Sunday, April 29, 2012

A Global Game Changer?

Joe Weisenthal of Business Insider reports on Hugh Hendry's latest letter, It Looks Like America Is 'Creating Yet Another Historic Turning Point':
We wrote yesterday about how how Hugh Hendry is back with his first big shareholder letter since 2010.

The gist is that Hendry is more bearish than ever on China, and that his favorite way to play it remains credit default swaps on China-exposed Japanese corporate names, which are still up to their necks in debt.

He doesn't write much about the US, but we wanted to highlight his bullish commentary...

This might be the year everyone else notices this; the year panic over Chinese economic growth comes to replace the market's morbid fascination with the travails of the European continent and the year in which we see that the US is not giving way to China in terms of global economic leadership. There is a near consensus that China will supplant America this decade. We do not believe this. We are more bullish on US growth than most. The momentous nature of recent advances in shale oil and gas extraction and America's acceptance of the unpleasantness of debt and labour price restructuring looks to us as if it is creating yet another historic turning point.

As we just noted, he's not the only one making this bullish argument. It does seem as though this is becoming a new conventional wisdom, that the best path forward for the US is revolves around the exploitation of domestic natural resources (such as those in Williston, North Dakota).

Last month we noted how economists from Citi said that the domestic energy story had the potential to turn the US into the next Saudi Arabia, sparking a new industrial revolution.

More and more, people aren't just bullish on domestic energy, but think this is going to be BIG. Like nation-changing big.

Zero Hedge published Hugh Hendry's entire letter on their site. I partially agree with Hendry. While I'm not bracing for a hard landing in China, I don't believe that China will overtake the US economy anytime soon, not even in the next 50 years. The faulty logic of many who believe so is that they wrongly extrapolate current growth rates to reach such conclusions (go back to read my comment on Galton's Fallacy and the Myth of Decoupling).

Those of us who understand economics understand that the US economy remains the engine of global growth and will remain so for many decades to come. Sure, there are serious structural problems, but at the end of the day, the US economy remains one of the most productive economies in the world. And economists all agree on this point: it's productivity growth that ultimately determines the wealth of a nation.

One of the most incredible revolutions occurring right now is the massive drop in energy prices, driven in large part by the historic drop in natural gas prices. Alexandra Marks of the Christian Science Monitor wrote an interesting comment, With all this natural gas, who needs oil?:

Natural gas has suddenly become almost everyone's favorite chassis for building an energy independent future. Many people on both sides of the drilling divide view the current abundance of the low-cost fuel as a "global game changer" – an energy source that will help wean the United States off Mideast oil, alter the nation's foreign policy, spur jobs and boost the economy, and reduce greenhouse gases.

President Obama has pledged to "take every possible action to safely develop this energy." Mitt Romney calls the domestic gas "a godsend." Energy tycoon T. Boone Pickens, an early natural gas booster, contends it's "obvious" that Washington should enact policies to encourage natural gas production and use throughout the economy.

"Do we have to take advantage of this?" asks Mr. Pickens, with his characteristic Texas Panhandle pragmatism. "Well, if you don't, you're going to go down in history as the biggest fools that ever came to town."

Indeed, as one executive declared to the NYT, Natural Gas is on a Roll:

A “perfect storm” of economic and regulatory factors is driving major United States utilities to rapidly switch from coal to natural gas as an electric power source, the top executive of one of the nation’s largest utilities said on Thursday.

Nicholas K. Akins, chief executive of Ohio-based AEP, said the company plans to retire 5 of its 25 coal-burning plants and shut down coal-powered units at other plants it owns in a shift that collectively means the elimination of about 5,000 megawatts of capacity. The result will be that by 2020, only about half of the power AEP produces will come from coal, down from about 67 percent last year.

The surge in domestic production of cheap natural gas, largely yielded by the rise of the controversial technique of forcing gas out of shale through hydraulic fracturing, has been a big factor in this shift. A series of new environmental regulations and pressure from environmentalists are also leading major utilities to either shut down older plants or spend billions of dollars to upgrade them.

Mr. Akins estimated that the industry would have to spend about $300 billion through the end of the decade to expand natural gas power generation capacity or retrofit older coal-fueled plants so they can meet new environmental standards — investments that it is asking regulators to allow it to pass on to its customers, at least in part, which total five million accounts in 11 states.

Renewable energy is expected to contribute a larger share of power to AEP’s mix by 2025, Mr. Akins said, but perhaps not as much as expected because of a decline in federal subsidies and continuing repercussions from the bankruptcy of Solyndra, the California solar manufacturer that collapsed last year despite receiving a $535 million federal loan guarantee.

And the once-anticipated nuclear power renaissance will probably not materialize, he added, in view of the Fukushima disaster in Japan last year.

Domestically, coal mining will be the hardest hit by this historic shift, he said. Last year alone, the amount of electricity produced by AEP’s gas-powered plants jumped 24 percent, with most of that resulting from a drop in production at coal plants.

“Our industry is in the midst of an extraordinary period of transformation and investment which will affect how we produce and delivery electricity — and what you pay for it — for decades to come,” Mr. Akins said in his remarks before the United States Chamber of Commerce,

At the Southern Company, another major coal-burning utility, natural gas is now responsible for 46 percent of its electricity, up from 16 percent four years ago. That translates into about 45 million tons of coal slated to be burned this year by Southern, down from 80 million tons in 2007, Southern’s chief executive, Tom Fanning, said in his own remarks on the topic on Wednesday.

Mr. Akins said he was somewhat concerned that the nation may end up too reliant on natural gas, particularly given the history of price volatility of natural gas. The price has dropped from $10.8 per thousand cubic feet at the wellhead as of July 2008 to $2.89 as of January.
I happen to think nat gas prices are bottoming and will head up over the next year, but there is no denying that cheap, abundant nat gas has hit shares of coal and solar stocks extremely hard allowing some well-known short-sellers like Jim Chanos to profit.

From a trading perspective, I don't see natural gas displacing US coal and think the selloff in some coal shares is way overdone, fueled by fears of a hard landing in China and the historic drop in nat gas prices. But keep in mind in this wolf market dominated by elite hedge funds using high frequency trading multi-million dollar computers, oversold can become extremely oversold, so tread carefully (Note: I am bullish on nat gas, coal, steel, oil and oil servicing and pipeline shares).

Finally, a Greek-Canadian friend of mine living in Israel now sent me an interesting Hareetz article, Greece, Cyprus to advance Israeli power line to Europe (h/t, Jimmy):

Greece and Cyprus have agreed to an Israeli request to lay a power cable to Europe via the two Mediterranean nations, their electricity authorities stated yesterday.

The 2,000-megawatt cable, dubbed the EuroAsia Interconnector project, would ensure that nations including Greece, Cyprus, Israel and others in southeast Europe and the Mediterranean basin have a regular power supply.

Israel has faced soaring power prices since losing its supply of Egyptian natural gas a year ago, following the revolution there. The supply became unreliable following the fall of Egyptian President Hosni Mubarak. This week, Egypt announced that it was halting gas exports to Israel altogether.

Meanwhile, Israel has been drafting emergency plans to address expected power outages this summer.

Cyprus for its part has been facing severe power shortages since a disaster at a production plant last year. Following the incident, local authorities had to bring old plants back online in order to meet local needs.

Also, Europe as a whole is expecting power shortages in the wake of Germany's decision to shutter all of its nuclear power plants following Japan's Fukushima disaster.

The Israel-to-Europe cable will be built by the Israel Electric Corporation and PPP Quantum Energy, which is controlled by the Greek power utility and Cypriot companies. Israel and Cyprus signed an accord to lay the underwater cable in March. Yesterday's announcement was the official one.

This is the first stage in a process that would bring Israel electricity from mainland Europe.

At 540 nautical miles (1,000 kilometers ) long and lying at a maximum depth of 2,000 meters, the cable would be the longest in the world.

I have long argued that Greece, Cyprus and Israel need to work together on all fronts, especially to secure their vital energy needs. I see the Greek-Cypriot-Israeli ’energy axis’ as a positive development for the region and for Europe as a whole.

Is natural gas a 'global game changer'? It already is leading to a renaissance of American manufacturing and will help many European nations struggling with competitiveness to lower their energy costs. The implications of this structural shift are profound and investors better be on the right side of the trade.

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