Michael Campbell: “I don’t think Canadians appreciate for a moment we’ve got the lottery ticket.” “I see oil prices going much further over time here and other natural resources too which is really allowing us to be incompetent at the government level because we have all of this money coming in. But I’m worried that we will blow that opportunity at the same time. Commodity cycles don’t last forever and while we were accurate in suggesting that the commodity cycle very clearly was beginning in 2001/2002 and the top would be somewhere off into the future, arguably 2016/2020. This is our time and I agree completely that we have this huge advantage, I’m just worried that we’re going to blow it.”
Energy: Canada’s Winning Lottery Ticket
Michael Campbell: Joseph Schachter joins us today, one of North America’s leading analysts in the energy sector with Schachter Asset Management.
Let’s start with that price of oil itself at $105-$106. I think Brent crude was $116 yesterday. That alone is going to have impact on economic growth throughout the west.
Joseph Schachter: Yes, the price of oil on Friday closed $106.559 for WTI, and the price has gone up because of the Japan incidents as well as the incidents in the Middle East. People are now saying we are now going to have to go back to fossil fuels. Moreover if you look at Libya we’ve lost about 1.6 million barrels per day, so UAE, Kuwait and Saudi have raised their production to offset that. But you’ve got a number of other countries that are now in the limelight, Syria for example produces about 400,000 barrels per day and consumes about 250,000 so they’re exporting about 150,000, not a big number. Bahrain of course has got problems there; they only produce about 48,000 barrels a day and export a few thousand, so again nothing important. Yemen produces about 350-400,000, exports about 200,000, so the number there with all the violence is one that’s had impact.
The next one in terms of the size that people worry about, and there is protests out there in the street, is Algeria. These guys produce about 1.4 million barrels a day of oil, 500,000 barrels a day and 350,000 barrels a day of natural gas liquids. If they went out, that would be a big one. Of course everybody looks at Saudi and Kuwait and others, so we’re sitting here with kind of a dominos issue where if these countries have export problems we will see the price of oil go up. When the price of oil goes up the price of gas at the pump goes up, at some point that takes away from disposable income because you pay more to fill your car, you have less money for other things. We saw what that did in 2008/2009 when the price of oil went to $140. At the high, that was about 11% of GDP in North America in that first quarter of 2008. When a barrel of oil went down to $32 GDP dropped back to about 4% of GDP. Now we’re pushing 8% of GDP which is where were in 1981/82 when Paul Volcker said game over, we have to fight this inflation.
And yet the CPI numbers and all the inflation numbers that we’re seeing in the States the government say’s are 2 to 3%. Well there not from the point of view, they are very, very high. The Americans have got their stimulus, QE2 has happened and we know the problems of inflation and for most people, probably 60% of the population. Costs rising from clothing at the store because of cotton prices moving up, oil prices going up, the heating of their houses, schooling for their kids, for most Canadians. The 10% who are the wealthy are the ones who benefit from QE2 because of the boom in the stock market and across the commodity board. So we’re seeing here with a very, very tight squeeze on most people this cost of pressure from oil is something that will definitely have an impact on us and the economy as we move forward.
Michael: It just begs a question Joseph, whether it’s the Alberta Sands or other oil production Canada has political stability relative to these other parts of the world. Do you think that makes us more prominent and those resources even more important?
Joseph: Yes. I think that absolutely is the case. With natural gas we’re now talking about a second export LNG terminal at Kitimat BC though its not going to come on till 2014/2015 because of the hearings for the environmental rules,native land claims and then the construction. Regardless the price of cargos to Japan right now are $12 in MCF while the price of natural gas in Alberta was $3.58 for which compares to $4.41 for NYMEX. NYMEX if you recall when were in November-December when we got bullish it was about 3.20, then when we were at the conference with you in Vancouver the price was about 3.80. So we’ve had a very big move in natural gas price, much more so than oil prices, which is interesting.
Michael: Energy self sufficiency was a big issue in the American election and it has been for years. Typical politicians talk about it but the system doesn’t seem to let much get done there. Canada is the biggest seller to them, is this where the opportunity is going to lie, especially in the natural gas field which has been languishing or so long?
Joseph: Yes. Right now the eastern part of the States has put a block on the shale plays. There’s been a lot of production that’s been brought on but the pace of the increases in production are now slowing and demand is now growing by mostly from the electrical side because the EPA is getting tougher on coal . As the economy grows 3-4% the demand for electricity grows by 2-3%, so any increase in capacity for new electricity is going to come from natural gas which means natural gas could see 6-8% incremental demand growth which unless the Americans develop all their shales they’re going to start importing again from Canada. So we’re going to see better export position for Canada, we’re going to see better trade surpluses, and of course the Canadian dollar is pretty robust at $1.02. How much farther we can let the Canadian dollar go given the industrial heartland of Canada, Ontario and Québec, but the Canadian government and all the provincial governments will be sitting there with more tax revenue coming, especially with the tax rises. So Canada is sitting in a very, very enviable position because we are very natural resource rich. It’s not only the energy side of course, mining has done very, very well in Canada between nickel, copper, all the other metals that we produce, and forestry.
Or currency will do well just like the Aussie dollar. Australia has had a lot of issues with rain and environmental issues this year, but they’re also one of the stronger commodity currencies. A lot of people are saying: look, we’re worried about the US dollar, we’re worried about the Euro. We can’t buy the Renmimbi, so they’re rushing in and our sales of paper and the bond market has been significant in the last several months with foreign investors coming in and Canada’s yields now are lower than US yields.
Michael: One of the things I’ve been saying Joseph for the last few years is that I don’t think Canadians appreciate for a moment we’ve got the lottery ticket. We’ve got the winning lottery ticket in terms of what you’ve just alluded to. I’ll ask you your opinion in a moment, but to elaborate on that point, I see oil prices going much further over time here and other natural resources too which is really allowing us to be incompetent at the government level because we have all of this money coming in. But I’m worried that we will blow that opportunity at the same time. Commodity cycles don’t last forever and while we were accurate in suggesting that the commodity cycle very clearly was beginning in 2001/2002 and the top would be somewhere off into the future, arguably 2016/2020. This is our time and I agree completely that we have this huge advantage, I’m just worried that we’re going to blow it.
Let me ask you about oil then, do short term geopolitical events that cause a spike really change the direction longer term?
Joseph: Yes, I think in a few years, I don’t know if that’s 2015/2018, we will be back in that peak oil argument where physical demand for liquids energy, will be greater than physical supply. Today that’s not the case, we have lots of inventory right now. On Wednesday the data came out and they’re sitting on 1.7 billion barrels in inventory, which is 91 days of consumption. So you’ve got lots of inventory right now and if you didn’t have these issues of the Middle East, if you didn’t have this fear where people are chasing the commodity board, the hedge funds and the ETFs with enormous buying of commodities, oil prices should be around $70. Now, fair value is at $70 but when you have shortages, when you have fear of production disruptions as we have today, you will go much higher. If you remember in March of 2009 when everybody thought we were going into the depression the price of oil went down to $32 and you might have argued that it was worth $59 or $60 fundamentally.
So we will always move around based on these issues or of a fear of weak economic growth and a lack of demand; so my view is that if these prices stay up here for much longer, another month or two, or if we have another disruption of supply and the prices spike much higher we may see that that would then kill off demand and we would probably head back into another difficult period. The US government doesn’t have anymore ability to pull off any more QE2s and 3s and 4s and 5s. They’ve spent their wad and with the Republicans now controlling the House, with inflation picking up I don’t believe that they can do more quantitative easing. With the debt ceiling battle coming in the next few weeks, I think that if there’s a chance here of some very difficult times in the financial markets, though as you know I’ve historically been a very strong bull and at the conference we talked about some of the names that we liked, and a lot of those stocks have done very, very well. I’m now saying to people: be a little careful out there, have some cash reserves, we will be facing some kind of downside here.
Is it like we say in 2010 when we had the issue with the European debt crisis and Greece had to be bailed out and we had we had a Stock Market correction. I don’t think it’s as bad as 2008 but it could be as bad as or somewhat worse than we ad in 2010. The long term commodity cycle is intact and we’re just going to have maybe a cool off or a cold shower in the short term, So be a little careful out there and have some firepower because there’s going to be some bargains.
Read Part II on Tomorrow’s Moneytalks.net for Schachter’s recommendations