Tuesday, May 14, 2013 -

Booms

by Sinclair Noe

DOW + 123 = 15,215
SPX + 16 = 1650
NAS + 23 = 3462
10 YR YLD + .03 = 1.95%
OIL - .94 = 94.23
GOLD – 5.00 = 1426.80
SILV - .24 = 23.51

So, we have record highs. I went back to check some of the earlier in the year predictions. Last December, Goldman Sachs was predicting the S&P 500 would hit 1625; sounded good, even a little bold back then. Of course, in the past week, we've blown past those numbers. Many experts are calling for a correction here. Maybe, maybe not. If your memory is still sharp, you'll recall a few weeks back I was talking about the “Sell in May” strategy; and if you're really sharp, you'll recall I said the way to play that strategy was to wait for a MACD sell signal for an exit, rather than just an arbitrary date on the calendar. We still haven't had the exit signal.

The market is in full melt-up mode, extending further above its longer-term moving averages every single day. The riskier stocks helped pushed the market higher over the past week or so. Technology names blasted higher. Materials broke out and helped lead the market to record heights. This shows that we are finally seeing investors beginning to believe in the market again.

In a recent Gallup survey, only 52% of folks said that they or their spouse own any stocks (that includes mutual funds). That's a jaw-dropping number if only for the fact that the S&P 500 has more than doubled since its 2009 bottom. The data shows that, left to their own devices, most individual investors sold into that 2009 bottom, and they kept selling stocks as the market recovered and pushed to new highs. So, there is a lot of money on the sidelines. If we do get a correction, it will probably happen right after Mom and Pop investor jump in.

The Congressional Budget Office just did a new series of baseline budget deficit projections and they're a lot lower than the old ones. The short-term deficit, in particular, is way lower; $200 billion lower; or a $643 billion deficit for 2013 rather than an $845 billion deficit. That's about half higher-than-expected tax revenues and about half higher-than-expected payouts from Fannie Mae and Freddie Mac. A big reason for the smaller-than-expected deficit is stronger economic growth.

The CBO is also revising the 10-year deficit forecast down by $618 billion, primarily because of the slowdown in health care spending. This doesn't mean the deficit problem is completely fixed. The current projection has the deficit shrinking for the next couple of years and then growing again. So, things will get better before they get worse, but that leaves us with a manageable 2024 deficit. The problem is that it's trending upward, and nothing in this revised projection changes that fact. There's no need to panic about the 2024 deficit, or for that matter, no need to strike a grand bargain. It is possible that we could start to control health care costs and do more to boost economic growth, and ten years from now, we might not have much of a problem at all. Key here is economic growth.

The Department of Labor reports US import prices fell in April due to a drop in oil costs, a positive sign for household finances that also pointed to benign inflation pressures. Import prices slipped 0.5 percent last month, the biggest decline since December. March's data was revised to show a 0.2 percent decline instead of the previously reported 0.5 percent drop. Stripping out petroleum, import prices dipped 0.1 percent.

The tame inflation environment should allow the Federal Reserve to stay on its ultra-easy monetary policy; so this flies directly in the face of those who are worried about the Fed “tapering off” of QE. At its policy meeting earlier this month the central bank decided to continue buying $85 billion worth of bonds every month to push long-term interest rates downward. At the same time, the economy has lately shown signs of resilience despite austerity measures.

The National Federation of Independent Business reports its gauge of confidence for small U.S. businesses rose in April to its highest in six months. Lower oil prices are also helping household finances. The United States imports much of the fuel it consumes. Last month, imported petroleum prices fell 1.9 percent. The Labor Department report also showed export prices fell 0.7 percent last month, the largest decline since June.

Meanwhile, there is a boom in North American energy that may be one of the biggest stories in the global economy, even though we haven't really felt the positive impact in the US; not yet anyway. The boom is related to the shale exploration in the US and the oil sands fields in Canada.

A new report from the International Energy Agency, the IEA, discusses the consequences of the boom, and they are looking at this as a boom. The report describes the US supply "shock" as that is sending "ripples" throughout the world, affecting every aspect of the market.

Here's the key part from the press release announcing the report:

The supply shock created by a surge in North American oil production will be as transformative to the market over the next five years as was the rise of Chinese demand over the last 15, the International Energy Agency (IEA) said in its annual Medium-Term Oil Market Report (MTOMR) released today. The shift will not only cause oil companies to overhaul their global investment strategies, but also reshape the way oil is transported, stored and refined.

According to the MTOMR, the effects of continued growth in North American supply – led by US light, tight oil (LTO) and Canadian oil sands – will cascade through the global oil market. Although shale oil development outside North America may not be a large-scale reality during the report’s five-year timeframe, the technologies responsible for the boom will increase production from mature, conventional fields – causing companies to reconsider investments in higher-risk areas.

In virtually every other aspect of the market, developing economies are in the driver’s seat. This quarter, for the first time, non-OECD economies will overtake OECD nations in oil demand. At the same time, massive refinery capacity increases in non-OECD economies are accelerating a broad restructuring of the global refining industry and oil trading patterns. European refiners will see no let-up from the squeeze caused by increasing US product exports and the new Asian and Middle Eastern refining titans.

“The good news is that this is helping to ease a market that was relatively tight for several years. The technology that unlocked the bonanza in places like North Dakota can and will be applied elsewhere, potentially leading to a broad reassessment of reserves. But as companies rethink their strategies, and as emerging economies become the leading players in the refining and demand sectors, not everyone will be a winner.”

While geopolitical risks abound, market fundamentals suggest a more comfortable global oil supply/demand balance over the next five years. The MTOMR forecasts North American supply to grow by 3.9 million barrels per day (mb/d) from 2012 to 2018, or nearly two-thirds of total forecast non-OPEC supply growth of 6 mb/d. World liquid production capacity is expected to grow by 8.4 mb/d – significantly faster than demand – which is projected to expand by 6.9 mb/d. Global refining capacity will post even steeper growth, surging by 9.5 mb/d, led by China and the Middle East.

Now, when you look at this energy boom, you might think this would be a real positive for US manufacturing. We just haven't seen it yet, and we might not. There has been talk about a renaissance in US manufacturing, and factory output continues to rise, but the truth is that manufacturing has dropped to just 9% of jobs, and in the last month, there were no new manufacturing jobs added. For every $1 of manufacturing output in a community, there’s another $1.48 of wealth created. And there has been a push for new manufacturing jobs which unfortunately has been hampered by austerity measures out of Congress. Any strength we've seen in manufacturing is probably just a short-term bounce reflecting more the relative weakness of Europe and Japan. Lower energy prices might help, but not yet. The ability to make things is fundamental to the ability to innovate things over the long term. When you give up making products you lose a lot of the added value.

Maybe we are on the leading edge of a new oil and natural gas boom in this country, but one thing we'll need to get there is water.

Water and energy are inextricably linked.

Power plants are the largest users of water in the United States, while substantial amounts of energy are needed to supply fresh water to homes, farms and factories and treat waste water prior to safe disposal.

Rising water consumption for hydraulic fracturing and production of biofuels, coupled with severe droughts across more than 60 percent of the continental United States in 2012, have propelled that link up the policymakers' agenda.

The threat to hydroelectric generation is obvious. But in 2007-2009, drought put the water supplies of 24 of the nation's 104 reactors at nuclear plants at risk.

The United States withdrew 410 billion gallons of water from aquifers, rivers and the ocean every day in 2005, of which 350 billion gallons were fresh water and 60 billion gallons were saline or brackish.

Cooling systems for nuclear plants and power plants that burned coal, gas and oil accounted for 41 percent of fresh water withdrawals and 49 percent of all water withdrawals. That put them ahead of irrigation (31 percent) and public supply to homes and offices (11 percent). The remaining uses including industry, mining, livestock and aquaculture accounted for less than 10 percent combined.

In addition to power plants, water used in growing crops for biofuels as well as for drilling and fracking oil and gas wells accounts for a rapidly increasing amount of total consumption.

The broader energy sector has been the fastest growing water consumer in the United States in recent years and is projected to account for 85 percent of the growth in domestic water consumption for the next 20 years.

Environmentalists and community groups cite water scarcity as one reason to ban or restrict fracking. Even in Texas, water conservation districts say they are considering introducing restrictions if reservoirs and the water table drop too low.

Most of the water employed in thermoelectric power stations is in the cooling system. In once-through cooling (OTC) systems, water is withdrawn from a source, normally a river or coastal location, circulated through heat exchangers, then returned to the surface water body. OTC systems withdraw large amounts of water but use comparatively little, returning most to the source.

Most thermal plants in the United States employ OTC systems. Net water consumption is therefore only 3 percent of the total, compared with gross withdrawals of almost 50 percent. The distinction between withdrawals and consumption is crucial. Water that is consumed cannot readily be used for another purpose.

Power plants need sufficient water at a low enough temperature to operate efficiently. Most states impose restrictions on the temperature at which water can be discharged back into rivers and the sea to prevent the animals and plants in the waterway from being cooked. If there is insufficient water or it is too hot, power plants may be forced to close or cut output.

In August 2012, the Illinois Environmental Protection Agency waived the normal environmental restrictions and allowed four coal-fired and four nuclear power stations to release hundreds of millions of gallons of hot water at nearly 100 degrees Fahrenheit into state lakes and rivers to keep the lights on.

On other occasions, low water levels forced power plants to turn down. During the 2003 heat wave in France, which was responsible for more than 10,000 deaths, nuclear plants had to reduce their output, worsening the crisis.

Nuclear and coal-fired power plants with OTC systems are especially vulnerable to droughts and heat waves because they rely on by far the largest volume of water withdrawals. Combined-cycle gas plants are much more efficient. And gas turbines, solar and wind generators use negligible quantities.

Options for reducing the power sector's vulnerability include switching the type of fuel from nuclear and coal to gas, solar or wind; switching to recirculating or dry and hybrid wet-dry cooling systems; or switching the water source from fresh water to saline or waste water.

The drawback is the capital cost and reduced efficiency of the plant.

Oil and gas extraction uses prodigious quantities of fresh water and produces large amounts of brackish waste water, which is normally reinjected far below the drinking water table. Drilling a conventional well uses relatively small quantities of water for drilling mud. Fracking uses vast amounts of water. A typical well drilled and fracked in the Eagle Ford uses 4.3 million gallons.

Pressure to reduce the amount of fresh water used in fracturing operations has led to interest in switching to saline or waste water, recycling water, or fracking with diesel or hydrocarbon gels, though all these systems are less efficient and remain experimental, and represent the threat of contamination to acquifers.

Biofuels present another problem. Huge amounts of water are being used to grow crops to produce ethanol.

Because biofuels need so much water for their growth, they are particularly vulnerable to droughts. Just as traditional agricultural crops are hindered in times of drought, so are energy crops.

We may be looking at a boom in energy production in this country, but it comes at a price.