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May 20, 2013

"North America has set off a supply shock that is sending ripples throughout the world."

THE WEEK IN REVIEW...

US:

• Selective swoon While some segments of the economy seem to be slowing, consumer spending continues to grow: retail sales rose 0.1% in April, for a year-over-year (YoY) gain of 3.7%. But with autos, building materials and gasoline excluded, the rise was 0.5% for the month, or an 8% rate for the past three months. The news wasn't uniformly positive; industrial production fell in Apr by 0.5%, worse than expected, and housing starts fell 16.5% in Apr to a five-month low, the bad news cushioned somewhat by an increase in building permits to a five-year high.
• Price relief: Moderating prices may be taking the edge off the economic slowdown. The downward trend showed up at both the wholesale and retail levels. Producer prices dropped 0.7% in Apr, the biggest decline since Feb 2010. Much of the decline reflected energy costs; ex food and energy, wholesale prices rose 0.1%. For consumers, prices declined 0.4%, the biggest decline since Dec 2008, also pulled downward by energy; "core" inflation, which excludes food and energy, rose 0.1%. This trend can be seen as supportive of the Fed's current inclination to continue its $85 bn monthly bond purchase program, with inflation apparently not an imminent concern.

Asia:

• Abe-nomics gains momentum: The recent summit meeting of G7 finance ministers (i.e. from the seven largest economies) made little mention of either Japan's aggressive monetary easing or the resultant plunge in the value of the Japanese yen. " I think Japan's stance is gaining broader understanding,"¹ noted Japan's finance minister Taro Aso. Positive results have helped; Japan's GDP² rose an annualized 3.5% in 1Q2013, with private consumption, 60% of GDP for Japan, contributing 2.3 percentage points of the gain.
• China slows but grows: The rate of growth of investment in fixed assets (excluding rural households) decelerated for the first four months of 2013 to 20.6% growth rate, down from 20.9% for the first three months. This change is consistent with the stated goals of China's new leadership to tolerate a moderation in the breakneck pace of growth for the past decade. Still, the transition to slower and more sustainable growth isn't seen as complete by China's central bank, which reported that the "foundation for stable economic expansion isn't yet solid."³

Europe:

• Some good news: Bond yields in Greece fell to their lowest levels in three years as Fitch upgraded the country's credit rating one notch, to B minus from CCC, with an outlook of "stable". Standard & Poor's had upgraded Greece to B minus in Dec 2012. Cyprus received €2bn ($2.6bn) in bailout funding from the European Union (EU), despite lingering concerns about money laundering. UK housing prices rose to the highest level in almost three years in Apr, as loans for house purchases rose 14.8% to 42k in Mar from Feb.
• The rest of the story: The 17-country eurozone economy shrank 0.2% in 1Q2013, from 4Q2012, slightly more than expected. The 27-nation European Union shrank by 0.1%. Germany grew an anemic 0.1%, though that was an improvement from 4Q's 0.7% decline. France, now in the spotlight due to its policy differences with Germany, contracted 0.2%, the second consecutive drop, thereby meeting the formal definition of recession.

SIGNS OF THE TIMES:

For All the Debt, There's a Shortage of Bonds - Reuters

ECB Picks Fight With Germany on EU Plan for Failing Banks - Bloomberg

Chinese Automakers Quietly Build a Detroit Presence - New York Times

Spain Home Expropriation Plans Seen Violating EU Bailout - Bloomberg

Spanish Billionaires Hire 4,000 Amid Country's Job Slump - Bloomberg

Crude awakening: US energy on the rise
US Crude Oil & Natural Gas Production: Feb 1993-Feb 2013

Source: US Energy Information Administration (EIA). The graph above is for illustrative purposes only and is not reflective of an actual investment.

The bottom line:

• US crude production is heading toward its all-time high and natural gas is setting new records.
• Some have gone so far as to proclaim that the US could achieve full energy independence within a decade; whether or not that is realistic, greater energy production would in principle create jobs and help cut the US trade deficit. With Europe in recession and China's growth slowing, a stronger US economy could be important to keep the global economy healthy.
• Increased US energy production could also benefit the rest of the world by possibly taking some of the pressure off global energy prices as global energy demand continues to grow.

The graph:

• The graph shows the rolling 12-month total of US crude oil & natural gas production over the past two decades. Crude oil production is measured in millions of barrels and natural gas production is measured in billions of cubic feet.
• Both natural gas and crude oil production have increased about 35% from their 2006 lows.
• US natural gas production for the past 12 months recently surpassed 25 trillion cubic feet.
• At a total production of nearly 2.5 billion barrels over the past 12 months, US crude oil production is the highest it's been since Feb 1995, but still well below the annual rate 20 years ago of 2.59 billion barrels – and below the 1985 all-time peak of 3.3 billion barrels.

Context and perspective:

• This past week, the Paris-based International Energy Agency forecast North America would dominate the growth of worldwide oil supply over the next five years – with the US a major contributor to the estimated increase in daily production of 3.9 million barrels between now and 2018.
• Both technology and discovery are driving production growth in the US – as well as the rest of the Western Hemisphere.
• The growth in oil production from countries outside OPEC⁴ could impact prices – as well as decrease demand for OPEC's output. But global demand is expected to grow as well, offsetting at least some of the effect that increased supply could have on prices.
• Increased natural gas production has already played a major role in the so-called US manufacturing renaissance by providing companies with lower energy costs—an incentive to expand overall US manufacturing capacity, as well as to repatriate manufacturing that moved abroad in recent years.
• And even in the short run, lower energy costs could benefit consumers by leaving more money available for discretionary spending, increasing savings and paying down debt.

Background:

Venezuela:

• Member of OPEC, with a nationalized oil & gas sector
• Some foreign firms that set up operations in the 1990s following liberalization of the oil sector continue to operate there, but their participation was restricted in 2006 by the Chavez government
• Thought to have 211 billion barrels of proven oil reserves (2011), the second largest in the world, but given the potential of Venezuela's Orinoco belt this number could be as high as 316 billion barrels
• Reportedly had 195 trillion cubic feet (2012) of proven natural gas reserves in 2012, the second largest in the Western Hemisphere behind the US

Canada:

• Privatized oil sector with many domestic companies and the active participation of international corporations
• Estimated to have over 170 billion barrels of proven oil reserves (2012), the 3rd largest after Saudi Arabia and Venezuela. Oil sands now account for approximately 98% of Canada's oil reserves.
• Estimated to have natural gas reserves of 61 trillion cubic feet (2012)

US:

• Reportedly had 25.2 billion barrels of crude oil reserves (2010), a 13% increase from 2009—the largest annual increase since 1977 and the highest total level since 1991. The EIA is scheduled to release an updated report this month.
• Natural gas reserves were thought to be 317.6 trillion feet in 2010, up 12% from 2009, marking the 12th consecutive annual increase and the first year US volumes exceeded 300 trillion feet. The EIA is scheduled to release an updated report this month.

Brazil:

• State-controlled energy sector, dominated by a national oil company. However, the government opened the oil sector to competition in 1997, so there are some international companies playing a role
• Estimated to have 14 billion barrels of proven oil reserves (2012), the second-largest in South America after Venezuela.
• With recent discoveries of massive offshore deposits Brazil could become one of the world's largest oil producers
• Reported to have approximately 14.7 trillion cubic feet (Tcf) of proven natural gas reserves (2012)

Mexico:

• Nationalized oil & gas sector, but trying to take steps to liberalize the sector and allow foreign involvement, to reverse a near decade long decline in oil production
• The decline is expected to continue for the next decade unless technology and investment are allowed from abroad—needed especially to help develop deep-water reserves
• Despite the handicaps, Mexico is one of the ten largest oil producers in the world and the third-largest in the Western Hemisphere
• Mexico is reported to have 10.2 billion barrels of proven oil reserves (2011) and 17.3 trillion cubic feet of proven natural gas reserves (2011), but has limited technological ability at present to develop these resources

...AND THE WEEK AHEAD:

GLOBAL ECONOMIC CALENDAR: May 19 – May 25

Sources: Bloomberg, Wall Street Journal, The New York Times, Financial Times, South China Morning Post, BBC, Xinhua, Reuters, International Energy Agency, US Energy Information Administration, US Dep't of Labor Bureau of Economic Analysis, US Federal Reserve

¹South China Morning Post, 13 May 2013

²Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

³Source: Bloomberg, 13 May 2013

⁴The Organization of the Petroleum Exporting Countries (OPEC) is a group of 12 petroleum-producing countries, with the goal of coordinating and unifying the petroleum policies of its members.

⁵The Federal Housing Finance Agency (FHFA) is the regulator and conservator of Fannie Mae and Freddie Mac and the regulator of the 12 Federal Home Loan Banks.

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