Archive for June, 2008

From RedOrbit: High Oil Prices, It's all about Speculation:

"Thunder Horse started pumping from a single well on Saturday and on schedule to have the field online by yearend. Thunder Horse alone will increase overall U.S. oil and gas production by 3.6%. Add British Petroleum's Atlantis platform that started up last year, and the boost grows to 6.4%." -- Houston Chronicle, June 16, 2008

"[U.S.] demand for oil over the first five months of the year was off 2.5%* from last year." -- American Petroleum Institute, June 18, 2008, Associated Press Online [*Translation: We are using approximately 525,000 fewer barrels of oil per day]

Given that Thunder Horse will do 250K barrels per day and Atlantis goes to 200K barrels, plus both of them together do 400 million cu. ft. of natural gas (together) this should seriously increase supply to the US. The US imported 10 million barrels a day (approx) so there's a 5% cut. They use 20 million barrels per day and if this plus the .575 millin, plus an economic slowdown due to the credit crisis, we may be talking of a lowered import demand of a total of 2M barrels per day from the US.

"Asian refiners cut West African crude oil imports in June. Asian imports will fall 36%* to 830,000 barrels a day this month from May's 1.3 million barrels per day." -- Bloomberg, June 17, 2008 [*Translation: Another 470,000 barrels a day of mostly light sweet crude rejected by the market.]

India consumes about 2.5 million barrels per day and China around 6. See this excellent map for how lopsided the oil world is.

Post olympics and the worldwide slowdown, how will the demand look like?

"Daily shipments of North Sea Brent crude will rise 8.6% in July. Tankers are set to load 175,097 barrels a day of Brent crude next month, up from 161,300 barrels a day scheduled for June." -- Bloomberg June 9, 2008

...

Just in the articles I cited, [Excess oil in the market] comes to 1,989,000 barrels of oil a day. That does not include the upcoming Saudi Khursaniyah field that will open in August with another 500,000 barrels per day in production. Some shortage, huh?

...Now is also a good time to note that on June 20, Saudi Arabia announced that its Khurais oil field would be online by this time next year, and that would contribute another 1.2 million barrels of oil per day to the world market.

Uhm. Someone said there's a supply problem? This is not counting the 30 million barrels Iran has floating on tankers in the persian gulf, the huge ass gas finds of Reliance getting operational this year and the next. And think worldwide, there is gargantuan supply out there.

And the final bit is ultra interesting:

One last thought on speculation in the oil market. In 2006, 100% of those who purchased oil contracts lost money because of the market's contango [meaning spot oil prices were less than the contracted price on the date of delivery]. In the fall of that year, when banks started demanding that margins be paid on those losing contracts, oil collapsed back to nearly $50 a barrel. In only 18 months, we've forgotten that lesson, too.

Now, is crude oil a mega problem in reality or is this another big Enron kind of market scam? There may not be a single entity behind it but if you think about it, both Dick Cheney and George Bush benefit from oil tremendously (on a personal level). My funda is that if you have to think of conspiracy theories, think of the wildest ones possible. So Bush and Dick do nothing to stop the speculation because they benefit from it and indeed they fuel it too. They fabricate news, they make statements that keep markets in turmoil. And speculators make lots of money on it. And when elections are over this year, they have sold and booked profits and suddenly everyone sees why there's oil, oil everywhere, and can you please take it back because we don't need no more of it.

But even without that conspiracy theory, the future for oil looks bleak. This is therefore the time to say that "peak oil" is close by, in the same sense that "peak sensex" was close by in December 2007. The graphs, at least, seem to say so, and as we've seen, the fundamentals too.

But there will be a rise before the fall. Wear protective clothing. Someone's gonna get hurt real bad, both ways.

• If oil prices has started to hit usage everywhere, including the US, then why isn't the slowdown hitting the oil futures prices? Why is oil price at $142 today, when the US driving stats show drops of 4% and nearly all countries have slowed down usage?
• Isn't speculation apparent in that there are now pension funds and long only commodity funds contributing to nearly 1.9 trillion dollars worth of commodities, of which nearly 70% is oil? What will happen if these speculators, which include banks, are told to put up more cash as margin or scale down non-delivery positions, an extremely likely even should prices rise any more?
• If this is all demand and supply like everyone seems to say, why are there at least 14 Iranian oil tankers carrying 2 million barrels each sitting idle in the persian gulf?
• What happens when China stops buying crude for diesel that it is stockpiling for the Olympic games in August? China has taken the price of diesel way beyond petrol, when it is in fact easier to produce than petrol (less refining required).
• When people say we have reached the peak of supply, do they not realise that the current prices will push people in looking for supplies where it was earlier unprofitable to do so? And that supply will suddenly materialise out of nowhere because a lot of countries have hidden their sources, and some haven't even explored areas which they know may contain oil but it's been too expensive to get at? And the thought that countries like India have a MASSIVE amount of oil under rocky beds like the deccan plateau, which is likely to be able to fuel the world for the rest of our lifetimes, but are too bloody expensive to explore?
• The problem with power has always been that it could not be stored in large enough quantity for a long enough time. With battery technology scaling up it is likely to reach the point soon where power can be stored in manageable sizes; then excess power which is currently lost can be reused. Won't this reduce the need for oil dramatically over time, and consuming units like cars, motors and mechanical equipment have attached batteries to store unused power? (Note: this is not very close by)
• What happens if the US opens up the strategic reserve, canada and alaska decide to forego environmental issues and open up the gigantic reserve and russia explores a lot more in the arctic? And that exploration is allowed in the antarctic belt? It will not just destroy oil prices, but absolutely kill Saudi Arabia, UAE, Nigeria, Iran and a whole host of smaller hostile countries like Libya, Columbia and Sudan. That would be a good consequence?
• What will happen if, as part of the worldwide slowdown, the demand for the output of the crude refineries (i.e. petrol, diesel etc.) drops tremendously, and the pension funds are left holding assets now selling at half price? Who suffers?

There are no correct answers. But there may be more questions.

This comes from two comments to my last post asking me how active bond markets or the lack thereof affect the policy reaction to inflation. I'm not an expert so please feel free to correct me if I'm wrong.

Inflation is bad. To control inflation you need to increase interest rates. The concept is to slow down demand for money (and thus, reduce demand for other goods which fuels inflation) TO do that, money must become more expensive - that's why the interest rate hike.

In an active bond market, all bonds are directly or indirectly benchmarked to the RBI interest rate. Companies will finance themselves using short term bonds - one week to a month types - and roll them over. Banks will lend long term and buy short term etc. The impact of an interest rate hike is immediate in this case - companies will see the impact of the rate increase. So short term borrowings will immediately be more expensive, increasing the cost for those that borrow short term, who will have to raise prices or take a profit hit.

Additionally the rate increase will cause the market value of longer term bonds to fall (since yields have gone up, the bond prices will go down). The m2m regulations will cause the holders of such bonds to take a little bit of a loss meaning they don't have so much more money to invest either (which in a small way reduces the money supply some more)

So bond markets provide a market value for loans, both short and long term, and the fact that interest rate hikes immediately affect this market, will immediately affect all participants. The wider and deeper (in value) this participant base is, the faster the impact of an interest rate hike is on reducing demand for money and therefore in containing inflation. But when I say "immediate" it still means maybe 3 months.

Without an active bond market, you have to wait till the consumer sees the hit. Meaning, a bank has to raise rates (which as we've seen they are loathe to do, sensing that customers may default if it gets too bad) Once a bank raises rates, the corporate and retail customers will have to slow down demand.

The effect of this, given these are largely longer term loans, is slow. And since there isn't a market value of these loans, there is no valuation either, a smaller problem. The change in demand for money will be visible in a longer time frame, maybe 6-12 months.

Even with active bond markets, Paul Volcker had to raise interest rates to 16% in the 70s in the U.S. to contain inflation - the darn thing was out of control. In the process, he ran the country through two recessions. Imagine if you were holding a 12% bond and thought - this is great. In a year it's market value was lower because the interest rates had gone to 16%!

It was so bad that even Paul Krugman, the famous analyst, got it wrong. In 1982, he predicted that inflation was coming back and that interest rates would rise further - they fell a huge amount from there.

An active bond market can save the government's backside when it comes to controlling runaway inflation, like in current times. Unfortunately now raising rates is like trying to use a vacuum cleaner to pull down a balloon that's flying away - you gotta keep getting bigger capacity suction before it impacts the balloon. In this context, an active bond market is like a loose rope tied to the balloon, the other end of which is in your hand. You tighten, it responds, and you probably don't need to increase suction that much.

If we are to tame this kind of inflation, interest rates need to be ABOVE inflation. RBI rates at 8.25% are not enough - and given the lack of a bond market it will need to go to 15% before inflation, at this level, is controlled. It will be much more difficult if it crosses 12-13%.

I hope my feeling about crude post July comes true. I believe supply will be much better in September, and demand for petro products is already going down considerably. If we crush the dollar, we won't need to raise interest rates any more. We have 314 billion dollars, for heavens sake can someone go and beat the dollar down already? It's far far far cheaper than hiking interest rates.

Note: this comes from a person who is a computer engineer and who, until last year, made his wages in an export oriented industry. Yes, a falling dollar will destroy this industry - but it's better for the nation, and we can still earn export income by going higher up the chain and doing stuff other people want, rather than doing stuff other people don't want to do.

Disclosure: No position because there are no active bond markets. (Hint, hint)

Inflation at 11.4% today and the folks on CNBC are jumping around in excitement. I usually don't watch business news, but today I have this viral fever and couldn't help but watch the gyrations of the anchors as they squirmed to explain the inflation. All of them blamed oil price increases, and one of them said non oil stuff is also going like crazy, and they even predicted that at this rate inflation would be 16% by the end of the year. (If it grew 0.4% every week)

This is a stupid extrapolation. This 0.4% was this week. Last week the jump was 2% (at that rate inflation will be 100% in a year) and before that we had spells of rising inflation and slowing rates - so there can be no conclusion of this dramatic sort.

11.4% itself is meaningless. It is so high it is ridiculous. To even make a statement that it is higher or lower is of no consequence - at an absolute level inflation about 8% or even 6% is too high. After that it doesn't matter how high, you have to do whatever it takes to bring it back down.

What is important is the policy reaction. The first reaction is to raise rates - not very effective because the bond market in India is not very liquid. (Issued bonds go down when rates rise, and that affects both short and long term portfolios and issuing companies - but we have very little liquidity in our bond markets)

The other reaction, and I really hope this happens, is the destruction of the dollar rupee equation. Take the dollar to Rs. 35 by selling, if necessary, even half the 300 billion USD we store for no real reason. That will destroy exporters, but inflation is a bigger problem - choose the better evil.

As crude goes up in value - today's rates were 142 - we will have even more inflation. But that will go away - this is starting to look like a panic rise, almost. Iran has 20 VLCCs sitting in the persian gulf looking for delivery - and given that it is heavy sour crude, not much takers. It's only when RPL comes online that more of this crude can be refined, but even that is only 0.66 million barrels per day (versus 85 million barrels per day consumed worldwide). Still the increase in refining capacity will bring down price somewhat, but for that RPL has to be operational.

Lastly, there is the entire issue of the next wave of the credit crisis - and if Lehman and Citi are affected there are bound to be more outflows.

So what do I make of the picture. Bad. Very bad. While there may be pullbacks, unless something dramatically good happens, we are going down further.

Disclosure: Am short the Nifty.

HOV Services, a stock I've traded in the past (and exited with a stop loss) has seen some major action in the last few days.

They made an announcement on June 5 saying:

Material Transaction Proposal
The Company has received an offer of approximately $202 million to purchase 100% of its wholly owned subsidiary HOV Services, LLC and its Hong Kong subsidiary from a company controlled by some of our promoters and shareholders. On a fully diluted basis including ADR’s if any, our shareholders will have the right to receive approximately $91 million in cash - our shareholders will have the right to receive either cash of approximately Rs. 170 or one share in the buyer for each share held as of the record date; the existing debt will be assumed under the terms of this offer. All shareholders as of the record date will continue to own their current shares after receipt of cash or shares in the buyer. Our independent directors believe this to be in the best interest of the shareholders and have recommended that the Company seek independent legal and financial advice. Upon satisfactory statutory or regulatory approvals, as required by law and subject to positive recommendation by the Company’s independent advisors to our board of directors, the transaction will then be submitted for approval to our shareholders.

This is a good thing, right? The stock is below 100, and a promoter owned company wants to buy a subsidiary and pay the current shareholders Rs. 170 per share, and the shareholders can keep their shares of the parent business. Fantastic?

For a couple days, The markets thought so. For two consecutive days, it was at the upper circuit, with large buying and obviously a lot of people thought 170 is the bare minimum for the stock.

As it should be, if there was really a proposal on the table. There is no mention of anything serious - i.e. which is the promoter company, what is the record date of the deal, when and how they will make the payment. And most importantly, what if they say ok and later say no? Is there a clause that says they have to pay some percentage anyhow? Will they put the money in escrow so that if the renege later, the company still receives a cut, and the shareholders aren't duped?

Now the story gets interesting.

NSE then put the stock into the T2T segment on June 13- where you can't speculate intraday, every single trade results in delivery. That means full cash up front. NSE does this to stocks when there is a tremendous move and they put the stock under surveillance for a few days or months. In fact NSE kept HOVS in T2T in a later announcement too.

If there was real buying in the stock it should have sustained the volume even after June 13. I have traded Jai Corp when it was in T2T and the volumes and demand remained even when it was in T2T - signifying that the move was on strong - in fact I exited with nearly 30% profit on that stock.

In HOV the situation is different. With 500,000 shares traded the day after the announcement and a couple 100K days, the volumes are down to less than 10,000 shares a day! For a share that's around Rs. 100, that's less than 10 lakhs worth of shares every single day - even with T2T that's remarkably low.

Now this makes you think, doesn't it? What if this announcement was made primarily to rig the price of the stock? What if the price went up and later there was no such deal, but someone intended and managed to get rid of their stock at the higher price?

Now the company by itself is good - they have a fantastic BPO setup and have over 12,000 employees, doing various kinds of KPO and BPO services. Still, there is some consternation about such announcements - and here is another problem.

The promoters have had cases filed on them accusing them of price rigging in U.S. Listed stocks.

Surinder Rametra, Chairman and MD, was involved in cases in his other companies ATEK and Interpharm, in the US. The case on ATEK was settled with the plaintiffs for an undisclosed amount.

Read these two links (Corporate Greed at it's worstand "Extra, Extra") for details on how insiders supposedly made announcements and sold heavily as the price of Interpharm went up. These are known as "pump and dump" schemes, and Rametra has been accused of doing this.

An exec director, Parminder Chadha was in a lawsuit accused of inflating stock of his company, Osicom(listed in the US), by issuing false statements. Read these links (Class Action Complaint and "Buyer Beware")

Now these links do not indicate any fraudulent behaviour, so that cannot be the conclusion. But in the face of such history it pays to be careful when investing - if they were accused of "pumping and dumping" shares, how can we be sure it is not happening now, with HOV? Investors need more clarity and some of the money down - in fact, should you get more news about this "deal", please try to find as much details, including calling the company up, before you invest. You need to know the record date of the deal, and what happens if the acquiring company says ditch. If those are clearly available, then this share can be purchased, T2T or otherwise.

And then there is the big question of why this announcement was sneaked into what was really quarterly results (see the rest of the pdf). Very weird, that.

I would be very careful in risking any money on this share. Yes, this is one time when SEBI must intervene and demand full and complete disclosure - otherwise make the company rescind the announcement immediately. This is what regulators are for.

Disclosure: No positions. None of our automated systems will buy this stock - we don't trade illiquid or non F&O stocks.

You want to read this post by Colin Seymour:

Read the full post to see what people said in various times. Nearly every time they said that the future looked better it got worse.

Where are we, in India, if this map were ours? Going by our series of pompous prognosticators, most of whom think that stocks are good "value" now and we should be buying after prices have gone this far down - I think we are around point 14. Are we going the same way? I don't know - can't predict anything - but we have similar statements being thrown.

The time has now come to deal with EPS growth on the Nifty - it is around 10% since the same time last year. The outlook for next year is bad. Interest rates are up. Inflation is up. We have a new election coming along, so no major policy moves. The next few months are definitely going to be bad - but will we recover after that? While I have my doubts, let's wait and see. Meanwhile, don't ask if this is the right time to invest. It's not, unless you have a 10 day horizon.