Tar Babies

In this essay, which originally ran in The Rude Awakening on Oct. 14, 2004, Eric Fry wonders what he and a 76-year old multimillionaire have in common…and can only come up with one answer – oil.

Ouch! We commodity bulls suffered more pain and misery yesterday than an insubordinate sailor on the HMS Bounty. Mr. Market viciously lashed us resource investors, as if he were wielding a cat-o’-nine tails. The salty and seasoned buyers of resource stocks understand that sell offs in the sector tend to be fast and furious, which is why we mentioned earlier this week the idea of finding "backdoor" plays. Even so, the trauma of sharply falling share prices is always slightly more shocking and slightly more painful than anticipated.

Yesterday’s most notable "lowlight" would be the nine-dollar intraday drop in the shares of Phelps Dodge, as copper prices suffered their biggest one-day drop in 14 years. Other notable lowlights – a $1.00 drop in the price of crude oil and a $6.00 drop in the price of gold – became highlights by day’s end, as both commodities reversed themselves and charged higher during the afternoon. Perhaps – although we strongly doubt it – the bull market in natural resources is winding down. This bull market seems to be the real deal – potent, durable and long-lived…so let’s turn our attention to this new "buying opportunity," and in the process return to Mr. T. Boone Pickens.

What do T. Boone Pickens and your New York editor have in common? Almost nothing, as it turns out. The 76-year old oilman has about $10,000,000 in the bank for every year that he has walked the earth. Your 45-year old editor has barely amassed 10,000,000 pennies in total. Pickens earned a few of his millions in the 1980s by raiding large corporations. Your editor has never raided anything larger than a cookie jar. Pickens runs a billion-dollar, oil-based hedge fund. Your editor once used an oil-based paint…

Oil Sands: Suncor Energy

But there is one lone similarity between the wealthy Texan and the house-poor New Yorker; we are both keen to invest in the oil sands of Alberta, Canada. Specifically, we both own shares of Suncor Energy, a company that extracts synthetic crude oil from oil sands – also known as tar sands. "Our number one pick is Suncor," Pickens informed Bloomberg News last August.

And as many Rude Awakening readers might be well aware, Suncor has also been a long-time recommendation of Outstanding Investments, which first recommended the stock in April of 2001 at a price of $12.69. The stock closed yesterday at $32.58.

But Suncor, itself, is not the focus is today’s column. (After all, every investor is fallible. So what difference does it make that three fallible investors all like the same stock? Furthermore, dear reader, please remember that your editor’s stake in Suncor does not in any way imply an endorsement of the stock or a recommendation to purchase the stock.) Rather, our interest lies in the long-term investment appeal of the oil sands themselves. Suncor is but one of the three main publicly traded entities devoted to extracting "syncrude" from the oil sands – the other two being Western Oil Sands, also a recommendation of Outstanding Investments. WTO on the Toronto Stock Exchange) and the Canadian Oil Sands Trust (COS-U on the TSE).

The oil sand reserve is massive – currently pegged at 175 billion barrels, based upon current extraction technologies. But few investors or global energy consumers paid much attention to this vast resource…until recently. For one thing, this gargantuan oil reserve did not technically exist until early last year. "North America’s share of the world’s oil reserves," Petroleum News reports, "rocketed to 18 percent last year from 5 percent in 2001, for one reason – the vast oil sands reserves of northern Alberta. Now that the sprawling resource has been officially added to the global energy mix, Cambridge Energy Research Associates said Canada’s oil reserves alone rose to 180 billion barrels from 5.6 billion barrels and helped push the world tally up by 18 percent to 1.213 trillion."

Oil Sands: Number Two with a Bullet

180 billion barrels, therefore, elevates Canada to the number two slot on the petroleum pecking order, right behind Saudi Arabia’s 259 billion barrels (if we are to believe the official numbers). However, the Alberta Energy and Utilities Board believes that rapidly emerging technologies will boost recoverable reserves to 315 billion barrels, thereby vaulting Canada into the number one slot.

In an era of $50 oil, and increasingly unreliable supply chains, the oil sands of Alberta assume a far more prominent position – strategically and geologically – among the world’s largest deposits. For one thing, $50 oil renders the relatively high-cost production of syncrude immensely profitable. Secondly, as Outstanding Investments argued persuasively in an April 2003 Daily Reckoning essay…

"Since homegrown sources of hydrocarbons are satisfying less and less of our domestic energy needs, we must rely more and more on foreign sources. All else being equal, domestic is better." Net-net, the world has changed suddenly and dramatically in ways that should enhance the long-term value of the oil sands."

Is it any wonder the Chinese are descending on Alberta to secure long-term supplies from the oil sands? "Sinopec Corp., the giant Chinese energy company, is eyeing a major investment in Alberta’s oil sands," Canada’s Globe and Mail reports, "as it pushes to secure supplies for its booming home market. That push comes even as the United States increasingly looks to the oil sands as a secure source of supply for its own uses, with terrorism and other geopolitical upheaval threatening conventional oil production overseas."

Oil Sands: Wandering to the West

Not for nothing is China’s wandering eye for oil reserves wandering to the West. Supplies from the East – not to mention the Middle East – have become increasingly unreliable. Just last month, the troubled Russian oil company, Yukos, abruptly halted crude oil shipments to Petrochina, forcing the Chinese to look elsewhere for supply…and so they are. Petrochina has begun negotiating with the Canadian Oil Sands Trust to structure a long-term agreement to buy synthetic crude from the joint venture in which the trust is the largest shareholder.

Meanwhile, officials from Sinopec, the other large Chinese oil company, have been sniffing around in the oil sands recently. "I met with them in Beijing [last June]," explains Alberta Premier Ralph Klein, "and true to their word they came over to examine the potential of investing in the tar sands. We encourage their investment…what they’re talking about is either joint-venturing with an existing oil sands developer or acquiring a new lease."

Until recently, investors exhibited little evident preference for "safe" oil reserves, versus "at risk" oil reserves. But over the last several months, the oil sands stocks have been outpacing the shares of multinational oil giants like BP and Exxon.

We would not be surprised to see this trend continue, as the world’s oil buyers develop a growing appetite for Alberta’s "safe and sane" oil sands reserves.

Regards,

Eric Fry
for The Daily Reckoning
December 7, 2004

P.S. Outstanding Investments has a portfolio loaded with top quality resource picks, and it’s soaring. It’s no surprise then that Outstanding Investments is following these trends like a hawk. If you were thinking of making an investment in the oil sands, you’d be well served to check out the service.

Someone ought to thank him. Perhaps a little gift would be appropriate. Say, sleeping pills – or a hara-kiri sword. What the man needs now is sleep. Ritual disembowelment is for the future.

Masatsugu Asakawa, that is.

Without him, many Americans couldn’t pay their mortgages. They couldn’t buy more than they can afford at Everyday Low Prices at Wal-Mart. America’s delusional EZ credit bubble would have already exploded – had it not been for Mr. Asakawa, who is the Japanese official with the daunting responsibility of managing Japan’s $720 billion worth of U.S. government securities.

We saw his picture in yesterday’s paper. The poor man looked tired, with circles under his eyes. In the text of the article, we found out why. It was just what we expected.

You recall, dear reader, how we’ve wondered why the Japanese continued to hold U.S. government paper in the face of a falling dollar? It made no sense. In the last three months, the dollar has lost 12% against euros… and 8% against yen. Let’s see, 8% of $720 billion is $57.6 billion. That is a lot of money, even for people as rich as the Japanese.

"If you owe your banker $1,000, you don’t sleep well," says the old American adage. "But when you owe him a million dollars, it’s the banker who cannot sleep." Times have changed, of course, and in America both creditors and debtors sleep soundly – secure in the knowledge that Mr. Alan Greenspan is wide-awake, his bony fingers wrapped around every knob and lever of the Great American Economy of 2004. (More on that below…)

America is not only a debtor nation, but also the biggest debtor nation the world has ever seen. Its overseas liabilities total $3.3 trillion – or 28% of its GDP. No one has ever seen such a pile of debt. And no where are U.S. debts stacked higher than in Japan, where poor Mr. Asakawa tosses and turns at night – fearful that the whole mountain will fall down at any moment.

So worried is he that he keeps a sort of money seismometer ticking by his bedside, to alert him should the ground beneath him begin to give way. The International Herald Tribune reports:

"’This thing wakes me up, it is terrible,’ Asakawa said as he toyed with a blue plastic portable currency monitor. After hours, the wireless device beeps by his bedside whenever the dollar strays beyond a set range."

Again, we stop dead in our tracks and hold our breath. We can scarcely believe it; what a wonderful, madcap world we live in. On one side of the world, 280 million people doze happily; apparently unaware that Mr. Asakawa could ruin their Christmas at any moment. All he has to do is pick up the phone and utter a single syllable: sell! In seconds, the U.S. bond market would begin falling apart. Seconds later, mortgage credit would disappear. Seconds later, stocks would crash…and real estate prices…and consumer buying…and GDP growth…and all the other delusions upon with the American consumer economy depends.

On the other side of the world, meanwhile…is Mr. Asakawa himself…with his ingenious little device by his bed. The alarm must have sounded more than once in the last few days, as the dollar sank on world currency markets. He must have sat up in bed, possibly in a cold sweat, wondering: Why do we still support the U.S. dollar? We are paying the price for America’s overspending!

And then, waking, the horrible logic must have come back to him: Because we have no choice.

"With Japan’s huge stake in the dollar losing value," explains the IHT, "the question is: What will Tokyo do next? The problem for Japan is that it is in so deep that, to a large degree, it is chained to its American debtor.

"Richard Koo, chief economist for the Nomura Research Institute, said that anything Japan might do to slow its dollar purchases would only create a self-inflicted wound. ‘If they could move it all out of dollars in one day, I am sure they would do it in an instant,’ Koo said. "But if they move 10%, and the dollar goes down 20%, they are stuck with 90% of the portfolio worth 20% less.’"

Poor Mr. Asakawa. The weight of the whole damned Dollar Era seems to ride on his shoulders. Experts now predict a further 20% decline in the greenback – maybe more. That will be a loss of $144 billion for Japan’s central bank. But what then? How will he ever be able to get out? Or is Japan expected to finance America’s deficits forever…no matter how much it costs?

We don’t know the answers to these questions. But surely they come to Mr. Asakawa’s mind when, in the dark of night, his dollar monitoring device goes off.

More news, from our friends at The Rude Awakening:

————–

Eric Fry, reporting from Wall Street…

"Just like ‘offline’ dating, the Web-based variety is more cruel than kind. Indeed, the process is Darwinian in the extreme – only the fittest thrive in this venue. Thus, for example, if you happen to be a 5-foot 10-inch Victoria’s Secret model, and provide ample photographic evidence within your ad, your ‘inbound’ email box will runneth over with communiqués from cyber-suitors."

What exactly can Internet dating teach you about stocks? More that you would think…check out today’s issue of The Rude Awakening for the whole story…

————–

Bill Bonner, back in London:

*** Another great little item in yesterday’s International Herald Tribune deserves notice:

"Greenspan’s act will be difficult to follow," says the headline, with a perspicacity that had to be accidental.

Who could ever fill the Fed chairman’s enormous shoes, the article asks, for Mr. Greenspan’s marvelous approach to monetary policy "has been highly intuitive and as much an art as a science."

We do not disagree. Mr. Greenspan is an artist. Not a graphic artist. Not a painter, even. Nor a musical artist. Nor will he win any awards for his poetry. But, the world’s favorite economist is one of the great performance artists of all time. He found a role that suited him and has hammed it up for all he was worth. He plays the part of someone who knows what he is doing.

You may not realize this, dear reader, but the Fed operates on a very thin plot. The idea that economic science can determine, for example, the exact short term interest rate the world needs at the precise moment it most needs it, is pure theatre. It requires an audience that is willing to suspend its disbelief long enough to enjoy the show…or so naïve it should be institutionalized.

But Mr. Greenspan’s stunning performance – for which he deserves an Oscar – is that he pretends to be able to find the perfect rate, not with science, but by intuition! Here, we enter the realm of the surreal…or perhaps the absurd. We don’t know whether to laugh or cry…applaud or throw tomatoes…walk out or wait to see how it finally ends. If Mr. Greenspan really could come up with the number that perfectly matches buyers and sellers of credit…perhaps he could fix the Dow too. Why go to all the trouble of running the New York Stock Exchange? Or maybe he could find the next whole number – using his intuition alone. Maybe he could be in charge of the next lunar landing. Yes, that’s it… something more appropriate to his skills or pretensions, something lunatic.

Yes, we must stay and see how the show ends. What would be a suitable denouement for a man – especially one who claims to believe in a free market – who stops to tell all the world’s borrowers and all the world’s sellers at what rate they should do business? Based on his intuition, our hero directs the entire world’s economy; what can we expect for him in the last act?

We don’t know. But we can’t wait to find out.

*** And here is a little note we picked up. Unfortunately, we can’t remember where (we will give credit when we recall where it is due):

"In 1913, at the height of its empire, Britain was the world’s biggest creditor. Within 40 years, after two costly world wars and economic mismanagement, it became a net debtor and the dollar usurped sterling’s role. Dislodging an incumbent currency can take years. Sterling maintained a central international role for at least half a century after America’s GDP overtook Britain’s at the end of the 19th century. But it did eventually lose that status.

"If America continues on its current profligate path, the dollar is likely to suffer a similar fate. But in future no one currency, such as the euro, is likely to take over. Instead, the world might drift towards a multiple reserve-currency system shared among the dollar, the euro and the yen (or indeed the yuan at some time in the future). That still implies a big drop in the long-term share of dollar assets in central banks’ vaults and private portfolios. A slow, steady shift out of dollars could perhaps be handled. But if America continues to show such neglect of its own currency, then a fast-falling dollar and rising American interest rates would result. It will be how far and how fast the dollar falls that determines the future for America’s economy and the world’s. Not even Mr. Greenspan can forecast that."