Energy and Natural Resources Market Cheat Sheet (October 31, 2011)

Energy and Natural Resources Market Cheat Sheet (October 31, 2011)

Strengths

• The commodities complex, including industrial metals and crude oil, gained across the board as markets welcomed a deal by the eurozone leaders this week. West Texas Intermediate (WTI) crude oil gained nearly 7 percent and copper jumped more than 14 percent this week as investors’ risk appetite exploded. Commodity-related equities also rallied which drove gains in the Global Resources Fund (PSPFX).
• Macquarie Research highlighted that U.S. durable goods orders, excluding transportation equipment, rose 1.7 percent in September. This was greater than the consensus expectation and is the strongest reading in the last six months.
• Scotiabank noted that copper inventories in Asia are falling at a rate of 50,000 tonnes per week, creating upward pressure on the copper price. The rapid decline means there’s potential for zero inventories by Christmas.
• Rising oil prices have led to a rise in corporate earnings for energy companies. Major producers including Exxon Mobil, Royal Dutch Shell and France’s Total reported strong earnings results for the third quarter this week. Both Exxon Mobil and Royal Dutch Shell reported earnings 40 percent greater than a year ago, while Total’s profit rose 13 percent over the same time period, according to Resource Investing News.

Weaknesses

• Despite positive numbers across the board for the week, the Alerian MLP Index and the Baltic Dry Ships Index were laggards in the sector. However, each saw positive gains, up 3.1 percent and 3.8 percent, respectively.
• A Macquarie report this week noted that the latest SteelBenchmarker assessment by World Steel Dynamics has again highlighted the pressures facing the steel industry. The benchmark World Export hot rolled coil (HRC) price fell 4.2 percent over the past 14 days to $656 per tonne, the lowest since December 2010.
• Non-OPEC oil supply outages have been running twice the level seen in 2010. Further evidence of the supply-side deterioration was seen in the extremely poor set of August numbers for U.K. domestic production. At 808,000 barrels per day, total production is at its lowest levels since 1978.

Opportunities

• Data compiled by Bloomberg this month shows that traders have rising bullish expectations for the agriculture sector. Options traders are snatching up protection against declines in agricultural stocks at the fastest rate in four years. Puts to sell the Market Vectors Agribusiness ETF outnumber calls by more than 2-to-1, the largest discrepancy in almost a year. Over the past month, $2.7 million has been invested in the agribusiness ETF, second-most among all U.S.-listed global equity ETFs.
• China will be reporting its October HSBC Manufacturing Purchasing Managers Index (PMI) on Monday, October 31. The flash PMI announced this past Monday showed expansion in the Chinese manufacturing sector for the first time since mid-summer and the country contributed more than half of global incremental oil demand for the month of September, according to the Financial Express. An accelerated PMI could have a meaningful effect on commodities.
• A shortfall in diesel fuel supply is spreading across China. The Xinhau news agency is reporting that private gas stations are scouring the country for diesel supplies and lines are growing longer at filling stations in major cities. Diesel fuel shortages are common in the winter but longer and heavier-than-usual refinery maintenance mixed with a reduction in retail prices could create the perfect recipe for a squeeze once again this year. PetroChina imported 120,000 tonnes of diesel fuel in October to meet the increasing demand while China National Petroleum Corp. (CNPC) is running its refineries at full capacity. Refinery runs have increased 5.7 percent on a year-over-year basis and the company has encouraged refineries to reduce naphtha output to allow for higher diesel production. Further, CNPC has said that it will raise refinery runs to the second-highest level on record next month in order to maximize diesel output.
• Resource Investing News says rising production costs are putting downward pressure on fertilizer profits. Fertilizer production is very energy intensive, with production requiring significant amounts of sulfur, ammonia and natural gas. Analysts worry that rising input costs and shrinking margin profits may negatively impact the entire industry. However, Potash Corporation of Saskatchewan anticipates improving margins over the near future due to “economy of scale” in terms of potash production. According to Potash, “with demand expected to rise, we believe our expanding potash capability provides a unique growth opportunity. The powerful levers of selling more volumes at higher prices, with the potential for lower per tonne operating costs, offer significant gross margin potential in the years ahead. Beyond the opportunity for margin expansion, the potential for lower per-tonne mining taxes and improved earnings from our equity investments provides significant growth potential.”

Threats

• September PMI data across Emerging Europe will be released on November 1. Roubini Global Economics (RGE) is forecasting further weakening in manufacturing conditions, reflecting a decline in export orders and weakening growth outlook in the eurozone.
• On Wednesday, Freeport McMoRan declared force majeure on shipments of copper concentrates from its Grasberg copper mine in Indonesia as an increasingly acrimonious labor strike over pay and conditions continued into its fifth week. Mineweb suggested that this would mean that the company is not anticipating a protracted period of disruption at the mine.
• In the midst of earnings reporting season, Resource Investing News reported that many analysts are skeptical about producers being able to reach their production targets. As an example, Exxon Mobil will need to pump out 5 million barrels a day to reach its 4 percent growth target for 2011. For the September quarter, Exxon Mobil reported producing 4.28 million barrels a day. Analysts have speculated that one problem for the producers is that companies must sign production-sharing contracts with local governments in some countries. This means oil producers receive a smaller output when countries cash in on rising crude prices. Such agreements are prevalent in Africa, which accounts for 20 percent of Exxon Mobil’s crude oil supply.