petrocapita jan 2010

8/14/2019 Petrocapita Jan 2010

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Petrocapita Energy Upda

January 2010


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Summary

CONTENTS

3 HowdoesUSPlantoImport10M

BOPDwithaDevaluedCurrency?

3 PeakOilasPredictedbytheIEA

3 ChinaOilDemandThoughtExper

4 QuickEnergyFacts

BarclaysCapitalrecentlystatedWe expect 2010to be a year of transition between the [oil] demand

concerns of 2009 and the supply concerns of 2011,

with geopolitical developments having a heightened

importance. Thelast24monthshavepushedthe

questionofoilsupplyoutofthelimelight,whileofcoursetheunderlyingissuesremainunchangedandperhapsmagniedbythenancialcrisis.

Attheheartofthematteristhefactthatweliveinapeakoilworld.Noresourceisinniteandconven-tionaloilsupplyisclearlydemonstratingcharacteris-ticsofpeakingproduction.

ArecentsurveypaperfromtheUKERCfoundthat:

Theglobalaveragedeclinerateofpost-peakeldsisatleast6.5%/yearandthecorrespondingdeclinerateofallcurrentlyproducingeldsisatleast4%/year.Thisimpliesthatapproximately3mb/dayofcapacitymustbeaddedeachyearjusttomaintainproductionatcurrentlevelsequivalenttoanewSaudiArabiacomingon-streamevery3years.Anadditional1mb/daymustbeaddedtomeetdemandgrowth.

Morethantwothirdsofexistingcapacitymustbereplacedby2030solelytopreventproductionfromfalling.

Apeakinconventionaloilproductionbefore2030appearslikelyandthereisasignicantriskofapeakbefore2020.Forexample,a2008reportbyTheUKIndustryTaskforceonPeakOilandEnergySecuritywarnedthatapeakincheap,easilyavailableoilproductionwaslikelyby2013.


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TofollowonthepeakoilpricingmodelcontainedinthelastEnergyBrieng,wehaveproducedanothermodelwhichattemptstocalculatetheeffectofthetransitiontoamiddleclassstandardoflivinginChinawillhaveontheglobalenergymarkets.Once

again,thepurposeofthisexercisewasnottomakehighlyaccuratepredictionsbutrathertogainsomeinsightintothepotentialmagnitudeofchangesgivenfairlyconservativeproduction,demandanddeclineassumptions.

ThekeyassumptionsarethatChinamovesfromitscurrentenergyconsumptionlevels(around2.5barrelpercapitaperyear)tolevelsmorecloselyresemblingSouthKorea(17barrelspercapitaperyear).Theprojectionperiodweusedwas30years,whichislongerthanittookSouthKoreatomake

thistransition.Theeffectofthischangeonglobaldemandisquitedramatic.Itwouldbenecessarytoreplace26millionBOPDproductionby2020tomaintainsupply(about30%ofcurrentproductionlevelsandalmost3timesSaudiArabiaoutput).Totaldailyproductionwillhavetoraise22%from84millionBOPDto102millionBOPD.

Summary (continued)


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Energy Update

HOW DOES US PLAN TO IMPORT 10 MILLION

BOPD WITH A DEVALUED CURRENCY?

TheUScurrentlyimportsover10millionbopd.TheUSgovernmentandFedareclearlyonthetracktosubstantiallydebasingthedollar.TheUShasnocrediblewaytopaytheonandoff-balancesheetliabilitiesthatithasaccumulatedtodatewithoutevenbeginningtopaythemassivefutureliabilitiesofthesocialprogramsforboomers.TheUSwilldefaultonitsdebtviatheprintingpress.Thequestionthenbecomeshowitsmanagestomaintainawayoflifethatrequirestheimportof10millionbopdfromforeignerswhomaynotbeinamoodtoacceptworthlessUSatinexchangeorattheveryleastthepriceofoilinUSDtermswillbeastronomical.

PEAK OIL AS PREDICTED BY THE IEA

In2009The Guardian(UK)publishedastoryabout2whistleblowersfromtheInternationalEnergyAgency(IEA).Oneofthesesources,stillwiththeIEA,saidThe IEA in 2005 was predicting oil supplies could

rise as high as 120 million barrels a day by 2030

although it was forced to reduce this gradually to

116m and then 105m last year [2008]. The 120m

gure always was nonsense but even todays number

is much higher than can be justied and the IEA

knows this. Many inside the organization believe that

maintaining oil supplies at even 90m to 95m barrelsa day would be impossible but there are fears that

panic could spread on the nancial markets if the

gures were brought down further.

ChristophedeMargerie,CEOofFrancesnationaloilcompanyTotalSAhasissuedanumberofpredictionsaboutworldoilsupplyconstraints.In2007,hestatedproduction of 100 million barrels

a day will be difcult. In2008,hestatedworld oilproduction would peak at or below 95 million barrels

per day,andlaterthat

world oil production may

plateau below 90 million barrels per day.

AstheIEAhasbeenwarningforyears,givencurrenttightersupply/demandbalanceandincreasingdeclinerates,areductioninupstreamoilinvestmentinevitablycausesanoilsupplyproblemlater.IEADirectorNobuoTanakastatedthatSustained

investment is needed mainly to combat the decline

in output at existing elds, which will drop by almost

2/3 by 2030. Tanakarecentlypredictedthatglobalupstreamspendinghaddropped$90billion,or19%,

during2009vs.2008therstdeclineinadecade.Theeffectsofacapexreductionwillbecompoundedbytheproductionanddeclinelimitsthatarebeingseeninanincreasingnumberofcountriesworldwide.

CHINA OIL DEMAND THOUGHT EXPERIMENT

AsathoughtexperimentwemodeledtheeffectofChinamovingfromitscurrentenergyworldoilconsumptionlevels(around2.5barrelpercapitaperyear)tolevelsmorecloselyresemblingSouthKorea(17barrelspercapitaperyear).Theprojectionperiodweusedwas30years,whichislongerthanittookSouthKoreatomakethistransition.Theeffectofthischangeofglobaldemandisquitestartling.Assumingamodestlevelofdeclineinexistingglobalproduction,itwouldbenecessarybereplace26millionBOPDproductiontomaintainsupply(about30%ofcurrentproductionlevelsand3timesSaudiArabiaoutput).Totaldailyproductionwillhavetoraise22%from84millionBOPDto102millionBOPD.


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Energy Update (continued)

CHART 1: CAPACITY ADDITION NEEDED

BY 2015

Source:CambridgeEnergyAssociates

2006200820102012

120

110

100

90

80

70

60

50

MillionBarrelsperDay

WorldOilDemand

SmallerFields/Upgrades

FieldsUnderAppraisal

NaturalGasLiquids

YettoFind

Projects(>10,000bd)

ExistingProductionCapacity(6%declineperannum)

Click Here for Link to the Login Page for the

China Oil Demand Calculator

QUICK ENERGY FACTS

ShaleGas:FormorethanadecadetheUSCongresshasexemptedtheoilindustryfromafederallawprotectingdrinkingwater.Inparticularthatthelawshouldnotbeappliedtohydraulicfracturing,theprocessthatisessentialtoextractingtheUSnaturalgasreservesparticularlyshalegas.In2005Congresspassedalawprohibitingsuchregulation.NowtheUSCongressisrevisitingtheexemptionandhasaskedtheEPAtoundertakeareviewofhowhydraulicfracturingmayaffectdrinkingwatersupplies.TheEPAitselfhasexpressedseriousreservationsaboutallowingshalegasdrillinginwatersheds.IftheEPAweretodecidetoremovethehydraulicfracturingexemptionwhateffectwillithaveonshalegasdrillingandthecurrentabundantNorth

Americannaturalgassupplies?

ChinasOilConsumption:ChinarecentlysurpassedtheGermanyandJapanintermsoftotaloilconsumptionandnowbuysmoreofSaudiArabiasoilexportsthantheUS.

BarclaysCapital:We expect 2010 to be a year oftransition between the [oil] demand concerns of 2009

and the supply concerns of 2011, with geopolitical

developments having a heightened importance.
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Petrocapita Macro Upda

January 2010


7/16M1

Summary

DEMOGRAPHICS ARE DESTINY

The 19th century belonged to the UK, the 20th century belonged tothe US and it appears that the 21st century may belong to China.

A consistent theme in the emergence of a new global power is ayoung population with a large and growing pool of domestic savingsand a focus on investing in the capital base of the economy ratherthan consumption. The worlds western economies nd themselvesheavily in debt with deteriorating demographics (our populations areaging and our birth rates are low) and economies skewed towardsconsumption. We are accruing ever-greater liabilities to cover vastsocial, medical and retirement programs that we currently do nothave the workers or more importantly the high growth economiesto pay for. It has been said that demographics are destiny.Unfortunately, rather than face these issues, our governmentsare attempting to x our manifest problems by accelerating theconsumption friendly policies that were largely responsible for

getting us into this situation in the rst place. As an example ofthis, the US Federal funding gap is growing rapidly. Over the last sixyears:

unfunded obligations increased approximately 50% from US$79trillion to US$114.7 trillion; but

revenue rose approximately 12%.

The US government is now in the position of increasing its liabilitiesfour times faster than its tax receipts. This is a trend being repeatedthroughout the developed world. The US Federal Reserve recentlydisclosed that it purchased half of the newly issued US Treasuries

in the second quarter of 2009 all of which would have beenpurchased with newly created money direct debt monetization.

Investors must be alive to the growing divergence between theeconomies of the west and those in the emerging world andposition themselves accordingly. We believe that the way to benetfrom long-term Chinese growth is to invest in what China needsin politically stable parts of the world. That gives you the best of

CONTENTS

M1 Demographics Are Destiny

M3 Forty Percent of US CorporProts From Finance!

M4 Americas Current Export Ination

M4 How Can this End Well?M4 ZIRP and Commodity Price

Is There A Link?M5 Money Velocity IncreasingM6 Interest on US DebtM6 US Residential Housing Sec

Losses Now Nationalized?

M7 Private Sector Growth isAbsent in the USM7 US Bailout CostM7 Equity and House Price

Declines Over?M7 Government Fiscal Decits

Continue to WorsenM8 Top 10 Points for Canadian

Limited Partnership InvestoM9 Quick News Review


8/16

M2

both options rst world political risk and transparency combined

with emerging world growth rates. Clearly a category that ts this

description is commodity investment in western Canada

AgricultureEnergy

And to a lesser degree commodity linked investment in western

Canada:

Businesses that service the commodity sectorBusinesses and sectors that benet from general population/

economic growth in Western Canada


9/16M3

Global Macro Update

FORTY PERCENT OF US CORPORATE PROFITS

FROM FINANCE!

Given the rapid reation of the prices of speculativeassets and the collapse of risk premiums, theongoing money printing efforts in the developedworld are having limited effect outside of the nanceeconomy. It is estimated that up to 40% of UScorporate prots are generated by the nance sector largely from speculative activities. Corporate protsattributable to the nance sector were effectivelystable until the 1970s when the growth in the USmoney supply turned sharply higher on a sustainedbasis. Given the nance sectors intimate relationshipwith the US Federal Government and the FederalReserve banking system it is not surprising that thenewly printed money has owed into and through

the nance sector acting as a wholesale subsidythat drove corporate prots, compensation andspeculation.

Despite widespread belief to the contrary,government intervention into broad swathes of theeconomy to support too big to fail companiesor more accurately to prevent capital destroyingbusiness activity from being eliminated to the benetof the entire economy is not a positive for futuregrowth. There is an economic truism that whateveryou subsidize you get more of hence by subsidizingfailure we are ensuring bigger failures in the futureand worst of all penalizing well run businesses. Therms that were prudently managed leading up to thecrisis should have beneted from the demise of theirpoorly run competitors in a free economy capitalwould have owed to the protable businesses rather

than the loss making ones. The fact that this didnthappen creates a perverse if you cant beatem,

joinem mentality with respect to risky and imprudentbusiness practices.

QUICK FACTS

China US

GDP: $4.3 trillion increased a total of 430% in last10 years

GDP: $14.2 trillion - increased a total of 18% (realterms) in last 10 years and added ZERO privatesector jobs

20% percent of economy in state sector 30% percent of economy in state sector

Consumer demand is 35 per cent of GDP Consumer demand is 70 per cent of GDP

Savings rate is 40 percent of household disposableincome (one of the highest in the world)

Savings rate is 6 percent of household disposableincome


10/16


11/16M5

Global Macro Update (continued)

CHART 5: CAPACITY UTILIZATION (PERCENT OFCAPACITY)

Source: St. Louis Federal Reserve (shaded areas indicaterecessions)

90

85

80

75

70

65

(PercentofCapacity)

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

CHART 6: MZM VELOCITY (DARK BLUE)V. US GDP % GROWTH (LIGHT BLUE)

Source: St. Louis Federal Reserve

2.4

2.2

2.0

1.8

1.6

1.4

MZMV

elocity

GDP

Growthcurrentterms

10.0%

8.0%

6.0%

4.0%

2.0%

0.0%

-2.0%

-4.0%

Jun-99

Jun-00

Jun-01

Jun-02

Jun-03

Jun-04

Jun-05

Jun-06

Jun-07

Jun-08

Jun-09

Interestingly, the rebound in the CRB index is mirroredby another powerful upward surge in US base moneysupply (M0) after its initial doubling in late 2008, early2009.

MONEY VELOCITY INCREASING

For those who are adherents of the money velocitytheory of economic activity, the velocity of MZM is

increasing after it started falling in the rst quarterof 2007 - six quarters before economic growthslumped. The recent increase in MZM velocity maypoint to increased economic activity, the questionthen becomes whether it will be sustained as can be

seen in the capacity utilization numbers.

CHART 7: ESTIMATED US INTERESTPAYMENTS

Source: GAO

$800 in billions

700

600

500

400

300

200

2010 2019

2,400

2,000

1,600

1,200

800

400

0

-400

(BillionsofDollars)

CHART 4: US M0 (US$ BILLIONS)


1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010


12/16M6


4,000

3,600

3,200

2,800

2,400

2,000

1,600

1,200

800

400

0

-400

(Billion

sofDollars)


1940 1950 1960 1970 1980 1990 2000 2010

CHART 8: REAL ESTATE LOAN AT COMMERCIALBANKS (US$ BILLIONS)

Further increases in this velocity are consideredby many as an essential precursor for sustainedeconomic growth.

INTEREST ON US DEBT

More than half of the $9 trillion in debt the US Federalgovernment is expected to build up over the nextdecade will be incurred to pay interest charges -US$4.8 trillion.

In 2015 $533 billion in interest payments will beequal to a third of the federal income taxes expectedto be paid that year obviously a dangerous trendgiven that longer term interest rates can be expectedincrease from their currently historically low levels.

The other issue for the US is that the duration of

its borrowing is rather short in simple terms thatmeans the US federal government must constantlyrenances its existing debt in addition to borrowingmore to fund ongoing decits. The magnitude of thisissue is shown in that the US Treasury estimatedin November 2009 that approximately 40 percentof the debt will need to be renanced in less thanone year. This shortened duration leaves the USquickly exposed to any increases in borrowing costsdemanded by the markets.

US RESIDENTIAL HOUSING SECTOR LOSSESNOW NATIONALIZED?

The US automobile industry has been nationalized,the banking sector has been nationalized, medicalcare has been nationalized and now the residentialhousing sector has been nationalized. With the

Treasury departments recent announcement that itwill provide unlimited backing to Freddie Mae andFannie Mac these two organizations now underwritealmost 80% of all new mortgage lending in the US de facto nationalizing of the market, a market that

represents:

$14.6 trillion in total U.S. mortgage debtoutstanding

$8.9 trillion in total U.S. mortgage-relatedsecurities.

$7.5 trillion in pooled mortgages, of which about$5 trillion is securitized or guaranteed by FreddieMae, Fannie Mac or FHA

Charts 8 & 9 show that while most mortgage lendershave been withdrawing from the US residentialhousing market, Freddie and Fannie loan books areexploding.


13/16M7

Source: Washington Post

CHART 10: US JOB GROWTH BY DECADE

1 2 3 4 5 6 7 8 9 10

0

0%

38%

Year in Decade

1940s 72.0% unavailable

1960s 53.1% 44%

1970s 38.1% 28%

1950s 51.3% unavailable

1980s 34.9% 42%1990s 38.6% 58%

2000s 17.8% -4%

% change in

gross domestic

product

By decade,

infation adjusted

% change in

household net

worth

By decade,

infation adjusted

PRIVATE SECTOR GROWTH IS ABSENT IN THE US

Private sector has actually shed jobs in thelast decade and generated very little in inationadjusted GDP growth hence the nagging feelingin the middle class that they are not getting ahead.Unfortunately the same cannot be said for the USgovernment that continues to grow relentlessly.

US BAILOUT COST

Despite the varied and often conicting reportsabout the total cost of the US bailouts when allthe programs are taken into account the cost isapproximately US$14 trillion. Given the pre-bailoutmoney supply of the US was around US$ 15 trillionthis represents a truly staggering amount of money.

EQUITY AND HOUSE PRICE DECLINES OVER?

Research (Aftermath of Financial Crisis, Reinhart andRogoff, 2008) shows that the average real declinein equity and house prices following a bankingcrisis is 56% and 35% over 3.4 years and 6 yearsrespectively. If this historical average holds, andarguably the current crisis far exceeds virtually all theothers over the past 100 years, then both house andequity prices will fall much farther in real terms.

GOVERNMENT FISCAL DEFICITS WILLCONTINUE TO WORSEN

Research shows that even with the current dramaticdeterioration in G7 government nances we canexpect worse to come (Aftermath of Financial Crisis,

Reinhart and Rogoff, 2008). Over the course of thetypical banking crisis government debt levels rise an


200

180160

140

120

100

80

60

40

20

0

-20

(BillionsofDollars

)


1975 1980 1985 1990 1995 2000 2005 2010

CHART 9: TOTAL FEDERAL GOVERNMENT ANDSALLIE MAE CONSUMER LOANS

(US$ BILLIONS)


14/16

M8

average of 86 percent in the three years following.

The buildup in government debt has been a dening

characteristic of the aftermath of banking crises for

over a century. The question that will inevitably

arise is that if investment demand is not present

for the huge debt issuances that this will entail, willthe worlds central banks revert to monetizing their

governments debts or in simple terms printing the

money.

TOP 10 POINTS FOR CANADIAN LIMITED

PARTNERSHIP INVESTORS

Investors in private limited partnerships are faced

with a wide range of offerings from classic private

equity vehicles to real estate development projects.

Here are some simple criteria to help you make your

decisions about what private LPs to consider for theirRRSP portfolio this year.

1. Experienced management team A signicant

number of investment teams have NO experience

in fund management or even in the sector in

which they are investing your capital. Work

with teams that have a track record at both

the investment management level and at the

operational level there is NO substitute for

a track record of successful investment and

operation in the business area by the team youare trusting to act on your behalf.

2. Clear investment premise The investment

premise should be based on sound fundamental

analysis that is simple to understand and clearly

laid out in the presentation. Avoid momentum-

based investments where the core rationale is

effectively that everyone else is doing it. To

quote Sir John Templeton - It is impossible to

produce a superior performance unless you do

something different from the majority...

3. Tax efcient structure Tax can have a major

effect on your returns. Make sure that all

reasonable and credible steps have been

taken by the management team to manage taxobligations.

4. Audited nancial statements Management must

provide annual audited nancial statements. A

past failure to do so should act as a red ag.

5. Regular operational reporting Management

must be open and available to answer your

questions about the business.

6. Clearly dened hold period Make sure that

the hold period is clearly dened and cannot

be arbitrarily changed or extended by the

management team. You need to know how long

your investment will be committed and exactlywhen you can expect repayment.

7. No non-arms length transactions Situation

where the management team acquires the target

assets rst and then sells them to the fund for

an upfront prot. Even if disclosed in the offering

documents this is a poor practice and creates

a mismatch between the economic interests of

the management team and the interests of the

investors.

8. No acquisition fees - Fees where the

management team gets paid a portion of allcapital deployed. This creates a mismatch

between the economic interests of the

management team and the interests of the

investors, as acquisition fees are not tied to

returns.

9. No fee escalation Management fees should not

be tied to appraised or calculated asset value that

is an unrealized gain. The only valuations that

matter are the purchase price and the sale price.



15/16

M9

Management should receive the bulk of their

fees based on gains that are actually realized for

investors.

10. Incentives reward ACHEIVED performance

Favor investments where the manager makes

the bulk of his return only when you make areturn. This fee structure is commonly referred

to as success based. Lifts, acquisition fees,

escalating annual management fees are not

success based.

QUICK NEWS REVIEW

Venezuela Devalues: Shouting buy, buy, the world

is going to die, Venezuelans went on a frantic

shopping spree on Saturday following a sharp

currency devaluation that is expected to drive up

prices. President Hugo Chavez announced a dualsystem for the xed rate Bolivar Friday night while

much of the country was watching a baseball game.

Ive been lining up for two hours outside to buy a

television and two speakers because by Monday

everything is bound to be double the current price,

said Miguel Gonzalez, a 56-year-old engineer

standing in the tropical sun outside a popular

store. The government acknowledges prices will

rise after the devaluation, but say the upward trend

will be more gradual. State run television and radio

stations avoided using the word devaluation,

preferring the word adjustment. One pro-Chavezradio station responded to critics of the measure by

playing a popular Argentine song called Imbecile.

With oil crowding out other sectors of the economy,

Venezuela heavily relies on imports for consumer

goods, leaving it subject to big price swings

depending on the exchange rate. Older Venezuelans

are accustomed to sharp losses in the value of their

money, with numerous devaluations and currency

regimes over the last three decades of economic

turmoil. Ination, the highest in the Americas, at

25 percent last year, reached 103 percent in 1996

after a previous president lifted exchange and pricecontrols. Chavezs high-spending policies during an

oil bonanza fueled a massive consumer boom and

fast growth that shuddered to a halt when oil prices

plunged a year ago. The sharp drop in oil revenues

also undermined the Bolivar and made a devaluation

inevitable at some point. Source: Reuters Jan 2010



16/16

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Canada

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