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Musings From the Oil Patch - March 3, 2009

Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies.  The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks

Early Signs of Petroleum Demand Revival In U.S. (Top)

Crude oil prices had a good week last week, closing up $5.82 to $44.76 a barrel on the futures market.  This rise amounted to a healthy 14.95% increase, although oil prices had actually advanced higher during the week, but fell on Friday when both the details of the Obama administration’s budget impact on the energy industry became clear and the nation’s GDP estimate for the fourth quarter was revised sharply lower. 

For the week, the oil price rise was driven by a number of factors – surprising strength in domestic oil inventory data, a positive report about OPEC’s cutback compliance and signs that oil demand is rising.  When the U.S. Department of Energy reported its weekly oil inventory data last Wednesday, crude oil inventories only rose by 717,000 barrels, about half the 1.2 million barrel rise anticipated by analysts.  Gasoline inventory fell by a surprising 3.3 million barrels, although refinery capacity utilization was down reflecting industry efforts to take advantage of weak petroleum demand to undertake refinery turnaround operations early. 

Another positive was the report from Petrologistics, a tanker tracking company, suggesting that OPEC members were achieving about an 89% compliance with the cartel’s December 2.2 million barrel a day production cutback.  At the same time, Dubai announced it was reducing further the amount of oil it will supply to refiners in Asia in March, which has revived hope that OPEC may be positioning to institute another production quota cutback at the body’s March 15 meeting. 

Exhibit 1.  Latest Weekly Oil Imports Are Starting To Fall
Latest Weekly Oil Imports Are Starting To Fall
Source:  EIA

Last week was the third weekly decline in oil imports, which suggests that OPEC’s production cutback is working.  Some analysts have speculated that oil is flowing to other markets around the world as the U.S. is awash in crude oil, at least at Cushing, Oklahoma.  If Petrologistics is right, and we have no reason to believe they are way off in their estimate, then one should expect a decline in imports to the world’s largest oil consuming and importing market. 

Exhibit 2.  Overall Domestic Oil Demand Rising
Overall Domestic Oil Demand Rising
Source:  EIA, PPHB

What may be more important for the oil market is that weekly demand has begun to show signs of improving.  This is noted in the chart of the 4-week average for petroleum product supplied over the period from 2005 through now.  Over that period the trendline has been down.  Starting last fall when the credit crisis exploded, petroleum product supplied fell sharply but then began a recovery back to the trendline at the start of 2009.  Demand then fell off but has since moved up closer to the trendline.  Whether the weekly

petroleum supplied volume rises above the trendline is unknown, but the fact it has recovered from the credit-crisis induced low last fall is encouraging. 

Gasoline supplied, which is a measure of demand, has also bounced off its credit crisis low, even though it has recently retested that low.  As shown by the chart in Exhibit 3, gasoline supplied has been much more volatile over the 2005-2009 period, but again, we are encouraged by the fact that although the recent low demand was lower than experienced twice in 2005, demand has not gone lower in the recent dip at a time when unemployment has been soaring and the economy has apparently dropped into an abyss. 

Exhibit 3.  Gasoline Demand May Be Starting Recovery

Source:  EIA, PPHB

The latest highway travel data shows that although December’s monthly vehicle miles driven of 237.2 billion is down by 3.8 billion vehicle miles, a decline of 1.6% from the prior year, the rolling 12-monthly total has shown a slight uptick.  Quite possibly this mileage increase is related to the dramatic decline in gasoline pump prices, but offsetting that positive one would have to factor in the impact of the dramatic economic and employment deterioration, which should negatively have impacted consumer spending and driving habits in the month.  To the contrary, the Federal Highway Administration’s release of the December data pointed out that 17 states showed increases in vehicle miles driven that month, the first time since August 2007.  For all of 2008, vehicle miles driven fell by 3.6%. 

All the latest oil supplied and consumption figures suggest that domestic demand is recovering somewhat.  We recognize that the upticks in oil use and the downticks in imports are small, and in some cases represent repeats of moves of earlier weeks, but they come in a period when the domestic economy is acknowledged to be experiencing one of its worst contractions since the Great Depression.  In the face of that weakness, any oil demand improvement should be noted.  Hopefully, these improvements are like green shoots through a winter blanket of residual snow.

Exhibit 4.  Vehicle Miles Driven Have Risen In Latest Week
Vehicle Miles Driven Have Risen In Latest Week
Source:  EIA, PPHB

Exxon’s Conservative Strategy Works For Investors (Top)

On Friday, stock market investors received a jolt when the Federal government announced an agreement with Citicorp (C-NYSE) to convert its preferred stock ownership position, derived from the earlier bailout funds injected into the company, into common shares.  The result was to make the U.S. government the company’s largest investor with a 36% ownership interest and raising the specter of nationalization of this bank and possibly the rest of the U.S. banking system.  Also announced that day was that General Electric’s (GE-NYSE) board of directors planned to cut the company’s quarterly dividend beginning in the third quarter of 2009 to $0.10 from its current rate of $0.31.  The impact will save GE approximately $9 billion annually, but it also drops the current dividend yield on the stock from about 13.6% to 4.7%.  The dividend cut had been expected by many investors and analysts as the company’s finance arm is suffering from the woes impacting the rest of the financial industry and probably is in need of additional capital, some which could come from the dividend cut savings. 

The dividend reduction may not be the last financial problem for GE as many analysts expect its AAA credit rating to be lowered by the ratings agencies soon, although the dividend cut may force them to hold off that action for a while.  A ratings reduction would leave the non-financial corporate world with only five AAA-rated companies, although at least another is under review for a possible downgrade.  Among the remaining companies, Exxon Mobil Corp. (XOM-NYSE) stands out from the group for its financial strength, operational performance and returns to investors. 

For many years there was a struggle between Exxon and GE as to which was the largest market cap corporation.  In the first part of this decade, following the oil industry recession of 1997-1998 when

Exhibit 5.  Exxon Has Blown Past GE In Market Cap

Source:  Bespoke Investment Group

crude oil prices fell to nearly $10 a barrel, GE was the undisputed market leader.  From 2002 through 2006 the leadership position went back and forth, but over the past two years, as the credit crisis has unfolded, Exxon has established itself as the clear market leader.  This leadership position has been achieved in the face of the collapse in crude oil prices last year and the general stock market retreat associated with the global economic recession.  Last year, Exxon was able to more than replace its annual production showing that its determination to remain focused on its oil and gas business is a sound strategy.  One would hope that the Rockefeller family heirs, who are promoting another resolution for this year’s Exxon shareholders’ meeting requiring the company to diversify from its oil and gas focus, would think about the possible problems a shift in strategy could cause.  GE under Jack Welch versus under Jeffrey Immelt might be an excellent example to study.

Natural Gas Demand Problem Is Housing and Autos (Top)

The collapse in natural gas prices that began at mid-year 2008 has continued and actually worsened since the start of 2009.  We are now seeing gas prices in the low $4 per thousand cubic feet (Mcf) range, a price last observed in the fall of 2006.  The cause of the gas price drop is a combination of weak demand and growing unconventional gas production. 

The fall in gas prices has contributed to a dramatic decline in the number of drilling rigs seeking natural gas.  As people have recently realized, the early phase of the rig count decline was focused on rigs drilling vertical wells.  It has only been in recent weeks that the number of rigs drilling horizontal wells has begun to fall.  These rigs are largely associated with the exploitation of unconventional shales containing gas that can be extracted after powerful fracturing treatments of the gas-bearing formations.  The unconventional gas

Exhibit 6.  Natural Gas Price Collapse Continues
Natural Gas Price Collapse Continues
Source:  EIA, PPHB

production flowing from these wells is large, but the high flow rate is only sustainable for relatively short time periods.  The success of these wells has created a relatively new phenomenon for the domestic natural gas industry – rising production.  That production growth coupled with falling gas demand due to the economic recession underway has led to an estimated roughly 3-5 billion cubic feet per day (Bcf/d) of surplus supply.  That supply has been building up in the nation’s natural gas storage facilities and is leading to concern within the industry that storage will be full well before the traditional time when heating demand kicks in and begins drawing down the stored gas.  As gas consumers see this inventory build-up, they are in no hurry to buy supplies and push prices up.  Not until either natural gas demand increases or gas supply falls will prices strengthen.

What is evident about the gas market is that supply has become a major issue.  The resulting supply surge and corresponding fall in gas prices has forced gas producers to stop drilling as much as they were last year.  But the issue of gas demand may be a larger problem unless, and until, the credit crisis is addressed in this country.  While the credit problems began with the housing industry, they have expanded since the mid-September collapse of Lehman Brothers and the corresponding seizing up of the global financial markets.  The absence of credit has brought global trade to a standstill and been the primary cause for the implosion of the global manufacturing sector.  Associated with manufacturing’s problems have been issues with credit availability for automobile purchasers.  According to Mike Jackson, the CEO of AutoNation (AN-NYSE), the problems of securing credit for automobile buyers has contributed to a huge portion of the shortfall in auto sales.  Mr. Jackson has made the point that the customer traffic at his auto dealer network would support roughly 20% more sales than his firm is currently generating.  Extrapolating that ratio to the balance of the domestic auto industry suggests to him that auto sales in the U.S. could be as much as two million vehicles higher than it currently is. 

The significance of the problems in the automobile and housing industries for the natural gas business cannot be underestimated.  Natural gas and natural gas liquids provide the feedstocks used to produce materials used in the manufacture of automobiles and the construction and outfitting of homes.  We decided to look at the relationship between natural gas production and consumption, and housing and automobile sales to see if we could discern any change in industry trends. 

Exhibit 7.  Housing Starts A Large Problem For Gas Industry
Housing Starts A Large Problem For Gas Industry
Source:  EIA, BEA, PPHB

As housing starts began to fall in early 2006, natural gas supply was below the gas production trendline for 2001 to 2008.  At the same time, gas demand essentially was flat.  However, as gas production began to ramp up in the second half of 2007, housing starts fell under 1.5 million units annually and the gas price collapse began as prices fell from $8 per Mcf to $6 per Mcf and below.  As monthly housing starts have fallen to close to 500,000 units in recent months and gas production continued to grow, gas prices became totally supported by heating demand.  Fortunately, we have had a substantial amount of winter weather across the country starting early in December.  Absent that demand, gas prices could be substantially lower.  Still, the growing gas supply in the face of little demand improvement has driven gas prices to the $4 per Mcf level.

The difference between the trends for gas supply and consumption become much more evident in the chart comparing them to annual domestic auto sales.  The upward sloping production trendline contrasts with the flat consumption trendline.  Once again, like with

Exhibit 8.  Auto Sales Collapse Critical to Gas Industry
Auto Sales Collapse Critical to Gas Industry
Source:  EIA, BEA, PPHB

housing starts, domestic automobile sales were relatively flat in 2006 and 2007 at around 15 million units each year.  Those sales fell to about 13.2 million units in 2008, which coincides with the gas price drop and the surge in unconventional gas production.  Both an auto industry consulting firm and Ford Motor Co. (F-NYSE) have recently forecast 2009 annual automobile sales to be about 10.5 million units.  Ford suggested that it believes that January auto sales were at the 9.57 million unit rate, but they have fallen in February to a 9.0 million rate.  They are expecting sales to pick up in the second half of 2009, but we believe that forecast assumes credit markets begin functioning normally and the automobile manufacturing companies are bailed out. 

At the moment, the keys to the health of the natural gas industry in the near term are the rate of sales of autos and houses.  Once house sales pick up, there will be a recovery in housing starts.  The most recent statistics for Houston point out that new house starts have fallen below the level of home sales.  If that continues for a while, whatever housing inventory overhang existing in Houston will disappear and builders will start constructing new homes.  Hopefully that trend will spread nationwide. 

Both housing and auto sales are dependent on the government addressing the credit markets, something that doesn’t appear to have their full attention.  As a result, we expect natural gas markets will remain under pressure.  Many people believe that gas prices could be pressured this fall when gas storage is full and heating demand has yet to arrive.  A potential problem with that analysis is that gas buyers – pipeline gatherers and gas distribution companies – are also under financial stress from the lack of a viable credit market.  As a result, many of these buyers will not be willing to use all their available working capital to purchase gas for storage.  That means it is quite possible that gas storage reaches effective full capacity meaningfully below the volume currently considered to represent maximum storage capacity.  The result would be that natural gas prices could be under their greatest pressure in a matter of months.

New Ways For Taxing Gasoline Now Front And Center (Top)

Last Thursday, the National Surface Transportation Infrastructure Financing Commission issued a report to Congress highlighting the problem of inadequate cash flow from the current gasoline tax structure relative to expenditures needed for highways.  The commission was established by the U.S. Congress to examine the issue of how to provide sufficient funds to build new highways, and repair and maintain the existing highway infrastructure, as the domestic vehicle fleet becomes more fuel-efficient and hybrid and alternative fuel-powered vehicles become a greater proportion of the fleet. 

Last fall the Congress transferred $8 billion from the general treasury to the highway trust fund to make up the shortfall between revenue going into the fund and money promised to the states for highway projects.  The shortfall is directly related to the sharp rise in gasoline prices that forced citizens to alter their driving habits.  For the past 14 months the number of vehicle miles driven in the United States has fallen, although the December data has shown a sequential uptick although still down year over year. 

The Federal fuel tax is 18.4 cents a gallon for gasoline and 24.4 cents a gallon for diesel fuel.  These taxes have not been rising and are not raising sufficient funds to keep pace with the cost of highway, bridge and transit projects.  The commission proposes boosting the federal gasoline tax by 10 cents a gallon and the diesel tax by 15 cents a gallon, but also to begin to index the fuel tax for inflation.  Equally important was the commission’s stated view that the existing vehicle fuel tax system is not functioning well enough to support our current method of paying for highway construction.  The commission’s report warns that if the government fails to find a better method for raising highway construction funds, “we will suffer grim consequences in the future: unimaginable levels of congestion, reduced safety, costlier goods and services, an eroded quality of life, and diminished economic competitiveness as a nation.” 

Merely days before the commission issued its report, Transportation Secretary Ray LaHood suggested that the government should not be raising gasoline taxes in the middle of a recession.  He also suggested that the nation should consider shifting how it finances highway construction by charging motorists by the mile driven rather than by the volume of fuel consumed.  No sooner had he uttered his views on a new highway fuel taxing scheme than the Obama administration publicly rejected the idea. 

Since 2006, the state of Oregon has been conducting a pilot program to test the idea of taxing drivers based on the miles they drive rather than the amount of gasoline they purchase.  The program, funded by the Federal Highway Administration, began in the fall of 2005 with 20 vehicles equipped with GPS systems that were linked to software installed at two specially equipped gasoline service stations in Portland.  The program eventually expanded to nearly 300 vehicles by the spring of 2006.  The participants would fuel their vehicles at these service stations and the software would determine the number of miles driven on Oregon, as opposed to out-of-state, roads and calculate the tax owed based on 1.2 cents per mile driven.  The software would calculate how this new tax burden compared to the state’s traditional 24-cent per gallon gasoline tax and adjust the participant’s fuel bill either up or down. 

We have written at least two articles in previous Musings about this test and the concerns that arose.  Most of them relate to privacy issues since the GPS system tracks a vehicle’s miles and could record where it went.  The software employed in the test does not record where the vehicle goes, only if it exits the boundaries of the state.  The GPS software, however, does record when the miles are driven, which could allow the imposition of congestion pricing for driving.  Based on recent reports, 90% of the participants in the pilot program indicated they would continue to use the system if the state equipped all service stations with the software.  The Oregon transportation director estimates that it would cost about $35 million to equip the roughly 2,000 service stations in the state with the software system.  He also pointed out that the system worked as expected in that the participants drove 12% fewer miles than they would otherwise have done.  Since we do not know what the measurement period was the director referenced, we are not sure that some of the mileage decline isn’t economically influenced. 

It is interesting to note that Oregon was the first state in the union to institute a per gallon gasoline tax back in 1919.  The tax was one cent per gallon, or approximately 12 cents today.  One of the reasons for instituting state gasoline taxes was to help boost revenues for road construction since motor-powered vehicles required stronger road surfaces than did horse-drawn wagons.  Horseless carriages were first required to pay registration fees by New York City starting in 1901.  By 1914, all the states collected registration fees with 90% of the money going to road construction.  The federal gasoline tax was first instituted in 1932 at a 1-cent per gallon rate, a Great Depression tax increase.  We doubt we have seen or heard the last of higher motor fuel taxes or a shift in how vehicle use is taxed.  This may be another example of the Obama administration letting the Congress take the lead on gasoline taxes.

RIG’s Long Defends Company’s Stock Buyback Decision (Top)

When a company completes a financial year successfully, it usually earns a profit. Shareholders are entitled to a share in the annual profit. The dividend is the portion of the net profit that a corporation distributes to its shareholders. Dividends are sometimes referred to as "interest on shares".
“Assessment base
Public limited companies are required by law to allocate 5 % of their reported net profit to the general reserves, provided these have not yet reached 20 % of the paid-up share capital. There are also further statutory and company-specific provisions on what needs to be done with the net profit. This reduces the assessment base for the dividend amount, but in turn strengthens the capital base.
Dividends are not distributed in the year during which the net profit was generated, but only shortly after the general meeting of shareholders in the following year.
“Determination
The dividend may be determined only after the appropriate allocations have been made in accordance with applicable laws and the articles of association. Afterwards the management can propose a dividend payment to the general meeting of shareholders. This motion is put before the shareholders, who determine the exact amount by vote. The dividend is denominated in Swiss francs (or the share's nominal currency) and always pertains to one share.
“Dividend policy
The management board decides on the basis of financial and business considerations what proportion of the profit should be retained within the company. Between zero and one hundred per cent of the net profit can be distributed as dividends. Companies with a low payout ratio (dividend payment as a proportion of profit) or no dividend at all retain a larger share of the profits within the company, for example for research, development, production or marketing. This may result in price gains in the medium to long term, thus compensating investors indirectly for the loss of dividends. Companies try to pursue a consistent dividend policy as far as possible. The aim is to pay out the same dividend as the previous year, regardless of the financial results for the year. “

We also read several articles dealing with corporate law in Switzerland seeking to better understand the powers of shareholders versus those of management and the board of directors of companies incorporated there.  According to one article, the Swiss Corporate Law “affords several fundamental, non-transferable powers to the shareholders’ meeting.”  Those powers include: 1) the appointment and removal of directors and the statutory auditors; 2) the approval or rejection of the annual business report; 3) setting of dividends; and 4) amendment to the articles of association, including the share capital.  Like the U.S. Constitution, there are specific and enumerated powers granted to shareholders, management and the board of directors under Swiss law.

What we perceived to be the real issue impacting management’s and the board of directors’ recommendation is spelled out in the following comments by Mr. Long in response to Mr. Cooperman’s questions as taken from the transcript of the earnings conference call. 

Robert Long
“…We detect from a lot of investors that there is a significant amount of concern about the level of debt, which is why we've been
concentrating on paying down our debt as quickly as we can and the flexibility to continue paying down that debt is something that is important to us in effect with our considerations. But, as we've discussed before there are a lot of different considerations in this…”

Mr. Cooperman pressed his point that a regular quarterly cash dividend would do more for the value of RIG shares than a stock buyback. 

Lee Cooperman - Omega Advisors
“Well, I really observed a $4 dividend is 1.2 billion a year, which takes you almost three years to spend the same amount of money on the repurchase program. And the question really is which is going to have a more salutary effect on your stock price. And my guess is, with the dividend of $4, your stock wouldn't be trading at 57…”
In essence, the crucial issue influencing management and the board of directors is retaining cash management flexibility.  It would have been nice if Mr. Long had expounded on that issue and the rationale for it rather than to claim it was all about the provision of Swiss corporate rules.  In actuality, Swiss law really requires management to deal with how it is going to share with its shareholders the annual profits it has already earned.  It appears that the law states that dividends should be approved by the shareholders and then paid out in one payment.  This may be a challenge for a company that wishes to establish a quarterly dividend, but if the funds are present, I suspect the shareholders’ meeting resolution could be written to provide for periodic payments over the next 12 months.  The reasoning behind this view is the way the current stock buyback plan approval resolution is written.  According to RIG’s press release on the issue, the buyback plan would have no expiration date and “could be suspended or discontinued by the company’s Board of Directors or company management, as applicable, at any time.”  Based on this language in which the shareholders are approving the buyback plan while granting total discretion over it, including its termination, we suspect similar wording could be used for a dividend resolution. 

Maybe the real issue is that Mr. Long is not quite as confident about the company’s backlog and cash flow projections, suggesting that cash to run the business could be an issue down the road.  The company reported an estimated $38.7 billion backlog of signed drilling contracts.  As shown by a chart used by management during its earnings call, this contract backlog generates $3.8 billion of free cash flow after payment of all the company’s $13.5 billion in long-term debt.  Based on this chart, RIG should certainly be able to pay some form of an annual dividend. 

Exhibit 9.  Cash Flow Could Fund Debt and Dividends
Cash Flow Could Fund Debt and Dividends
Source:  Transocean

As we have argued in the past, dividends have been a key component of shareholder long-term investment returns.  We also believe that dividends will pay an even greater role in future shareholder returns.  RIG had a chance to set a course that would reward current and long-term shareholders rather than reward share-sellers through a stock buyback plan. 

Recent data about corporate American dividend cuts and share price performance shows that while dividends are an important return measure, investors are not rewarding their payment.  It is as if investors view the use of any cash, other than for sustaining the business, as a bad move.  This recent attitude emerges from the recent performance comparison of financial and non-financial companies in the S&P 500 Index and whether they are or are not paying dividends.  As the chart shows, the worst performance has been among the dividend-paying financial stocks, primarily the large banks that have omitted or drastically cut their dividends.  While at less than half of the year-to-date decline for financial dividend paying companies, non-financial dividend paying companies performed six percentage points worse than non-dividend paying companies.  We suspect that in the dividend paying non-financial companies are some who have cut their dividends that has partially driven the poorer performance.  This performance data is not, in our minds, an indictment about dividends and their relative importance to investors, but rather reflects the current investment malaise inflicting investors currently.

RIG has the benefit of being in a very healthy financial position.  Moreover, based on Mr. Long’s outlook, the company is poised to benefit from the long-term trend favoring more deepwater drilling and fewer newbuild deepwater drilling rigs, ergo a stronger utilization and pricing environment in the future.

Exhibit 10.  Dividend Paying Company Shares Are Suffering

Source:  Bespoke Investment Group

Exhibit 11.  Share Price Suffers From Oil Collapse
Share Price Suffers From Oil Collapse
Source:  Big Charts

The great recapitalization of RIG at the time of its merger in 2007 with Global Santa Fe helped propel the stock price to new highs, but those shares were bought at higher than current prices – increasingly the story of poor shareholder returns from share repurchase programs.  The concept of buybacks is to boost share prices by increasing earnings per share, but in cyclical industries price-to-earnings per share ratios do not remain static over time.  What drives P/E ratios up and down is more a function of the current state of an industry’s business cycle than the actions of the companies.  In our view, RIG’s board of directors and management are missing an opportunity to become the oilfield service industry’s leading shareholder-friendly company. 

Dividends

On February 17th, the last participant on the Transocean Ltd. (RIG-NYSE) earnings conference call was Leon Cooperman, the head of the Omega Advisors’ hedge fund.  RIG’s CEO, Robert Long, may have wished that he had ended the call one question earlier.  The previous day, RIG announced it would be asking its shareholders to approve the authorization of the board of directors to repurchase RIG shares equal to CHF 3.50 billion ($3.02 billion).  Based on RIG’s February 20th closing share price ($59.52), the buyback amount could purchase approximately 50.7 million shares, or close to 16% of the company’s outstanding shares. 

Leon Cooperman, the long-time investment strategist at Goldman Sachs (GS-NYSE) before he retired and started Omega Advisors, raised the question of why RIG didn’t consider instituting a cash dividend rather than another stock buyback plan.  Mr. Cooperman raised the rhetorical question of whether RIG’s share price would have been down $2.50 a share, as it was at the time of the earnings call, if the company had announced a $4 per share annual cash dividend.  He went on to point out that the dividend he was suggesting ($1 a share per quarter) would cost the company approximately $1.2 billion a year.  At that dividend rate, he further pointed out, it would take three years to dividend out the same amount of money management was asking the shareholders to approve, an amount that could be spent entirely this year if management elected. 

Mr. Long’s initial response was to suggest that the Swiss law, which requires shareholders to approve corporate dividends, would create a rigidity that could not easily be adjusted without calling another shareholders’ meeting to approve any change.  In some aspects Mr. Long’s answer is correct, but we think he was trying to hide behind a European shareholder that appears to be inflexible.  Clearly European shareholder rules are different from those followed in the United States, but we are not quite so sure they are as inflexible as Mr. Long suggests.  Understand that the author is not a Swiss corporate securities lawyer.  If one goes to the web site for the SIX Swiss Exchange, there is a section entitled “Know-How” that discusses various aspects of stocks, bonds, ETFs and investment funds that are traded on that exchange.  Below are various sections taken from the web site dealing with dividends. 

Sheep and Global Climate Change Pushing Animal Research (Top)

In New Zealand, scientists are hard at work analyzing why sheep burp, releasing methane gas, and how to keep them from doing it.  Methane is one of the most potent greenhouse gases and researchers now believe the livestock industries are a major contributor to climate change.  According to the United Nations, the livestock industries are responsible for more greenhouse-gas emissions than cars.  There are plenty of skeptics to this theory, but those skeptics also fear that regulators such as the U.S. Environmental Protection Agency will institute rules and/or taxes on bovine belches. 

The scientists are hard at work studying sheep stomachs.  They are interested in how the stomach functions when the animal eats grass.  Sheep, cows, goats and other so-called ruminants are unique in the way they digest their food.  While that uniqueness allows them to convert more energy from grasses, the process also generates hydrogen as a byproduct.  Microbes known as methanogens convert the hydrogen to methane, which then leaves the animal through belching, and to a lesser extent, flatulence.  The gases float into the atmosphere, where they trap heat and potentially accelerate global warming.  Humans emit methane, too, but not as much.

The reason why the research is ongoing in New Zealand is because roughly 48% of the country’s greenhouse gases come from agriculture compared to less than 10% in large, developed economies such as the United States.  Agricultural leaders fear their livestock-heavy economy could be at risk if there is an international move to tighten rules on animal emissions.  New Zealand is a clean island, but it is home to 35 million sheep – nearly 10 times the human population.  The country also holds millions of cows, deer and goats.

Interestingly there was an earlier period of sheep stomach research in the 1950s, ‘60s and ‘70s.  At that time the emphasis was on trying to improve animal digestion so livestock could produce more food for what was then perceived as a world soon to be desperately short of foodstuffs.  This research reminds us of the furry raised at that time by Malthusian-influenced social scientists and economists worried about overpopulation.  Today, the global climate change debate is driven somewhat by a similar Malthusian belief that the world has too many people. 

Last month, a columnist on MarketWatch, wrote about the problems challenging society in America.  He wrote his column starting from the position that the challenge the current administration is having with the government’s spending is driven by entitlements such as Social Security and Medicare.  At one point this columnist states: “Yes, population is the core problem that, unless confronted and dealt with, will render all solutions to all other problems irrelevant.”  He goes on to outline five problems confronting the country as a result of the “exploding population” that he says will remain the “key variable driving all other major economic issues in the next four decades:”  1) global wars…over food, water and energy; 2) global warming…and nuclear threats; 3) peak oil…versus peak population;

4) alternative energies, political will and lobbyists; and 5) the mythological math of economic growth.   All of these issues are influenced by too many people and their demands.

In recognition of the problem of bovine belching and flatulence, some global climate change supporters are urging that people stop eating meat.  In their view, if we take that step then maybe the globe can survive with fewer animals and climate change can be dealt with more easily.  Maybe if we all become vegetarians we will be able to have the same energy supplies we are living with today.  Unfortunately, we will need more, new and varied sources of energy to power the world of the future.  We hope that free markets will drive the development of those new fuel supplies rather than government regulation.

Commodity Prices Tend To Revert To The Mean (Top)

All investments can have wide price swings during any given year.  Over time, however, they usually revert to their long-term averages.  This tendency is referred to as “mean reversion.”  In Exhibit 13 we show the performance of 14 major commodities for the past nine years and during the first two months of 2009.  Noticeable is the fact that no one commodity has performed consistently over this 9-year time period.  The chart also highlights exactly how bad last year was for commodities, just as it was for real estate, bonds and equities.  In 2009, 12 of the 14 commodities lost money while the worst prior periods were 2000 and 2001 when seven and eight commodities, respectively, generated negative returns.  The message of this chart is that long-term investors should diversify across all asset classes and keep in mind the mean reversion principle.  That principle should encourage investors to rebalance portfolios periodically and consistently to maximize returns.

Exhibit 12.. Oil Price Collapse A Record
Oil Price Collapse A Record
Source:  Bespoke Investment Group

Another consideration about commodities was the fact that last

year’s oil price decline was virtually a record.  It required only 101 days to fall 77%.  When compared to the Internet bubble market’s 78% correction of 2000-2002, the homebuilders’ 87% drop over 2005-2008 and the S&P financials’ 81% collapse of 2007-2009, the oil price drop was amazing.  Of course virtually all of us were spellbound watching the fall unfold – almost in slow motion.

Exhibit 12.  Commodity Performance And Mean Reversion
Commodity Performance And Mean Reversion
Source:  US Global Investors, LME, MarketWatch, PPHB

(Top)

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Main Fax:   (713) 621-8166
www.pphb.com

Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.

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