pile of ¥60 trillion.

With all this buying power and few opportunities at home, it is hardly surprising that Japanese firms are snapping up foreign companies, especially in fast-growing emerging economies. “Unless we grow we’re not able to stay alive simply by staying in Japan,” explains Tadashi Yanai, the boss of Uniqlo’s Fast Retailing, a big clothing firm. The time is ripe for foreign deals, he chirps. The economic crises in America and Europe have pummelled share prices, making companies cheaper to acquire.

Back in the 1980s Japanese firms hunted trophies such as golf courses and film studios. Now they are taking a more pragmatic approach, buying solid firms in fast-growing markets and filling gaps in their product lines.

For example, Kirin, a big Japanese brewer, is acquiring a majority stake in Schincariol, a Brazilian one, for $2.6 billion. The Japanese beer market is flat; Brazil’s is growing by 10% a year. The biggest deal of the year was when Takeda, a Japanese drug firm, bought Nycomed, a Swiss one, for ¥1 trillion. Almost 40% of Nycomed’s sales are in emerging markets.

Japanese trading houses are hungrily buying energy projects, especially those involving shale gas. This year they spent $10 billion, up from less than $3 billion in 2010. The pace of such deals accelerated after Japanese nuclear-power plants were suspended following the nuclear accident at Fukushima in March, which made many Japanese worry about their energy supply. Toshiba spent $1.6 billion on Landis+Gyr, which makes “smart” electricity meters for homes. Sony paid $8.4 billion for control of its cellphone venture, Sony Ericsson, a stake in the record label EMI and other stuff.

This time really is different

In the past, Japanese firms would parachute in bosses from Tokyo to run the show. Many were monocultural and mediocre. Now, Japanese firms wisely rely on local talent. Many of the new generation of Japanese executives have lived and worked abroad, notes Shinsuke Tsunoda, the head of mergers and acquisitions in Japan at Nomura, a Japanese securities house. This means they are more comfortable doing deals with foreigners, and they are better at integrating the foreign firms they buy with their new Japanese owners.

The foreign shopping spree is internationalising Japanese industry by the back door. Japan Inc is acting like a massive sovereign-wealth fund, placing its money abroad to earn investment income at home (and help Japan maintain a current-account surplus).

When old people retire, they tend to live off their savings. They supply capital to younger, sprightlier, cash-strapped folk, who put it to work and pay dividends or interest to the retirees. That is, roughly speaking, what Asia’s ageing archipelago is starting to do.

Source: http://www.economist.com/node/21541848