 | ||
June 6, 2009 Editor's Note: Long-time PF Weekly readers know that one of my favorite energy sub-sectors for generating income is the master limited partnership (MLP) group. I've teamed up with income guru Roger Conrad on a detailed report on the MLP sector, which includes a handful of our favorite names. This report--complementary to PFW readers--is available here. -- Elliott Gue | ||
| Fishy Weather, Agriculture and Energy | ||
On the night of Oct. 15, 1987 the British public retired to bed expecting some windy weather and rain but nothing like the storm that actually hit southern England in the early morning hours of Oct. 16. Many had been reassured by a 9:30 pm forecast on the BBC; weatherman Michael Fish predicted that a hurricane wasn't going to hit the British Isles that evening. Just a few hours after that broadcast aired, southwest England experienced sustained winds over 70 miles per hour (mph) and gusts as high as 122 mph. Just a few hours after that, London experienced hurricane-like conditions, with sustained winds over 70 mph hitting Heathrow Airport, downing trees and closing motorways. In short, it was the worst storm to hit England since 1703, and it caused significant damage. Nearly a decade later, when I was living in London, Fish's name was still infamous for and synonymous with that wildly incorrect weather forecast. Fish himself never lived this incident down, though since his retirement in 2004 he's repeatedly denied his culpability. But one thing is for certain: Fish was neither the first nor will he be the last weatherman to make a bad call. His alleged blunder just goes to show how tough it is to predict the weather, even over a relatively short time period. Nevertheless, the weather is an important factor for investors to consider; expectations and forecasts, even when they ultimately prove incorrect, have a meaningful impact on some key market sectors. In this regard, one of the factors I watch most closely is El Niño Southern Oscillation, more commonly known by the acronym "ENSO."
ENSO refers to a pattern in the atmosphere and ocean in the Tropical Pacific. El Niño is a warming of ocean waters that takes place off the coast of Peru in the Pacific Ocean, typically reaching its peak intensity around Christmas, hence the term El Niño, or "Christ Child." The opposite of El Niño is La Niña, a cooling of waters across the same region of the Pacific. The Southern Oscillation refers to a pattern in the movements of air masses between the eastern and western Pacific; these movements correspond roughly with the El Niño/La Niña cycle. The US National Oceanographic and Atmospheric Administration (NOAA), among other groups, deploy buoys offshore in these key areas to monitor and detect changes in ENSO. At this point you're probably wondering why anyone cares about atmospheric and ocean water temperature in the Tropical Pacific. The reality, however, is that shifts in this cycle have effects on global atmospheric conditions and the path of key ocean currents such as the Atlantic's Gulf Stream. El Niño conditions typically bring warm winter weather to much of the US and are thought to reduce the number and intensity of hurricanes during the peak of Atlantic season in August through October. In contrast, La Niña conditions can bring about colder-than-normal winter temperatures; last year's La Niña event was thought to be a factor that contributed the colder-than-average winter across the US in the winter of 2008-09. El Niño also has major impacts on agriculture. Typically, El Niño events can cause droughts across Australia and other parts of Asia, reducing harvests of key soft commodities such as palm oil, wheat and rice. El Niño also affects agriculture in Latin America and parts of Africa as well as fishing harvests off the west coast of Latin America. Two industries that are profoundly impacted by these weather events: agriculture and energy. Droughts across key farming regions obviously reduce crop yields and tend to be bullish for soft commodity prices and related market sectors such as fertilizer producers, crops and seed producers. Weak Atlantic hurricane seasons coupled with warm winter weather can be bearish for energy demand and, most particularly, for US natural gas prices. At the present time, it appears that El Niño conditions are developing in the Pacific. The Australia Bureau of Meteorology issued a report in early June stating that the chance of El Niño developing this year is greater than 50 percent. And since the chance of El Niño developing in any given year is less than 25 percent, this indicates an extraordinarily elevated risk level compared to historical norms. NOAA issued its own monthly report on ENSO on 4 June, stating that: All statistical models predict ENSO-neutral conditions will continue for the remainder of 2009. However, most dynamical models, including the NCEP Climate Forecast System, predict the onset of El Niño during June-August 2009. Current observations, recent trends and the dynamical model forecasts indicate that conditions are favorable for a transition from ENSO-neutral to El Niño conditions… The elevated risk of a developing El Niño has been one contributing factor to a run-up in the prices of key commodities of late. According to the US Dept of Agriculture, Australia is the world's fourth-largest exporter of wheat, so a weak harvest would curtail supply. Wheat futures have been soaring. Although palm oil is probably an obscure commodity to many American investors, it shouldn't be. Palm oil is the key edible oil across Asia, and China is the world's No. 1 consumer. But that's not to say palm oil isn't used in the US and Europe; if you check out the wrapper on some candy bars, you may well find palm oil among the key ingredients. And palm oil is also becoming an important feedstock in the manufacture of biodiesel in Europe. Biodiesel is, like ethanol, a fuel manufactured from crops. But unlike ethanol, biodiesel isn't an alcohol; it's produced from oilseed crops such as rapeseed, soybeans and palm oil. Biodiesel is also heavily subsidized, particularly in Europe, where cars burning diesel-fuel are far more common than in the US. Palm oil futures collapsed late last year alongside most other commodities, but check out a chart of recent action.
Source: Bloomberg Since late last year palm oil futures prices traded in Malaysia have nearly doubled. The two largest producers are Malaysia and Indonesia, countries that typically see the most drought impact from El Niño events. And even before the risk of El Niño began to develop there were indications of improving fundamentals in the palm oil market. Demand for foodstuffs like palm oil is much less sensitive to economic conditions than demand for products like crude oil; consumption of soft commodities wasn't as badly impacted by last year's credit crunch and global economic meltdown. And, to the extent demand was impacted, it should be expected to improve markedly this year. After all, as I've discussed on numerous occasions over the past few months, the Chinese economy appears to be improving far more quickly than was expected earlier this year. Moreover, palm oil in inventory is dropping fast. According to the Malaysian Palm Oil Board inventories were at 1.29 million metric tons in April, the lowest levels since 1997 and well under the 2.27 million tons in storage in November 2008. In Indonesia, inventories are thought to be even lower, below a million tons. Thus, even before El Niño impacted crops, the supply demand/balance for palm oil looked tight.
And, of course, it's not just palm oil that's being affected; wheat, soybeans and other key commodities are impacted as well. Just as with palm oil, the supply/demand balance already looked tight before the risk of El Niño was first raised by global weather services. This is just another bullish factor likely to push up the costs of all sorts of soft commodities. We can also see that trade in soft commodities (as well as hard commodities) is stepping up again. Check out my chart of the Baltic Dry Index below.
Source: Bloomberg Dry bulk ships are ocean-going vessels designed to carry dry commodities such as coal, iron ore and grains. The Baltic Dry Index is a measure of the rates that dry bulk carriers charge to transport goods. Although rates remain well under last year's highs, the index has more than tripled off its lows, indicating a tightening in the supply/demand relationship for these ships. The rally in the Baltic Dry Index also indicates an ongoing loosening in credit conditions. In most cases, dry bulk shipments are secured by what's known as a letter of credit, typically written by a bank. One of the reasons that the Baltic Dry Index collapsed to such low levels last year was that, thanks to the ongoing credit turmoil, banks stopped writing letters of credit. We've been playing the agriculture markets in The Energy Strategist, my subscription-based advisory, due to the connection between biofuels and food markets. One of the components of my Biofuels Field Bet is MP Evans (London: MPE), a small British company that owns a series palm oil plantations in Indonesia as well as cattle-producing land in Australia. And in the June 24 Personal Finance (available online June 20) we'll be covering some bigger plays on the developing boom in global agriculture. As for energy, as I noted above the primary effect of El Niño would be on US-traded natural gas. The reason is that warm winter weather would tend to suppress demand for residential and commercial heating; this is a key swing factor in terms of gas demand. Second, a below-average hurricane season tends to be gas bearish as the Gulf of Mexico is a key region for natural gas production and processing, and hurricanes disrupt this activity. While such storms would also disrupt oil imports and refining, oil is a global commodity and therefore doesn't tend to see quite the same long-term impacts from Atlantic hurricane season as natural gas. The obvious conclusion is to be bearish natural gas, but I think that's also entirely the wrong read. As with any market, you can't analyze the impact of newsflow without considering price and the way prices react to newsflow. Agricultural commodities have tended to rally in reaction to predictions about El Niño--this bullish newsflow is supporting the rally in the soft commodities and agriculture stocks. However, news about El Niño appears to be already priced into the natural gas market. Gas has been trading around the $3.50 to $4.50 per million British thermal units range for weeks now, and the market has been beset with a constant stream of bad news. Gas prices are currently well off their highs in the mid-teens last summer. After all, US gas inventories are extremely glutted for this time of year, the highest they've been at this time of year over the past five years. Gas production is booming thanks, in large part, to a boom in drilling activity over the summer of 2008 and the extraordinary growth in production from America's ocean of gas locked in unconventional reserves such as the Barnett and Haynesville shales. On top of that, forecasters are calling for a cooler-than-average summer dampening demand for cooling and, in turn, gas-fired power. Meanwhile, industrial demand collapsed last year with the economy and many believe will take time to rebuild; industry accounts for about a third of US gas demand. And many pundits are worried about an influx of liquefied natural gas (LNG) into the US this summer due to the fact that several new LNG liquefaction (export) projects are due to come on-line this year; all that gas will be looking for a market. El Niño would hit demand even harder, pushing down winter heating demand and reducing hurricane disruption potential. Most analysts already expect natural gas inventories to reach their physical maximum levels by the end of the injection season in November, if not far sooner. Yet natural gas prices haven't been able to push much below $3.50 despite the steady drumbeat of bad news. This week, the US Energy Information Administration (EIA) reported a build in US gas inventories of 124 billion cubic feet (bcf), well above analysts' consensus expectations for a build of 115 bcf. In fact, a 124 bcf build is the fourth-largest weekly build of gas in storage since the EIA started collecting and reporting weekly data. Predictably, natural gas prices tumbled in the wake of the report. But by the end of the day, gas was actually trading higher, and that strength followed through on Friday morning as well. In other words, natural gas is tending to rally despite bad news. You should always sit up and take notice when a market reacts positively to bad news. This simple indicator will highlight some of the best investing opportunities you'll encounter. This seeming paradox is a classic example of a washed-out market that already reflects the worst possible news on inventories, summer weather and demand. Since the market is already replete with bears there just aren't many potential sellers left. Meanwhile, gas doesn't reflect some key positives such as the rapid decline in US gas production likely to result from the 60 percent decline in drilling rigs actively drilling for gas in the US since last August. For a deeper look at what's happening in the natural gas market, including specific ways to play it, check out the June 3 issue of The Energy Strategist, The New Super-Cycle. Speaking Engagements Eight score and one year ago, with the onset of the California Gold Rush, San Francisco earned a reputation as a prospector's town. It's time again to seek paths to prosperity--and to enjoy one of the most beautiful natural settings in the US, if not the world. Venture west for the San Francisco Money Show Aug. 21-23, 2009, at the The San Francisco Marriott and discover how Elliott Gue, Roger Conrad and GS Early can help you profit in these adventurous times. Elliott will detail the new direction for Personal Finance and provide his forecast on energy markets for 2009. Roger will discuss utilities, Canadian income and royalty trusts as well as his new service focused on exploiting the greatest spending boom in history, New World 3.0. GS, a constant at PF for two decades, will be there to speak on emerging tech, nanotech and defense tech. Click here or call 800-970-4355 and refer to priority code 014315 to register as a guest of Personal Finance. | ||
| You're receiving PF Weekly at finan4@finanmart.com because you indicated your interest in having a a subscription to this publication. If you no longer wish to receive, please unsubscribe here. Please do not reply to this message. To contact us, please use our contact form. Copyright 2009 KCI Communications, Inc.7600A Leesburg Pike West Building, Suite 300 Falls Church, VA 22043
| ||
Personal Finance Weekly - Fishy Weather, Agriculture and Energy
