Wednesday, August 13, 2014 - Oil, At Least in Theory

Oil, At Least in Theory
by Sinclair Noe

DOW + 91 = 16,651
SPX + 12 = 1946
NAS + 44 = 4434
10 YR YLD - .03 = 2.41%
OIL - .04 = 97.33
GOLD + 3.70 = 1313.20
SILV - .11 = 19.91

The economic news today did not point to a positive session for Wall Street. Retail sales for July were flat compared to June. Excluding autos and gas, retail sales were up just 0.1%. Clothing sales increased 0.4% but that was primarily due to extreme discounting. That report was confirmed by an earnings report from Macy’s, which missed expectations on earnings and revenue, and then lowered guidance. In after-hours trade, Cisco reported better than expected earnings and revenue.

The US has deployed 130 Marines and Special Operations forces to northern Iraq to help assess ways to rescue thousands of members of the Yazidi religious group taking refuge on Mount Sinjar. Those military advisers will not have a combat role, but the Defense Department left open the possibility that US troops could help create a safe passage for the Yazidi off Mount Sinjar. That might put US troops in direct combat with the ISIS militants trying to kill the Yazidi, a proposition President Obama has not signed off on, but one the military advisers are exploring.

The US and Iran don't agree on much, but it appears the two countries are backing Iraqi Prime Minister Nouri al-Maliki's replacement, Haider al-Abadi. Iran's endorsement on Tuesday means that Maliki, who has indicated he won't go quietly, will have an even harder time holding onto his position. The United States and its allies hope that replacing Maliki, who alienated the Sunnis of Iraq, will undermine support for the militant group the Islamic State in Iraq and Syria (ISIS). For now, Maliki is trying to cling to power, but his days appear numbered.

There are daily multiple sorties by US fighter bombers flying off a US Navy aircraft carrier in the Gulf, some resulting in airstrikes on advancing ISIS forces that have threatened civilian refugees and the Kurdish capital of Erbil. Unmanned US drones are in the air gathering a constant stream of intelligence which is being fed back to a US-manned operations center in Baghdad and then shared with America's allies.

There are close to 1,000 US military advisors in Iraq, including Special Operations forces, divided between Baghdad and Kurdistan and the CIA is believed to be running an operation to supply Kurdish forces, the Peshmerga, with arms and ammunition. Iraqi Kurds have overtaken 2 northern oilfields.  The two oilfields are said to have a combined daily output capacity of some 400,000 barrels per day. The operations are most certainly not entirely humanitarian. France and Germany both say they will send military equipment to help the Kurds defend themselves. Hercules transport planes have been dropping aid to civilians fleeing from the onslaught of ISIS.

While the case for intervention on humanitarian grounds to save the lives of thousands of fleeing refugees is overwhelming, there is now the risk of what is known as "mission creep"; of a small, narrowly defined operation ballooning out of control, sucking in Western countries into a lengthy conflict with no clear exit. Politicians are fond of saying "there will be no boots on the ground" but in practice there are already growing numbers of US military personnel deployed to Iraq behind the scenes. The ISIS fighters are now embedding in residential areas like Mosul, essentially using civilians as shields. Already Iraqi government airstrikes around Mosul have led to reports of civilian casualties. What if advice and air power alone are not enough to prevent the ISIS from taking more towns in Iraq and Kurdistan? What if Baghdad itself or the cities of Kirkuk or Irbil look threatened?

The militants from ISIS have been causing problems in Iraq and Syria for several months, but then they took control of the area around Kirkuk, a gigantic oilfield; then they captured the Mosul Dam, which controls electricity and might serve as a weapon; and then they encroached on the Kurdish capital of Erbil, an oil boomtown which happens to have a US consulate but also has hundreds of employees of companies like Chevron and ExxonMobil; that’s when the airstrikes against ISIS started. To be fair, it was also when ISIS became especially barbaric, and tens of thousands of Yazidi refugees became stranded. The current US intervention certainly has humanitarian purpose, but it would also be wrong to pretend that oil is totally irrelevant to the larger crisis in Iraq.

Meanwhile, the markets are discounting any disruption in distribution in Iraq; Iraq is currently the world's seventh-largest oil producer, churning out some 3.3 million barrels per day; Kurdistan in the north is only responsible for about 10% of the national production; most Iraqi oil exports come from the southern part of the country, and those oil fields are far away from the current fighting, so it’s highly unlikely that there will be a disruption, at least in theory.

In theory, all oil sales in Iraq are supposed to be handled by the central government in Baghdad, which then splits revenues among the various regions according to an existing agreement. Iraqi Kurdistan has been pushing to sell more of its own oil directly to other countries, bypassing the central government entirely, because Kurdish officials claim that the central government hasn't been sending Kurdistan its promised share of oil revenue.

The United States is officially opposed to Kurdistan's direct sales of oil abroad because it might undermine the unity of the Iraqi government. There's currently an oil tanker filled with about 1 million barrels of Kurdish oil parked about 50 miles offshore from Houston that can't unload its crude. State Department officials have been quietly warning any potential buyers of the Kurdish oil that they could face "serious legal risks." But now, the Kurds are stepping up the fight against ISIS.

Iraq has scheduled to export about 2.4 million barrels per day of Basra Light crude in September, up from 2.2 million in the previous month. Libya has resumed shipments of crude. According to the IEA: "The Atlantic market is currently so well supplied that incremental Libyan barrels are reportedly having a hard time finding buyers." If Iraqi oil goes offline, even for a short time, the rest of the world does not have enough spare capacity to replace that production; that would likely push oil prices over $125 a barrel, and that might then increase the leverage for Putin.

And it had been thought that sanctions imposed on Russia over its support for Ukrainian rebels might cause disruptions in oil distribution. Russia is the largest oil producer in the world, at over 10 billion barrels equivalent per day or 13% of world supply. However, the markets are looking at Russia and saying that Putin needs to sell oil even more than the EU needs to buy it. Russia turning the taps off would cause an oil shock in the West as it would cause a steep rise in prices and significant disruption, however it would also bankrupt Russia. At least in theory.

Ukraine vows to stop Russian-supply convoy unless conditions are met. Wary that the Russians may be trying to move military supplies into their country to aid pro-Moscow separatists, Ukrainian officials said they would not allow a convoy of 280 Russian trucks to cross the border unless the Red Cross took over the delivery. Ukraine says the cargo, which Russia insists is humanitarian aid, must be loaded onto other vehicles by the Red Cross. It will take the trucks about two days to make the 620 mile trip from Moscow to eastern Ukraine.

Ukrainian state-run energy firm Naftogaz said yesterday that the ongoing dispute over natural gas prices between Kiev and Moscow may lead to disruption in Russian gas transit to the European Union (EU) countries. Kiev and Moscow have been locked in a dispute for three years over a 2009 contract under which they agreed to tie the price of gas to the international spot price of oil. In June, Russia's energy giant Gazprom has cut all gas supplies to Ukraine after the two sides have failed to reach an agreement on payments. The dispute between the two former Soviet countries triggered fears that Russian gas transit to Europe may be halted. Currently, around 15 percent of EU gas supplies flow through Ukraine.

Yesterday, the International Energy Agency (IEA) said: "Oil prices seem almost eerily calm in the face of mounting geopolitical risks spanning an unusually large swathe of the oil-producing world." Global oil prices have fallen to their lowest levels in 13 months. Brent crude is trading around $103 a barrel, and WTI is around $97, then 10^th straight session with prices under $100. Retail gas prices have dropped about 23 cents a gallon since April.

And you probably remember back in 2008, when tensions with Iran helped push oil prices up to a record $148 a barrel. So, with all the problems around the world now, why are oil prices dropping? The US is pumping the most oil in 27 years, adding more than 3 million barrels of daily supply since 2008. Supplies from the Organization of Petroleum Exporting Countries, which pumps about 40% of the world’s oil, rose to a five-month high of 30 million barrels a day in July as Libyan output recovered and Saudi Arabia increased production. At the same time, global demand is weak, although it is expected to pick up towards the end of the year. Meanwhile Mexico has privatized its oilfields, at least partially. The state-owned energy group Pemex will lose the monopoly it has held since nationalization in 1938. Mexico’s oilfields had been underperforming and production dropped by more than a million barrels per day in the past few years. So, if we can just hold it together for a couple more years, North America could become energy independent. Until then, it could go either way, at any moment, and send the economy into a tailspin in a heartbeat, at least in theory.

Friday, July 11, 2014 - TGI Friday

TGI Friday

by Sinclair Noe

DOW + 28 = 16,943
SPX + 2 = 1967
NAS + 19 = 4415
10 YR YLD - .01 = 2.52%
OIL – 2.44 = 100.49
GOLD + 3.70 = 1340.00
SILV + .03 = 21.55

We start with a quick review of the global hot-spots.

Israel and Gaza are throwing missiles at each other. Israel has better offense and defense. Approximately 100 Palestinians have died in the bombing; one Israeli has died in the missile attacks. President Obama has offered to negotiate a ceasefire but there isn’t much interest. Palestinian militants say they will fire missiles at Tel Aviv’s main airport. Israelis won’t rule out a ground war and vow the aerial assault will continue until quiet is restored.

Ukrainian President Poroshenko vowed to "find and destroy" pro-Russian rebels who killed 23 servicemen and wounded nearly 100 in a missile attack today. Kiev blames Moscow for fanning the violence and allowing fighters and high-powered weaponry to cross the frontier from Russia to Ukraine.

Kurdish forces seized two oilfields in northern Iraq and took over operations from a state-run oil company. Kurdish politicians formally suspended their participation in Iraqi government in Baghdad. An oil ministry spokesman in Baghdad described the takeover as dangerous and irresponsible. The Shi’ite run government of Prime Minister Maliki has been trying to cobble together a coalition government with very little success and it now appears the country has literally been divided into three states. Meanwhile, when the extremist Sunni faction known as ISIS took over the city of Mosul, they reportedly captured some radioactive materials, 40 kilos of uranium. The International Atomic Energy Agency says it is low grade and doesn’t pose a risk. I’m just guessing that story isn’t the last we’ll hear about the radioactive materials.

Portugal’s government and central bank tried to reassure investors that the country’s banking system is safe and sound. Banco Espirito Santo said any losses at the holding company Espirito Santo International would not pose a danger to the bank. European markets moved a little higher today.

Recent financial history in the Eurozone paints a less than compelling picture of bank soundness. You will remember when the Greek banks floundered. About four years ago, there was that little problem with Bankia in Spain. Bankia bought up smaller bankrupt regional banks and then went bankrupt itself. Bankia shareholders and Spanish taxpayers took the brunt of that failure. You will also remember the Bank of Cyprus, where the depositors took a big haircut.

The common theme in Eurozone bank failures is that things go wrong, governments claim everything is under control, banks fail, banks get bailed out or bailed in, depositors and taxpayers get the shaft. Rinse, lather, repeat. And then you think, these are just the banks in the peripheral countries. Don’t forget the money laundering by HSBC and BNP Paribas, and the tax evasion schemes from Credit Suisse.

Back in the USA, the speaker of the House of Representatives is suing the President. Politics makes strange bedfellows. Casino magnate and conservative donor Sheldon Adelson joined Berkshire Hathaway CEO Warren Buffett and former Microsoft CEO Bill Gates to write a New York Times op-ed criticizing House Republicans for failing to address an overhaul of the nation’s immigration system, which they said “borders on insanity.”

And the top story in America today…, Lebron James will take his basketball talents to Cleveland.

The World Cup championship will be played Sunday; Germany versus Argentina. More than one billion people are expected to watch at least a bit of the final game; more than 3.2 billion will have watched at least some of the games of the tournament, which would make World Cup 2014 the most watched televised event ever.

The markets moved higher today, which is more than we can say for CYNK Technology, the obscure OTC stock that surged 36,000% from a couple of pennies to more than $25 dollars in a few weeks, with nothing in the way of an actual business. The SEC closed down trading. I told you it was a bad idea.

Potato salad, however, is apparently a good idea. A guy from Ohio posted a simple request on the crowd-funding website, Kickstarter: Help him raise $10 to buy the ingredients to make potato salad. Within about a week’s time, 5,300 people donated between $1 and $10 to the potato salad endeavor for a grand total of $44,000.

Meanwhile, Wells Fargo was the first of the big banks to report second quarter earnings. The bank’s earnings per share of $1.01 in the second quarter matched analyst’s estimates; profit rose 4% from the same period a year ago, to $5.7 billion. The bank’s second-quarter revenue fell to $21.1 billion from $21.4 billion a year ago.

The FTC has sued Amazon for billing parents millions of dollars for unauthorized app purchases made by children. The FTC suit seeks an order that Amazon pay back parents for such purchases and also force the company to require parental consent for such purchases in the future.

Meanwhile, Amazon is seeking permission from the FAA to test its delivery drones near Seattle. Amazon wants to use drones to deliver packages in 30 minutes or less as part of a program called “Prime Air”. In 2012, Congress required the FAA to establish a road map for the broader use of drones. The FAA has allowed limited use of drones in the US for surveillance, law enforcement, atmospheric research and other applications. The Federal Aviation Administration estimates about 7,500 drones will be flying across the sky for commercial use by 2018. The agency plans to issue rules by the end of this year governing the flight of drones weighing less than 55 pounds. Last year, the US government created six sites for companies, universities and others to test drones for broader commercial use.

About a month ago, I told you that Apple was working on a new type of glass made of synthetic sapphires. This week, Apple won a patent for “fused glass device housings”, a new method of fusing glass to make casings for devices like the iPhone.  There is speculation that the next version of the iPhone will use the nearly indestructible glass for a cover or for an entire casing. According to the new patent, Apple has figured out a way to build an all-glass device that would still be durable and lightweight, essentially by fusing multiple pieces of glass together rather than designing casings out of a single slab. The new casing could be a sales killer; if the case doesn’t break, why would you be forced to buy a new one.

America’s largest reservoir and Las Vegas’ main water source and an important indicator for water supplies in the Southwest, will fall this week to its lowest level since 1937 when the manmade lake was first being filled. Lake Mead is expected to drop to 1,081 feet above sea level; by 2016 the lake is projected to drop below 1,075 feet above sea level and trigger water rationing.

The California State Water Resources Control Board will hold a public hearing next week to impose rules that would ban wasteful outdoor watering; things like hosing down sidewalks and driveways, or washing a car without a shut-off nozzle. The rules would give local agencies the authority to impose fines of up to $500 a day on scofflaws, although enforcement would probably start with warnings and escalating fines.

At the beginning of the year, Governor Brown declared a drought emergency and asked residents to voluntarily cut use by 20%, but water use has only declined by 5%, and in Southern California’s 3 largest cities, water use has increased in the last year.

Over a three-week span starting next Monday, 72% of the S&P 500's members will report earnings, and we’re off to an uneven start. Alcoa kicked off the season with strong results. Wells Fargo posted decent numbers but mortgage originations were down; that had been a cash cow for Wells Fargo. Container Store reported earnings that were a big disappointment. Why would you buy boxes, if you weren’t moving? The results seem to indicate that the housing market is weak, or possibly consumer spending is weak.

Yesterday, the discount chain, Family Dollar reported same store sales fell 1.8% during the quarter, and the CEO offered a downbeat assessment: "Our results continue to reflect the economic challenges facing our core customer and an intense competitive environment."

And then Gap topped off the week of discouraging retail commentary by reporting June same-store sales that fell 2% year-over-year. Sales were expected increase 0.8%. Gap's management, however, was light on additional commentary. This rash of discouraging retail data, however, makes the broader US economic picture seem murky, and consumer demand seems to have been weak in a number of sectors of the economy, but earnings season is just starting.

Many of the biggest banks on Wall Street will turn in quarterly results that will provide some insight into how the slowly improving economy is translating to companies’ bottom lines. Among the big names on the earnings calendar this week: Citigroup, Goldman Sachs, Morgan Stanley, JPMorgan, Bank of America.

Next week’s economic calendar includes a report from the Commerce Department on retail sales in June. Wednesday brings the PPI, or producer price index, or prices at the wholesale level. Another, though indirect, part of the inflation outlook is the level of slack in industrial capacity. When goods producers have little capacity to spare, chances increase for bottlenecks and shortages that could introduce price increases at the wholesale level. The Fed will report on industrial production and capacity utilization on Wednesday. On Wednesday, the National Association of Home Builders and Wells Fargo will release its July housing market index, a gauge of builder confidence. The Commerce Department will report on June housing starts and building permits Thursday. And Tuesday and Wednesday, Federal Reserve Chairwoman Janet Yellen takes the Hill to deliver semi-annual testimony before the House and the Senate, where she will regale lawmakers with tales of noisy inflation and an economy that is inches from liftoff.