Ages ago, in the basement of our five-story walk up, my father's sideline was packaging matzo farfel. I would help him mangle the matzos there and then sell farfel door-to-door like encyclopedias. Any housewife worth her salt fried up matzo brie fritters for her family over Passover using Old Ben's farfel.
It was my bad luck to hail from the East Bronx, far from Texas oil field country. I could'a been another Boone Pickens instead of a nerdy old MBA squinting at spread sheets with 40 lines of numbers filling the page.
Fast-forward to the presidential primaries: While my little lady was canvassing for Hillary in the Indianapolis suburbs (10 hours, daily) she noted pickup trucks sitting in driveways even though nobody was home. Families now carpool to work, their gas guzzlers abandoned.
Our airlines mothball in the desert more 20-year-old 737s and MD-80s, trimming the seats that would have been flown with these old and inefficient planes. Few of these carriers make the cash flow to replace these oldies with Boeing's (nyse: BA - news - people ) fuel efficient 737-900s.
Meanwhile, ExxonMobil, with momentous generosity to shareholders, kicked up its quarterly dividend from 35 cents to 40 cents a share--still under 20% of current earnings power. The company will spend an incremental $5 billion per annum looking for more oil because it failed to increase production the past five years.
Was ExxonMobil expecting $60-a-barrel oil--what we had little more than a year ago?
Delta Air Lines owns and leases over 100 16-year-old Boeing 757s--with just a dozen fuel-efficient aircraft on order--out of a 600-plus fleet. Fuel hedges for the rest of 2008 cover less than half the fleet's consumption and were written around gas pegged at $2.75 a gallon. Jet fuel this week sold at $3.41 a gallon, and Delta burns 500 million gallons quarterly. You do the arithmetic. The airline's fuel bill ballooned over $500 million during the March quarter, year over year.
In short, Delta Air Lines' incremental fuel bill runs over $2 billion this year. The company can raise ticket prices just so much before it eats into revenue passenger miles. Delta Air Lines' liquidity approximates $3.6 billion, but it could lose at least a billion this year. Crunch time comes some time in 2009 because mergers don't yield much in cost savings.
On the other side of the world, OPEC nations wallow in an embarrassment of riches. Sovereign funds, already in the trillions, will grow by $3 trillion to $5 trillion the next five years. This manna pours into direct investments around the world in real estate, minority interests in banks, brokerage houses and industrial ventures, as well as securities markets. The dollar can't rally much if $100-plus oil darkens our sky--even if European economies stall out. Remember, they pay in euros.
Energy is a meaningful cost of doing business, hitting mining operators, industrial plants and big box retailers. Alternative fuels like coal and natural gas key off oil in terms of equivalent British thermal units content pricing. Expect higher utility bills. My home fuel supplier always seems to fill my tank with diesel when prices peak. This winter, I'm setting my thermometer down to 67 degrees and wearing pullovers.
On short flights, passengers can expect double last year's ticket prices with no end in sight. Discretionary travel is suspect this summer with some impact on both hotel occupancy and room rates. Las Vegas is already feeling the pinch.
In the work force, the slowing economy is cutting into average hourly earnings, decelerating from 5% to 3% as payroll employment weakens. Overtime is down from over five to under four hours a week. It never fell below 2.5 hours in the horrendous recession of 1981-82. For guys in work boots and women on assembly lines in the heartland--who rely on some overtime--belts need to be tightened a notch.
Short of junking 100 million cars on the road today with poor gas mileage, it may take 10 years before we approach 30 miles per gallon efficiency. To cut back demand and consumption of gasoline, the country needs to shorten the grace period for Detroit to reach acceptable mpg standards, a costly makeover. Don't count on it.
Don't blame the refineries for gouging the public: Refining margins are paper thin because they're processing more expensive crude oil. With no quick fixes to sky-high oil, financial markets slog along. We are lucky the country doesn't face an inflationary bias in labor costs.
Food and energy inflation may be a way of life for us. Our domestic oil reserves peaked years ago, and attacking the demand side of oil consumption is a responsibility our politicos have ducked for 20 years.
Don't expect OPEC to open the spigots for us. Satellite photographs of the elephantine Saudi oil fields suggest there's more pressure-pumping going on to keep production at a high level. Aramco claims it can increase output a few million barrels a day over the next few years, but this is oil-speak politics.
If the bears are right that Saudi fields are peaking, only a decrease in demand (owing to higher and higher oil prices) keeps the equilibrium with world supply. Futures markets now reflect this point of view. Even long-term contracts track well over $100 a barrel.
The future market is in a state of regression, with spot prices much higher, but any serious shortfall in world supply sends the market into a contango mode with long-dated quotes higher than spot prices. Investors will read this as bearish for inflation, the dollar, our balance of trade and profitability of domestic businesses--not exactly bull market indicators. Half our trade deficit is oil imports.
I've increased my commitment to the energy sector from underweight to slightly overweight. If I include pipeline, storage and natural gas liquids partnerships--all of which yield rich investments--I'm about 20% allocated in energy, which is now 14% of the S&P 500, double what it was two years ago.
What stops me from grossly overweighting energy is that most oil and gas operators can't increase production or the reserve-life of their assets. Costs for everyone escalate 10% to 15% annually for labor, seismic services and drilling rigs. Transocean and Schlumberger make operators pay up, pegging prices to rising oil market quotes.
With refining margins minimal and chemicals profits somewhat depressed, a peaking of oil prices must impact earnings big time for all integrated oil producers. That's why ExxonMobil is a mediocre investment. The company can't increase production and needs to allocate more capital for drilling and exploration just to maintain the reserve life of its oil fields worldwide.
Strategically, I'm going with properties that can at least increase production modestly. My horses are Devon Energy, Apache and Occidental Petroleum. Service operators, like Schlumberger, and deep water rig outfits, like Transocean, get my money.
It was my bad luck to hail from the East Bronx, far from Texas oil field country. I could'a been another Boone Pickens instead of a nerdy old MBA squinting at spread sheets with 40 lines of numbers filling the page.
Fast-forward to the presidential primaries: While my little lady was canvassing for Hillary in the Indianapolis suburbs (10 hours, daily) she noted pickup trucks sitting in driveways even though nobody was home. Families now carpool to work, their gas guzzlers abandoned.
Our airlines mothball in the desert more 20-year-old 737s and MD-80s, trimming the seats that would have been flown with these old and inefficient planes. Few of these carriers make the cash flow to replace these oldies with Boeing's (nyse: BA - news - people ) fuel efficient 737-900s.
Meanwhile, ExxonMobil, with momentous generosity to shareholders, kicked up its quarterly dividend from 35 cents to 40 cents a share--still under 20% of current earnings power. The company will spend an incremental $5 billion per annum looking for more oil because it failed to increase production the past five years.
Was ExxonMobil expecting $60-a-barrel oil--what we had little more than a year ago?
Delta Air Lines owns and leases over 100 16-year-old Boeing 757s--with just a dozen fuel-efficient aircraft on order--out of a 600-plus fleet. Fuel hedges for the rest of 2008 cover less than half the fleet's consumption and were written around gas pegged at $2.75 a gallon. Jet fuel this week sold at $3.41 a gallon, and Delta burns 500 million gallons quarterly. You do the arithmetic. The airline's fuel bill ballooned over $500 million during the March quarter, year over year.
In short, Delta Air Lines' incremental fuel bill runs over $2 billion this year. The company can raise ticket prices just so much before it eats into revenue passenger miles. Delta Air Lines' liquidity approximates $3.6 billion, but it could lose at least a billion this year. Crunch time comes some time in 2009 because mergers don't yield much in cost savings.
On the other side of the world, OPEC nations wallow in an embarrassment of riches. Sovereign funds, already in the trillions, will grow by $3 trillion to $5 trillion the next five years. This manna pours into direct investments around the world in real estate, minority interests in banks, brokerage houses and industrial ventures, as well as securities markets. The dollar can't rally much if $100-plus oil darkens our sky--even if European economies stall out. Remember, they pay in euros.
Energy is a meaningful cost of doing business, hitting mining operators, industrial plants and big box retailers. Alternative fuels like coal and natural gas key off oil in terms of equivalent British thermal units content pricing. Expect higher utility bills. My home fuel supplier always seems to fill my tank with diesel when prices peak. This winter, I'm setting my thermometer down to 67 degrees and wearing pullovers.
On short flights, passengers can expect double last year's ticket prices with no end in sight. Discretionary travel is suspect this summer with some impact on both hotel occupancy and room rates. Las Vegas is already feeling the pinch.
In the work force, the slowing economy is cutting into average hourly earnings, decelerating from 5% to 3% as payroll employment weakens. Overtime is down from over five to under four hours a week. It never fell below 2.5 hours in the horrendous recession of 1981-82. For guys in work boots and women on assembly lines in the heartland--who rely on some overtime--belts need to be tightened a notch.
Short of junking 100 million cars on the road today with poor gas mileage, it may take 10 years before we approach 30 miles per gallon efficiency. To cut back demand and consumption of gasoline, the country needs to shorten the grace period for Detroit to reach acceptable mpg standards, a costly makeover. Don't count on it.
Don't blame the refineries for gouging the public: Refining margins are paper thin because they're processing more expensive crude oil. With no quick fixes to sky-high oil, financial markets slog along. We are lucky the country doesn't face an inflationary bias in labor costs.
Food and energy inflation may be a way of life for us. Our domestic oil reserves peaked years ago, and attacking the demand side of oil consumption is a responsibility our politicos have ducked for 20 years.
Don't expect OPEC to open the spigots for us. Satellite photographs of the elephantine Saudi oil fields suggest there's more pressure-pumping going on to keep production at a high level. Aramco claims it can increase output a few million barrels a day over the next few years, but this is oil-speak politics.
If the bears are right that Saudi fields are peaking, only a decrease in demand (owing to higher and higher oil prices) keeps the equilibrium with world supply. Futures markets now reflect this point of view. Even long-term contracts track well over $100 a barrel.
The future market is in a state of regression, with spot prices much higher, but any serious shortfall in world supply sends the market into a contango mode with long-dated quotes higher than spot prices. Investors will read this as bearish for inflation, the dollar, our balance of trade and profitability of domestic businesses--not exactly bull market indicators. Half our trade deficit is oil imports.
I've increased my commitment to the energy sector from underweight to slightly overweight. If I include pipeline, storage and natural gas liquids partnerships--all of which yield rich investments--I'm about 20% allocated in energy, which is now 14% of the S&P 500, double what it was two years ago.
What stops me from grossly overweighting energy is that most oil and gas operators can't increase production or the reserve-life of their assets. Costs for everyone escalate 10% to 15% annually for labor, seismic services and drilling rigs. Transocean and Schlumberger make operators pay up, pegging prices to rising oil market quotes.
With refining margins minimal and chemicals profits somewhat depressed, a peaking of oil prices must impact earnings big time for all integrated oil producers. That's why ExxonMobil is a mediocre investment. The company can't increase production and needs to allocate more capital for drilling and exploration just to maintain the reserve life of its oil fields worldwide.
Strategically, I'm going with properties that can at least increase production modestly. My horses are Devon Energy, Apache and Occidental Petroleum. Service operators, like Schlumberger, and deep water rig outfits, like Transocean, get my money.
Source: FORBES | by Martin T. Sosnoff
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