Petrocapita December 2010
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Petrocapita December 2010

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Petrocapita is an investment trust built around the premise that demand for energy will continue to move prices higher over the long-term. Petrocapita was created to allow investors to add......

Petrocapita is an investment trust built around the premise that demand for energy will continue to move prices higher over the long-term. Petrocapita was created to allow investors to add professionally managed oil & gas assets directly to their portfolios.

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  • 1. Petrocapita UpdateDecember 2010
  • 2. Petrocapita UpdateIF YOU CAN KEEP YOUR HEAD WHEN ALL ABOUT YOUARE LOSING THEIRS ... YOU DON’T WORK FOR THEFEDERAL RESERVEApologies to Mr. Kipling for using his work to create aninflammatory headline.A considerable amount of ink is being spilled on the topic ofwhether there is a recovery underway in the west and if so,whether that recovery is sustainable. So much ink in fact thatone would have thought that when combined with the mightylabors of our central banks to single-handedly create an inkshortage this lowly substance would have been used up longago.Fortunately, or perhaps unfortunately depending on your view ofmy monthly musings, we haven’t run out yet so let me give youmy view on the recovery debate - a recovery in nominal or realterms? With the printing presses running full time (ink suppliesnotwithstanding) some form of nominal recovery will occur in thewestern economies. Sadly, it’s not going to be anywhere nearlyas satisfying as other post-war recoveries because it largely willbe an illusion in real terms. Our recovery is not being built on thesound fundamentals for growth:– Favorable demographics;– Low national debt levels;– High savings rates; and– Persistent trade surpluses.Please take a moment and consider which so-called developednation has these characteristics. Stumped? None. Now turnyour gaze to the emerging world - I doubt you are still stumpedas the list is long and obvious. 1
  • 3. Petrocapita Update (continued)Take Canada as an example of a country suffering is one of the world’s largest net exporters of bothfrom the western growth malaise. Canada has: energy and agricultural commodities. As we know, energy and food consumption undergo rapid growth– An aging population; as a developing economy makes the transition to– Large unfunded liabilities for social benefits; a middle class standard of living. These markets– High total debt-to-GDP levels; already appear to be tightening and demand is still– Low savings rates; accelerating. Here are some quick numbers to– Large and increasing government intervention in give you an idea of western Canada’s resources the economy; endowment:– Large fiscal deficits; and– An overly accommodative monetary authority. Energy – Oil (13% of world reserves; 4% of worldI’m sorry to be the bearer of bad tidings but these production)are not the seeds from which mighty recoveries – Uranium (8% of world reserves; 20% of worldare grown. By insisting on printing over the production)systemic solvency issues in the financial sector,by actively preventing the liquidation of decades Agricultureof mal-investment, by subsidizing speculation and – Potash (60% of world reserves; 30% of worldconsumption to the detriment of production (and production)so on) our valiant central bankers will not create a – Wheat (21% of the world export market)recovery. Unless these problems are addressed they – Oil seeds (10% of the world export market)are creating an inflationary environment with poor – Farmland (80% of Canadian total)real growth dynamics - i.e. the ideal raw materials forstagflation in the west. The Canadian economy appears bifurcated between the lower growth east and the higher growth west.What are our investment options? It should come as Investing in western Canada provides exposure tono surprise to anyone who has read one of my letters emerging market consumption patterns in energythat I believe its important to find investments in and agriculture in a politically stable market. I believepolitically stable regions of the world that are directly a good approach is to make direct investmentsexposed to emerging economy growth - i.e. regions in commodity production assets - in addition tothat export what the emerging economies need and providing less volatile exposure to commodity priceare not exposed to emerging economy competitive trends, production assets are excellent inflationadvantages - i.e. regions that do not export what the hedges that, unlike gold, generate cash flow.emerging economies make. In addition, investors who have a value orientationIn my funds’ backyard, western Canada, energy have been provided what I believe is an attractiveand agriculture are dominant industries. In fact, entry point into the Western Canadian conventionalwestern Canada, with only 10 million inhabitants, oil market. The credit crisis has caused financing to 2
  • 4. Petrocapita Update (continued)become scarce for junior oil & gas companies while we assume that BOC actions are keeping interestlow natural gas prices are reducing their profitability. rates at least 4% below their equilibrium level thenThey are being forced to sell assets to stay in Canadian savers are being taxed by the BOC to thebusiness. This has created a buyers’ market for the tune of $50 billion annually in the form of lost interestacquisition of smaller oil production assets - assets income. Canadian federal government income taxthat are highly cash flow positive at current oil prices. revenues are approximately $150 billion, so is it not accurate to say the BOC has unilaterally increasedShifting gears for a moment - I want to ask when Canadian income taxes by around 33%?we gave permission for central banks to take overthe tax role of our governments? Central bankers Let me leave you with this. If central banks reallynow seem to feel free to increase the money supply believe that printing money and giving it to theby any quantity they deem necessary to keep the government and the banking sector is solving ourbanking sector solvent. In effect, they are extracting problems and is not inflationary why not print much,a massive tax from savers everywhere via the much more and be done with the crisis once and forhistorically low interest rates they have engineered. all? Perhaps all this money printing will usher in aWhen questioned about what they are doing with our new era of wealth, prosperity and low inflation - whatmoney they get downright testy and roll out the cliché do you think?of “central bank independence”. Kind RegardsLet’s take a look at what that vaunted“independence” is costing Canadians using some Stephen Johnston - PartnerBank of Canada (“BOC”) data. There is C$1.2 Petrocapita Income Trust & Agcapita Farmlandtrillion on deposit with Canadian chartered banks. If Investment PartnershipStephen is a partner at Petrocapita, an energy investment fund built around the core premise that the worldis in a bull market in commodities driven by inflation and a step-change increase in demand and, accordingly,that investments with direct or indirect exposure to commodities in a politically stable environment such asCanada will provide above average returns. Petrocapita holds a portfolio of low risk, producing energy assets.Stephen graduated from London Business School and is the founder of one of Canada’s largest farmlandinvestment funds, and Petrocapita. He has over 15 years experience as a fund manger – working fororganizations such as the European Bank for Reconstruction and Development, Societe Generale and BaringBrothers.Stephen has appeared on Business News Network and CBC News and been quoted in such media outlets asFortune, the Financial Times and The Globe and Mail. 3
  • 5. 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 Petrocapita Income Trust (“PETROCAPITA”) 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 PETROCAPITA 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 PETROCAPITA 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 PETROCAPITA or its relevant affiliate directly.#400, 2424 4th Street SW Tel: +1.403.608.1256 www.petrocapita.comCalgary, Alberta T2S 2T4 Fax: +1.403.648.2776Canada