Thursday, August 25, 2005

Instability Adds Up

With protests that virtually halted oil production in this country now quelled, Ecuador's government took grim stock Tuesday of a week's worth of damage that unsettled the oil markets, and began the demanding task of getting production levels back to normal.

The threat of more protests has only added to more uncertainty in this country, whose $30-billion-a-year economy depends on oil for 40 percent of export earnings and a third of tax revenue.

Oil companies have long complained about rampant corruption, the propensity of the Energy Ministry to alter contracts, and chronic political instability. Three presidents have been ousted in the last eight years.

"This is an extremely dysfunctional place," an executive of a foreign company said.—New York Times, August 24.

So who cares about Ecuador?

It is, after all, only the fifth-largest oil producer in Latin America, behind Venezuela, Brazil, Argentina and Columbia.

Total production from pristine jungle lands occupied by natives who've been treated about as fairly as native Americans back in the 1800’s—while meaningful enough to Ecuador to cause government instability and political protests—amounts to all of half a million barrels a day.

That’s barely a drop in the 84 million barrel a day world oil habit.

And while Ecuador does send half its production to the refinery complexes of the United States, Ecuadorian light sweet crude amounts to only about 2% of our total crude oil imports.

The reason to care is that it’s not just inside Ecuador that this battle of “with, without” (to quote Pink Floyd) is taking place.

There’s Nigeria (10% of U.S. crude oil imports), which is run by a “former military ruler” who was about as “freely elected” as Saddam Hussein back in his glory days of winning 99.9% of the Iraqi vote; along with a whole lot of corrupt government officials each with their hand in the till.

There’s Iraq (5% of U.S. crude oil imports), where things aren’t exactly settled yet.

And then there’s Venezuela (11% of U.S. crude oil imports), which is run by a certifiable Castro-style socialist and a whole lot more corrupt government officials than even Nigeria can come up with.

In July, for example, Venezuela “tax auditors” raided Chevron offices in Maracaibo, seizing boxes of records “to build a case that Chevron and other energy companies owe Venezuela $3 billion in back taxes,” according to Bloomberg. “The raid is part of President Hugo Chavez’s push to squeeze more money out of foreign oil companies…”

Add them all up—Venezuela, Nigeria, Iraq and Ecuador—and you’ll find that more than 25% of daily U.S. oil imports come from countries which are, as the man said, “extremely disfunctional.”

And I’m not even counting Mexico (15% of U.S. crude oil imports), whose corruption and bureaucracy have stifled the state-run oil company’s exploration efforts to the point where Mexico is now an importer of natural gas from the United States.

For those of you not familiar with the history of U.S. energy relations with Mexico and our dependence on that country’s rich offshore fields for our oil and gas needs…well, let’s just say that this development is about as shocking as if we learned that an OPEC member country (OPEC stands for “Organization of Petroleum Exporting Countries”) such as Indonesia had become a net importer of oil.

Oh, wait. I forgot. Indonesia has become a net importer of oil.

Instability adds up. Let’s hope the math doesn’t get out of hand.

Jeff Matthews
I Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


tahoe kid said...

This story ran yesterday on the Bloomberg News Service:

Indonesian Stocks, Bonds Fall as Rupiah Plunges 1.8% (Update3)
2005-08-24 10:36 (New York)

By Naila Firdausi and Arijit Ghosh
Aug. 24 (Bloomberg) -- Indonesia's government said it will
act to arrest a decline in the rupiah, which has fallen to a 3
1/2-year low on speculation surging oil prices will force the
government and companies to buy more dollars.
``We are concerned about the weakening of the rupiah,''
Indonesian President Susilo Bambang Yudhoyono told reporters at a
late night briefing in Jakarta. ``We are trying to take the right
steps so that the decline in the rupiah doesn't continue.''
A surge in oil prices has raised the cost of importing the
commodity for Indonesian companies and widened the cost of
subsidizing fuel prices for consumers. Stocks and bonds fell as
the rupiah extended a five-day slide, dropping 1.8 percent to the
lowest since Feb. 19, 2002, even after the central bank moved in
to support the currency by raising a key interest rate.
``The central bank is looking desperate and the situation
doesn't look good,'' said Sabrina Jacobs, a currency strategist
at Dresdner Kleinwort Wasserstein in Singapore. `Investors are
trying to get out.''
The Jakarta Composite Index fell for a ninth day, dropping
30.65, or 2.9 percent, to 1035.45 at the 4 p.m. local time close,
its longest losing run since the 10 days ended Oct. 3, 2001. The
benchmark has lost 12 percent since Aug. 11. The yield on the
14.25 percent bond due in June 2013 rose 37 basis points to 14.18
percent, according to Deutsche Bank International. A basis point
is 0.01 percentage point.

Seeking Safety

``People feel uncertain about what will happen, what the
government will do about rising oil prices,'' said Dwina Wijaya,
president, PT Bahana TCW Investment Management, which manages 7.6
trillion rupiah ($740 million) in assets. ``There is a fear in
the market and some investors are buying dollars to be safe amid
the uncertainty.''
Yudhoyono didn't say what action he will take to support the
currency. The rise in oil prices is threatening to choke a
recovery in the country's $258 billion economy, which grew 5.5
percent from a year earlier in the second quarter after expanding
a revised 6.2 percent in the previous three months.
Indonesian markets fell as crude oil prices rose for a fifth
day, gaining 0.8 percent to $66.22 a barrel. The rupiah has
dropped 4.6 percent in the past month, making it the worst
performer among the 15 most actively traded Asia-Pacific
currencies tracked by Bloomberg.

Economic Growth

The economy is still forecast to expand 6 percent this year
and 6.2 percent in 2006. That would be the fastest pace since
1996, the year before the Asian financial crisis triggered a
collapse in the rupiah that left hundreds of companies unable to
pay debts and forced the country to seek an International
Monetary Fund-led bailout.
Indonesia, the only OPEC member to be a net importer of oil,
subsidizes prices to keep fuel affordable to the nation's 40
million poor people. Reducing those subsidies may trigger unrest
in the country, which has had four presidents since former
dictator Suharto resigned amid public protests in 1998.
Investors are concerned that the removal of fuel subsidies
``will push inflation higher and increase political risks,''
analysts at BCA Research in Montreal wrote in a research note.
``In 2001, when the government last attempted to remove fuel
subsidies, this incited social unrest and led to the
reinstatement of the subsidies.''

Fuel Prices

Fuel prices have already risen once this year. President
Yudhoyono's government decided on March 1 to reduce fuel
subsidies in a bid to narrow the budget deficit, leading to an
average 29 percent rise in the cost of fuel.
``The inflationary shock from higher fuel prices will be
transitory, and long-term bonds yielding nearly 14 percent offer
good value,'' they wrote.
The rupiah fell even after the central bank raised the seven-
day deposit rate by 0.25 percentage point to 7.5 percent to stem
the currency's decline. The bank yesterday drained 200 billion
rupiah ($19.5 million) from the banking system by selling three-
day deposits. It bought about $200 million of rupiah today,
IDEAglobal said, without citing anyone.
The nation's foreign-exchange reserves are ``still safe,''
said Aburizal Bakrie, the country's top economics minister. The
government plans to speed up changes in the fuel-price subsidy
system and is studying ways to increase fuel prices, he told
reporters today in Jakarta.


Indonesian bonds are the worst performing of any Asia
Pacific local-currency bond markets this year, according to
indexes compiled by International Index Co., which is made up of
10 banks. The iBoxx Indonesia index has fallen 5.5 percent in
2005 as of Aug. 23.
The slump in Indonesia's bonds is ``almost all oil-driven,''
said Christian Stracke, an emerging-market bond analyst for
CreditSights Inc. in New York. ``You could make the case that
Indonesia's bonds'' don't give investors enough yield for their
credit ratings.
Bank Indonesia ``can't just pour dollars into the market to
shore up the rupiah,'' Stracke said. ``They can hike rates a lot
more, and that's what they're going to have to do.'' The bank's
benchmark interest rat is ``only 7.5 percent, down from 16
percent in 2002, so they have plenty of room to tighten.''

Credit-Default Swaps

The annual cost of insuring $10 million of Indonesia's U.S.
dollar-denominated government debt for five years using credit-
default swaps rose to 325,000, from $300,000 yesterday, according
to Deutsche Bank AG prices. A week ago, the cost was about
$245,000. Indonesia's dollar-denominated international bonds have
junk ratings of B+ from Standard & Poor's and one step lower at
B2 from Moody's Investors Service.
Credit default swaps allow investors to bet on a company's
or nation's creditworthiness or protect against a default. Like
insurance, buyers pay an annual fee similar to a premium to
protect a certain amount of debt against default for a specified
number of years. In the event of a default, they are paid the
face value of the bonds.
Derivatives are financial obligations whose value is derived
from interest rates, the outcome of specific events, or the price
of underlying assets.
The government in June forecast a deficit of 20.3 trillion
rupiah for this year, or 0.8 percent of the gross domestic
That deficit is swelling because the demand for oil is
outstripping the nation's ability to produce it. The country may
import a net 61,000 barrels a day this year, compared with net
exports of 27,000 barrels in 2004, based on figures in a document
prepared for the Energy and Mineral Resources Ministry and
obtained by Bloomberg News.
``Until oil prices stabilize, I am staying away from the
bond market,'' said Ricky Ichsan, who trades Indonesian
government bonds for PT Bank NISP in Jakarta. ``Many investors
want to sell but there are few buyers.''

RDS said...

Ecuador is just a microcosm of the political risk that Big Oil faces in the developing world. Big Oil has abandoned Ecuador and left it to smaller players like Oxy. KMG pulled out back in 2002.

The oil is there, but the expsure to third world turmoil is high.

Nuclear Power anyone??

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Chris Fischer said...

"(OPEC stands for “Organization of Oil Exporting Countries”)"

Not to be a wiseass, but I thought the 'P' stood for petroleum. :)

dearieme said...

I like your blog too and I'm not selling anything.

dthorn said...

Energy has to be the big story of 2005. I am not sure, though, that the fact that oil comes from unstable places is the crux of the story. Oil has always come from these places, even when oil traded at close to $10. I know your point is that an increasing percentage is coming from these regions, and you didn't even mention Russia. However, a fungible commodity is always about the marginal barrel.
Oil has also always had the fascintating (to an equity centric individual anyways) property of a commodity that it goes up on bad news.

So what has changed? I am torn between energy simply being a monetary phenomenon, and there being an actual structural change ie. underinvestment relative to demand growth.

What will the impact be on the broader economy? Is this still a $1,500 LCD xmas? does inflation get pushed into the whole economy (ala your prior post?)

What comes first $40 or $80? And why?

I say higher interest rates, a stronger (slightly) dollar and dampened demand post labor day (you think the median income can pay a 50% premium on last years already high heating bill?)kill the rally.

$40 oil leaves plenty of money for investment $50 leaves a nice risk premium - I say $40 - $50 oil in 2006 to go with the housing reversal you predicted earlier this month. Then again I knew oil should be an easy short when it first spiked to $40.

Jeff Matthews said...

"organization of Petroleum Exporting Countries" it is. Gross oversight--thank you for flagging it.

My apologies to readers for the "spam" comments from other blogs.

I am considering moving to a blog that blocks that junk.

gvtucker said...

Jeff, you should be able to just blacklist the URLs/IP addresses from the spamming blogs. That solves a good deal of the spam comment problem.

As far as the price of crude is concerned, I doubt we'll see $70, much less $80. Demand is starting to cool on many fronts. Global inventories are now 5% above last year's level, even though we've seen a worldwide heat wave this summer that contributed to abnormally high demand. Spare capacity hasn't changed in three years; the only thing that has changed is the perecption of that capacity. Contrary to popular belief, E&P investment hasn't declined, it has just shifted away from the traditional powers so it isn't as evident. And the US will stop filling the SPR in a matter of days.

Vaibhav Gautam said...

I don't think that any oil crisis will have any long term negative effect on economy. After all rising oil prices will make the use other sources of energy cheaper in comparison which will drive more effort and resources into developing the new technologies like hydrogen power. And with the easy and cheap availabilty of these alternate sources of energy the oil demand is fall which will drive down the oil prices. So, you see its a viscious circle :)
More over, the fuel cell automobiles are already about to hit mass market and an oil crisis will only hasten it.
~ Vaibhav

DreamsUnlimited said...

Jeff, that is a good perspective on the oil issue. The problem is, oil issues are not just related to "dysfunctional" governments only. Oil is equally problematic with "functional" governments. Last weekend NY Times ran a good article on oil issues. While it is safe to assume oil is not going to run out next year or next ten years, we don't know with any degree of certainity when oil production is going to peak and when it is going to run out.

We can only hope that our political leaders gather conviction to take some tough decisions to take alternative approach.

BelowTheCrowd said...

As we are seeing this weekend, instability comes in many forms, and in many places, including our own coastline and our most critcal oil ports.