Agcapita January 2010 Energy Briefing
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Agcapita January 2010 Energy Briefing

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Agcapita is Canada's only RRSP and TFSA eligible farmland fund and is part of a family of funds with almost $100 million in assets under management. Agcapita believes farmland is a safe investment, ...

Agcapita is Canada's only RRSP and TFSA eligible farmland fund and is part of a family of funds with almost $100 million in assets under management. Agcapita believes farmland is a safe investment, that supply is shrinking and that unprecedented demand for "food, feed and fuel" will continue to move crop prices higher over the long-term. Agcapita created the Farmland Investment Partnership to allow investors to add professionally managed farmland to their portfolios. Agcapita publishes a monthly agriculture briefing.

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Agcapita January 2010 Energy Briefing Agcapita January 2010 Energy Briefing Document Transcript

  • Agcapita Energy Update January 2010 1
  • Summary Barclays Capital recently stated “We expect 2010 to be a year of transition between the [oil] demand concerns of 2009 and the supply concerns of 2011, with geopolitical developments having a heightened importance.” The last 24 months have pushed the question of oil supply out of the limelight, while of course the underlying issues remain unchanged and perhaps magnified by the financial crisis. At the heart of the matter is the fact that we live in a peak oil world. No resource is infinite and conven- tional oil supply is clearly demonstrating characteris- tics of peaking production. A recent survey paper from the UKERC found that: CONTENTS – The global average decline rate of post-peak 3 How does US Plan to Import 10 Million fields is at least 6.5%/year and the corresponding BOPD with a Devalued Currency? decline rate of all currently producing fields is at 3 Peak Oil as Predicted by the IEA least 4%/year. This implies that approximately 3 mb/day of capacity must be added each year 3 China Oil Demand Thought Experiment just to maintain production at current levels – 4 Quick Energy Facts equivalent to a new Saudi Arabia coming on- stream every 3 years. An additional 1 mb/day must be added to meet demand growth. – More than two thirds of existing capacity must be replaced by 2030 solely to prevent production from falling. – A peak in conventional oil production before 2030 appears likely and there is a significant risk of a peak before 2020. For example, a 2008 report by The UK Industry Taskforce on Peak Oil and Energy Security warned that a “peak in cheap, easily available oil production” was likely by 2013. 1
  • Summary (continued) To follow on the peak oil pricing model contained in the last Energy Briefing, we have produced another model which attempts to calculate the effect of the transition to a middle class standard of living in China will have on the global energy markets. Once again, the purpose of this exercise was not to make highly accurate predictions but rather to gain some insight into the potential magnitude of changes given fairly conservative production, demand and decline assumptions. The key assumptions are that China moves from its current energy consumption levels (around 2.5 barrel per capita per year) to levels more closely resembling South Korea (17 barrels per capita per year). The projection period we used was 30 years, which is longer than it took South Korea to make this transition. The effect of this change on global demand is quite dramatic. It would be necessary to replace 26 million BOPD production by 2020 to maintain supply (about 30% of current production levels and almost 3 times Saudi Arabia output). Total daily production will have to raise 22% from 84 million BOPD to 102 million BOPD. 2
  • Energy Update HOW DOES US PLAN TO IMPORT 10 MILLION BOPD WITH A DEVALUED CURRENCY? The US currently imports over 10 million bopd. The a day will be difficult.” In 2008, he stated “world oil US government and Fed are clearly on the track to production would peak at or below 95 million barrels substantially debasing the dollar. The US has no per day,” and later that “world oil production may credible way to pay the on and off-balance sheet plateau below 90 million barrels per day.” liabilities that it has accumulated to date – without even beginning to pay the massive future liabilities As the IEA has been warning for years, given current of the social programs for boomers. The US will tighter supply/demand balance and increasing default on its debt via the printing press. The question decline rates, a reduction in upstream oil investment then becomes how its manages to maintain a way inevitably causes an oil supply problem later. IEA of life that requires the import of 10 million bopd Director Nobuo Tanaka stated that “Sustained from foreigners who may not be in a mood to accept investment is needed mainly to combat the decline worthless US fiat in exchange or at the very least the in output at existing fields, which will drop by almost price of oil in USD terms will be astronomical. 2/3 by 2030.” Tanaka recently predicted that global upstream spending had dropped $90 billion, or 19%, PEAK OIL AS PREDICTED BY THE IEA during 2009 vs. 2008—the first decline in a decade. The effects of a capex reduction will be compounded In 2009 The Guardian (UK) published a story about 2 by the production and decline limits that are being whistleblowers from the International Energy Agency seen in an increasing number of countries worldwide. (“IEA”). One of these sources, still with the IEA, said “The IEA in 2005 was predicting oil supplies could CHINA OIL DEMAND THOUGHT EXPERIMENT rise as high as 120 million barrels a day by 2030 although it was forced to reduce this gradually to As a thought experiment we modeled the effect 116m and then 105m last year [2008]. The 120m of China moving from its current energy world oil figure always was nonsense but even today’s number consumption levels (around 2.5 barrel per capita per is much higher than can be justified and the IEA year) to levels more closely resembling South Korea knows this. Many inside the organization believe that (17 barrels per capita per year). The projection period maintaining oil supplies at even 90m to 95m barrels we used was 30 years, which is longer than it took a day would be impossible but there are fears that South Korea to make this transition. The effect of this panic could spread on the financial markets if the change of global demand is quite startling. Assuming figures were brought down further.” a modest level of decline in existing global production, it would be necessary be replace 26 million BOPD Christophe de Margerie, CEO of France’s national production to maintain supply (about 30% of current oil company Total SA has issued a number of production levels and 3 times Saudi Arabia output). predictions about world oil supply constraints. In Total daily production will have to raise 22% from 84 2007, he stated “production of 100 million barrels million BOPD to 102 million BOPD. 3
  • Energy Update (continued) CHART 1: CAPACITY ADDITION NEEDED QUICK ENERGY FACTS BY 2015 Shale Gas: For more than a decade the US Congress has exempted the oil industry from a 120 Natural World Oil Demand Fields Gas Yet to Find federal law protecting drinking water. In particular that Million Barrels per Day Under Liquids 110 Appraisal the law should not be applied to hydraulic fracturing, Smaller Fields/ 100 Upgrades the process that is essential to extracting the US’ natural gas reserves – particularly shale gas. In 2005 90 Congress passed a law prohibiting such regulation. 80 Projects (>10,000bd) Now the US Congress is revisiting the exemption and has asked the EPA to undertake a review of 70 Existing Production Capacity how hydraulic fracturing may affect drinking water (6% decline per annum) 60 supplies. The EPA itself has expressed “serious reservations” about allowing shale gas drilling in 50 2006 2008 2010 2012 watersheds. If the EPA were to decide to remove the Source: Cambridge Energy Associates hydraulic fracturing exemption what effect will it have on shale gas drilling and the current abundant North American natural gas supplies? Click Here for Link to the Login Page for the China’s Oil Consumption: China recently surpassed China Oil Demand Calculator the Germany and Japan in terms of total oil consumption and now buys more of Saudi Arabia’s Navigate to our Investor Login Area oil exports than the US. User Name: Energy Password: Energy Barclays Capital: “We expect 2010 to be a year of transition between the [oil] demand concerns of 2009 and the supply concerns of 2011, with geopolitical developments having a heightened importance.” 4
  • Agcapita Macro Update January 2010 M1
  • Summary DEMOGRAPHICS ARE DESTINY The 19th century belonged to the UK, the 20th century belonged to the US and it appears that the 21st century may belong to China. A consistent theme in the emergence of a new global power is a young population with a large and growing pool of domestic savings and a focus on investing in the capital base of the economy rather than consumption. The world’s western economies find themselves heavily in debt with deteriorating demographics (our populations are aging and our birth rates are low) and economies skewed towards consumption. We are accruing ever-greater liabilities to cover vast social, medical and retirement programs that we currently do not have the workers or more importantly the high growth economies to pay for. It has been said that “demographics are destiny’. Unfortunately, rather than face these issues, our governments are attempting to fix our manifest problems by accelerating the CONTENTS consumption friendly policies that were largely responsible for M1 Demographics Are Destiny getting us into this situation in the first place. As an example of M3 Forty Percent of US Corporate this, the US Federal funding gap is growing rapidly. Over the last six Profits From Finance! years: M4 America’s Current Export – Inflation – unfunded obligations increased approximately 50% from US$79 M4 How Can this End Well? trillion to US$114.7 trillion; but M4 ZIRP and Commodity Prices – – revenue rose approximately 12%. Is There A Link? M5 Money Velocity Increasing The US government is now in the position of increasing its liabilities M6 Interest on US Debt four times faster than its tax receipts. This is a trend being repeated M6 US Residential Housing Sector throughout the developed world. The US Federal Reserve recently – Losses Now Nationalized? disclosed that it purchased half of the newly issued US Treasuries M7 Private Sector Growth is in the second quarter of 2009 – all of which would have been Absent in the US purchased with newly created money – direct debt monetization. M7 US Bailout Cost M7 Equity and House Price Investors must be alive to the growing divergence between the Declines – Over? economies of the west and those in the emerging world and M7 Government Fiscal Deficits Will position themselves accordingly. We believe that the way to benefit Continue to Worsen from long-term Chinese growth is to invest in what China needs M8 Top 10 Points for Canadian in politically stable parts of the world. That gives you the best of Limited Partnership Investors M9 Quick News Review M1
  • both options – first world political risk and transparency combined with emerging world growth rates. Clearly a category that fits this description is commodity investment in western Canada – Agriculture – Energy And to a lesser degree commodity linked investment in western Canada: – Businesses that service the commodity sector – Businesses and sectors that benefit from general population/ economic growth in Western Canada M2
  • Global Macro Update FORTY PERCENT OF US CORPORATE PROFITS FROM FINANCE! Given the rapid reflation of the prices of speculative Despite widespread belief to the contrary, assets and the collapse of risk premiums, the government intervention into broad swathes of the ongoing money printing efforts in the developed economy to support “too big to fail” companies world are having limited effect outside of the “finance or more accurately to prevent capital destroying economy”. It is estimated that up to 40% of US business activity from being eliminated to the benefit corporate profits are generated by the finance sector of the entire economy is not a positive for future – largely from speculative activities. Corporate profits growth. There is an economic truism that whatever attributable to the finance sector were effectively you subsidize you get more of – hence by subsidizing stable until the 1970s when the growth in the US failure we are ensuring bigger failures in the future money supply turned sharply higher on a sustained and worst of all penalizing well run businesses. The basis. Given the finance sector’s intimate relationship firms that were prudently managed leading up to the with the US Federal Government and the Federal crisis should have benefited from the demise of their Reserve banking system it is not surprising that the poorly run competitors – in a free economy capital newly printed money has flowed into and through would have flowed to the profitable businesses rather the finance sector acting as a wholesale subsidy than the loss making ones. The fact that this didn’t that drove corporate profits, compensation and happen creates a perverse “if you can’t beat’em, speculation. join’em” mentality with respect to risky and imprudent business practices. QUICK FACTS China US GDP: $14.2 trillion - increased a total of 18% (real GDP: $4.3 trillion – increased a total of 430% in last terms) in last 10 years and added ZERO private 10 years sector jobs 20% percent of economy in state sector 30% percent of economy in state sector Consumer demand is 35 per cent of GDP Consumer demand is 70 per cent of GDP Savings rate is 40 percent of household disposable Savings rate is 6 percent of household disposable income (one of the highest in the world) income M3
  • Global Macro Update (continued) AMERICA’S CURRENT EXPORT – INFLATION CHART 2: CRB SPOT INDEX (1967 = 100) The US zero-interest rate policy (“ZIRP”) has lead to sustained efforts to cause currency devaluations on 550 the part of its trading partners. The idea is that if they 500 weaken their currencies, domestic producers will be 450 able to maintain market share in the US. The net 400 result is that the US is effectively exporting inflation to 350 its global trading partners. 300 250 200 HOW CAN THIS END WELL? 150 100 Often a picture is worth a thousand words… 50 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 CHART 1: FEDERAL SURPLUS OR DEFICIT Source: Commodity Research Bureau (USD$ BILLIONS) 400,000 200,000 CHART 3: 2009 CRB INDEX CONSTITUENT 0 -200,000 RETURNS (Millions of Dollars) -400,000 Wheat -11.46% -600,000 Nat Gas -0.89% Live Cattle 0.15% -800,000 Corn 1.72% -1,000,000 Soybeans 6.97% Lean Hogs 7.84% -1,200,000 Coffee 21% Gold 22.91% -1,400,000 Cocoa 23.41% -1,600,000 Aluminium 44.81% 1895 1910 1925 1940 1955 1970 1985 2000 2015 Silver 48.5% Heating Oil 50.73% Cotton 54.22% Source: St. Louis Federal Reserve, White House – Office of Nickel 58.33% Crude 77.94% Management and Budget (shaded areas indicate recessions) Orange Juice 88.25% RBOB 102% Sugar 128.19% Copper 138.38% -30 0 30 60 90 120 150 Source: Reuters ZIRP AND COMMODITY PRICES – IS THERE A LINK? The CRB Index of 19 raw materials increased 23 The rebound in commodity prices was lead by oil percent in 2009 as can be seen in Chart 2 – this copper and sugar (see Chart 3) as China’s demand represents the largest annual increase since 1979 – continued to grow even in the face of the global the last period of highly inflationary monetary policy. recession. M4
  • Global Macro Update (continued) Interestingly, the rebound in the CRB index is mirrored increasing after it started falling in the first quarter by another powerful upward surge in US base money of 2007 - six quarters before economic growth supply (M0) after its initial doubling in late 2008, early slumped. The recent increase in MZM velocity may 2009. point to increased economic activity, the question then becomes whether it will be sustained as can be MONEY VELOCITY INCREASING seen in the capacity utilization numbers. For those who are adherents of the money velocity theory of economic activity, the velocity of MZM is CHART 6: MZM VELOCITY (DARK BLUE) V. US GDP % GROWTH (LIGHT BLUE) CHART 4: US M0 (US$ BILLIONS) 2.4 10.0% GDP Growth current terms 8.0% 2.2 6.0% MZM Velocity 2,400 2.0 4.0% 2,000 2.0% 1,600 1.8 (Billions of Dollars) 0.0% 1,200 1.6 -2.0% 800 1.4 -4.0% 400 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 0 -400 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 Source: St. Louis Federal Reserve Source: St. Louis Federal Reserve (shaded areas indicate recessions) CHART 7: ESTIMATED US INTEREST PAYMENTS CHART 5: CAPACITY UTILIZATION (PERCENT OF CAPACITY) $800 in billions 90 700 85 600 (Percent of Capacity) 500 80 400 75 300 70 200 65 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2010 2019 Source: St. Louis Federal Reserve (shaded areas indicate Source: GAO recessions) M5
  • Global Macro Update (continued) Further increases in this velocity are considered Treasury department’s recent announcement that it by many as an essential precursor for sustained will provide unlimited backing to Freddie Mae and economic growth. Fannie Mac these two organizations now underwrite almost 80% of all new mortgage lending in the US INTEREST ON US DEBT – de facto nationalizing of the market, a market that represents: More than half of the $9 trillion in debt the US Federal government is expected to build up over the next – $14.6 trillion in total U.S. mortgage debt decade will be incurred to pay interest charges - outstanding US$4.8 trillion. – $8.9 trillion in total U.S. mortgage-related securities. In 2015 $533 billion in interest payments will be – $7.5 trillion in pooled mortgages, of which about equal to a third of the federal income taxes expected $5 trillion is securitized or guaranteed by Freddie to be paid that year – obviously a dangerous trend Mae, Fannie Mac or FHA given that longer term interest rates can be expected increase from their currently historically low levels. Charts 8 & 9 show that while most mortgage lenders The other issue for the US is that the duration of have been withdrawing from the US residential its borrowing is rather short – in simple terms that housing market, Freddie and Fannie loan books are means the US federal government must constantly exploding. refinances its existing debt in addition to borrowing more to fund ongoing deficits. The magnitude of this issue is shown in that the US Treasury estimated CHART 8: REAL ESTATE LOAN AT COMMERCIAL in November 2009 that “approximately 40 percent BANKS (US$ BILLIONS) of the debt will need to be refinanced in less than one year.” This shortened duration leaves the US 4,000 3,600 quickly exposed to any increases in borrowing costs 3,200 demanded by the markets. (Billions of Dollars) 2,800 2,400 2,000 1,600 US RESIDENTIAL HOUSING SECTOR – LOSSES 1,200 NOW NATIONALIZED? 800 400 0 The US automobile industry has been nationalized, -400 the banking sector has been nationalized, medical 1940 1950 1960 1970 1980 1990 2000 2010 care has been nationalized and now the residential Source: St. Louis Federal Reserve (shaded areas indicate housing sector has been nationalized. With the recessions) M6
  • Global Macro Update (continued) EQUITY AND HOUSE PRICE DECLINES – OVER? CHART 9: TOTAL FEDERAL GOVERNMENT AND SALLIE MAE CONSUMER LOANS Research (Aftermath of Financial Crisis, Reinhart and (US$ BILLIONS) Rogoff, 2008) shows that the average real decline in equity and house prices following a banking 200 180 crisis is 56% and 35% over 3.4 years and 6 years (Billions of Dollars) 160 respectively. If this historical average holds, and 140 120 arguably the current crisis far exceeds virtually all the 100 80 others over the past 100 years, then both house and 60 equity prices will fall much farther in real terms. 40 20 0 -20 GOVERNMENT FISCAL DEFICITS WILL 1975 1980 1985 1990 1995 2000 2005 2010 CONTINUE TO WORSEN Source: St. Louis Federal Reserve (shaded areas indicate recessions) Research shows that even with the current dramatic deterioration in G7 government finances we can expect worse to come (Aftermath of Financial Crisis, PRIVATE SECTOR GROWTH IS ABSENT IN THE US Reinhart and Rogoff, 2008). Over the course of the typical banking crisis government debt levels rise an Private sector has actually shed jobs in the last decade and generated very little in inflation adjusted GDP growth – hence the nagging feeling CHART 10: US JOB GROWTH BY DECADE in the middle class that they are not getting ahead. Unfortunately the same cannot be said for the US % change in gross domestic % change in household net government that continues to grow relentlessly. product By decade, worth By decade, 38% inflation adjusted inflation adjusted 1940s 72.0% unavailable US BAILOUT COST 1960s 53.1% 44% 1970s 38.1% 28% Despite the varied and often conflicting reports 1950s 1980s 51.3% unavailable 34.9% 42% about the total cost of the US bailouts – when all 1990s 38.6% 58% the programs are taken into account the cost is approximately US$14 trillion. Given the pre-bailout 0% money supply of the US was around US$ 15 trillion 0 2000s 17.8% -4% Year in Decade this represents a truly staggering amount of money. 1 2 3 4 5 6 7 8 9 10 Source: Washington Post M7
  • Global Macro Update (continued) average of 86 percent in the three years following. produce a superior performance unless you do The buildup in government debt has been a defining something different from the majority...” characteristic of the aftermath of banking crises for 3. Tax efficient structure – Tax can have a major over a century. The question that will inevitably effect on your returns. Make sure that all arise is that if investment demand is not present reasonable and credible steps have been for the huge debt issuances that this will entail, will taken by the management team to manage tax the worlds central banks revert to monetizing their obligations. governments’ debts – or in simple terms printing the 4. Audited financial statements – Management must money. provide annual audited financial statements. A past failure to do so should act as a red flag. TOP 10 POINTS FOR CANADIAN LIMITED 5. Regular operational reporting – Management PARTNERSHIP INVESTORS must be open and available to answer your questions about the business. Investors in private limited partnerships are faced 6. Clearly defined hold period – Make sure that with a wide range of offerings – from classic private the hold period is clearly defined and cannot equity vehicles to real estate development projects. be arbitrarily changed or extended by the Here are some simple criteria to help you make your management team. You need to know how long decisions about what private LPs to consider for their your investment will be committed and exactly RRSP portfolio this year. when you can expect repayment. 7. No non-arms length transactions – Situation 1. Experienced management team – A significant where the management team acquires the target number of investment teams have NO experience assets first and then sells them to the fund for in fund management or even in the sector in an upfront profit. Even if disclosed in the offering which they are investing your capital. Work documents this is a poor practice and creates with teams that have a track record at both a mismatch between the economic interests of the investment management level and at the the management team and the interests of the operational level – there is NO substitute for investors. a track record of successful investment and 8. No acquisition fees - Fees where the operation in the business area by the team you management team gets paid a portion of all are trusting to act on your behalf. capital deployed. This creates a mismatch 2. Clear investment premise – The investment between the economic interests of the premise should be based on sound fundamental management team and the interests of the analysis that is simple to understand and clearly investors, as acquisition fees are not tied to laid out in the presentation. Avoid momentum- returns. based investments where the core rationale is 9. No fee escalation – Management fees should not effectively that “everyone else is doing it”. To be tied to appraised or calculated asset value that quote Sir John Templeton - “It is impossible to is an unrealized gain. The only valuations that matter are the purchase price and the sale price. M8
  • Global Macro Update (continued) Management should receive the bulk of their standing in the tropical sun outside a popular fees based on gains that are actually realized for store. The government acknowledges prices will investors. rise after the devaluation, but say the upward trend 10. Incentives reward ACHEIVED performance – will be more gradual. State run television and radio Favor investments where the manager makes stations avoided using the word “devaluation,” the bulk of his return only when you make a preferring the word “adjustment.” One pro-Chavez return. This fee structure is commonly referred radio station responded to critics of the measure by to as “success based”. Lifts, acquisition fees, playing a popular Argentine song called “Imbecile.” escalating annual management fees are not With oil crowding out other sectors of the economy, success based. Venezuela heavily relies on imports for consumer goods, leaving it subject to big price swings QUICK NEWS REVIEW depending on the exchange rate. Older Venezuelans are accustomed to sharp losses in the value of their Venezuela Devalues: “Shouting “buy, buy, the world money, with numerous devaluations and currency is going to die,” Venezuelans went on a frantic regimes over the last three decades of economic shopping spree on Saturday following a sharp turmoil. Inflation, the highest in the Americas, at currency devaluation that is expected to drive up 25 percent last year, reached 103 percent in 1996 prices. President Hugo Chavez announced a dual after a previous president lifted exchange and price system for the fixed rate Bolivar Friday night while controls. Chavez’s high-spending policies during an much of the country was watching a baseball game. oil bonanza fueled a massive consumer boom and “I’ve been lining up for two hours outside to buy a fast growth that shuddered to a halt when oil prices television and two speakers because by Monday plunged a year ago. The sharp drop in oil revenues everything is bound to be double the current price,” also undermined the Bolivar and made a devaluation said Miguel Gonzalez, a 56-year-old engineer inevitable at some point.” Source: Reuters Jan 2010 M9
  • DISCLAIMER: The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither AGCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to AGCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting AGCAPITA or its relevant affiliate directly. #400, 2424 4th Street SW Tel: +1.403.218.6506 www.agcapita.com Calgary, Alberta T2S 2T4 Fax: +1.403.266.1541 Canada