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FEBRUARY IN MACAU

February projection of 1-9% YoY growth

 

 

February is off to a strong start in Macau, although we would caution that the data includes only 5 days of data and some of the strength reflects the lagging impact of the Chinese New Year (CNY) celebration.  Average daily table revenues for the first 5 days of February (2 weekend days) were HK$809 million compared to HK$748 million for all of January.  There are a number of moving parts (like that term) impacting the month including:

  • Negative - CNY occurring in January of this year versus February of last year
  • Positive -  February of 2012 contains one extra day (leap year)
  • Positive -  VIP hold was low last year

Given the above factors and the strong start to the month, we are projecting full month GGR (including slots) of HK$19.5-21.0 billion which would represent YoY growth of 1 to 9%.  

 

FEBRUARY IN MACAU - macau1

 

FEBRUARY IN MACAU - macau2


THE HBM: DNKN, DPZ, BWLD, CHUX

THE HEDGEYE BREAKFAST MONITOR

 

MACRO NOTES

 

Comments from CEO Keith McCullough

 

Adam Smith said defense is superior to opulence – the NY Football Giants agree:

  1. CHINA – interesting, but not surprising, to see Chinese stocks fail at intermediate-term TREND resistance of 2342 on the Shanghai Comp last night; this week we’ll get inflation data out of China (wed) and there’s a good chance its inflationary (sequentially) vs what we’d been calling Deflating The Inflation (DEC).
  2. FRANCE – keep an eye on the CAC because it just failed at its long-term TAIL line 3503 resistance this morning. Unlike Germany’s DAX (up +14% YTD and comfortably above long-term TAIL support of 6501), the CAC, MIB, and IBEX indices remain bearish TAILS. If they all continue to fail here and the Greek thing isn’t “news” anymore, what happens next?
  3. GOLD – down another -1.2% this morning after getting beat up a bit on Friday. Should remind people that what goes straight up will eventually come down, but Gold is a buy on red provided that UST Yields remain in a Bearish Formation (10s = 1.91% this morn, continuing to signal that US Growth Slowing in FEB vs JAN is the call to make). Gold’s immediate-term TRADE support = $1685. I’ll buy that and UST bonds on weakness.

 1 is my refreshed risk mgt range for the SP500, which continues to make lower long-term highs (vs 1363 APR 2011).

 

 

SUBSECTOR PERFORMANCE

 

THE HBM:  DNKN, DPZ, BWLD, CHUX - subsector fbr


 

QUICK SERVICE

 

DNKN: Dunkin’ Donuts has introduced four new bakery sandwiches.  The four options are ham and cheese, turkey, cheddar and bacon, chicken salad, and tuna salad.

 

DPZ: Domino’s CEO Patrick Doyle appeared on CNBC on Friday and said that commodity costs are easing off.

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

PEET: Peet’s Coffee & Tea bounced on an upgrade.

 

 

CASUAL DINING

 

BWLD: Buffalo Wild Wings was cut to “Hold” from “Buy” at Miller Tabak & Co.

 

BWLD: Buffalo Wild Wings was cut to “Sell” from “Hold” at Feltl & Co.

 

CHUX: O’Charley’s is to be purchased by Fidelity National Financial (FNF) for $9.85 per share.

 

CHUX: O’Charley’s reports 4Q11 EPS of -$0.38 versus consensus of -$0.22.  O’Charley’s company-operated comparable sales came in at -1.5%.

 

NOTABLE PERFORMANCE ON ACCELERATING VOLUME:

 

KONA:  Continues to trade down on accelerating volume.

 

 

THE HBM:  DNKN, DPZ, BWLD, CHUX - stocks

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


PFCB – THE QUEEN MARY

Like the Queen Mary, P.F. Chang’s turn will be slow and gradual; a new direction for PFCB is – in our view – starting now.

 

TRADE: This is a tough call, but we’re positive on the near-term trade for PFCB.  We’re confident that the current consensuses of $1.61 for 2012 is not reliable in that there are several estimates included in that number of $1.80 where, our guess would be, the analyst responsible has not updated his/her model for a while.   Extracting those estimates from the basket brings the mean estimate down to $1.56.  For that reason, I think a “miss” of $1.55 or $1.56 may now impact the stock as heavily as some may anticipate.  More importantly, the plan to turn around P.F. Chang’s is taking shape and, as that visibility improves, so will the stock’s performance.

 

TREND: Regardless of what happens to guidance we are buyers of PFCB on down days over the next three months.  We think that management will be articulating on the earnings call a comprehensive plan to fix the PF Chang’s brand with solid evidence that the plan is working.  Given that PFCB is trading at 6.4x EV/EBITDA NTM versus one of the worst run companies in the restaurant space (RT) at 6.9x, we believe this aberration will close when management can articulate a comprehensive plan to right size the sinking ship.  This move alone could add $3 to the stock or 15% upside.  

 

TAIL: Our due diligence has convinced us that the company is undertaking strategies that will positively impact the consumer’s experience at and, therefore, perception of the P.F. Chang’s brand.  If all goes according to plan, PFCB could be one of the best performing restaurant stocks in 2012.  We believe there is possibility for a quarter or two of choppy results but, while some seem to be pricing this stock for disaster, our long term tail view is positive from here.  As MCD and SBUX saw declines in their stocks as a result of missing extremely high expectations, we believe that PFCB’s stock could gain from any upside surprise in results or enough evidence that such a surprise might be forthcoming.

 

Nearly every restaurant concept gets a second chance; for the PF Chang’s brand its time is getting closer.  There remains much work to be done but the risk/reward favors the longs at this price.  Our focus has been primarily concentrated on what management is doing to the PF Chang’s brand and not Pei Wei.  That is not to say that Pei Wei does not matter to the company but, given that sentiment on the name is so poor, our primary concern is to discern whether or not management can fix the P.F. Chang’s brand.  If that is not addressed first and foremost, Pei Wei is irrelevant.  P.F. Chang’s represents roughly 75% of the company’s revenues.  For the stock to work, management has to rectify the issues at P.F. Chang’s.  We believe P.F. Chang’s is turning around.  Like the Queen Mary, the turn will be slow and gradual; a new direction for PFCB is – in our view – starting now.

 

Here is how I think about the set up for the company as we look out over the next couple of month and years. 

 

THE COMPANY IS OPERATING FROM A POSITION FROM STRENGTH NOT WEAKNESS:

  1. Since the company owns its store base, it is more able to implement significant changes than some others in the space.  The company has a strong balance sheet and generates solid cash flow; nearly $75 million FCF in 2012 and little funded debt.
  2. PFCB has a strong real estate position.
  3. Over the years, management has not compromised culinary standards at P.F. Chang’s so the challenge they face is more aptly described as enhancing the marketing message rather than trying to convert previously disappointed customers.  The customer experience of P.F. Chang’s has not been compromised and that, while small, does make the turnaround easier. 

 

THE ROAD TO RECOVERY (18 months in the making):

  1. DISCOVERY AND EVOLUTION: 2010 was the year of admitting to the real problems and 2011 was the year of planning for the future.
  2. IMPLEMENTATION AND EXECUTION: Now 2012 becomes the year of executing - new menu items, new look and new price points.  The Irvine store will play a key role in this process.
  3. GETTING THE SYSTEM MOTIVATED: The onus in on management to get the employee base geared up for the changes, manage costs and driving consumer awareness of the changes taking place at PF Chang’s.
  4. CONTINUE TO EVOLVE: As a company, PFCB is not going to play defense, rather it is going on to be offensive in its strategy.

 

THE ISSUES THAT REMAIN ARE:

  1. Are the right people in place to execute the current plan?
  2. Can management menu engineer lower price points and not kill margins?  
  3. How conservative is current guidance?  Has management build in a margin of error for an inevitable road block on the road to recovery?

There seems to be very little confidence among the investment community that management can turn around the decline in traffic trends without a significant hit to margins.   That skepticism may not be completely inappropriate but, if our view of the turnaround is correct, EPS and EBITDA will bottom at around $1.50-1.55 and $125 million, respectively.  These represent numbers that are slightly below current consensus estimates (stripping out the outliers).  If this is correct and management gains creditability in their ability to turn around the company, the stock could go higher.

 

The list of companies trading at a better cash flow multiple than PFCB include companies that are in far worse shape.  For us, the one that sticks out is RT.  RT is currently trading at an EV/EBITDA multiple that is 0.5x higher than PFCB.  If PFCB can trade in line with RT there is $3 of upside.  If PFCB can trade at an average multiple of the group there is nearly $9 of upside.  None of this is going to happen until management can convince the street they are on the road to recovery.

 

There are two significant initiatives that the company is working on that, we believe, will help get P.F. Chang’s on that path to regaining investor confidence.  The first is implementing new price points at lunch and the second is bringing excitement back to the P.F. Chang’s concept.  The new store in Irvine, CA, is critical to the latter as the company looks to bring the concept back to its former glory. 

 

 

REINVGORATING THE ASSET BASE

 

Since the store in Irvine is one-of-a-kind, and not representative of the true direction the company is going, the challenge is determining which elements in Irvine will translate into the Bistro system and how many can be implemented at once.  It appears that the PFCB remodel program will not just be changing out the carpets and tables, but creating a new environment for employees and customers within the four walls.  

 

As we experienced during dinner at the recently scrapped Irvine store, the staff was visibly excited about what was happening at the store level.  Creating an environment with a high energy level will be critical in getting the employee base motivated to embark on the changes that need to happen to stimulate customer traffic again.  We have seen this work at Chili’s over the last eighteen months, and we think that the same can happen at P.F. Chang’s.

 

Management believes and we agree that “it will be important to introduce several new initiatives at once and give the employees that sense of pride that you might not get if you introduce initiatives one at a time.”  Management is seeking to reinvigorate the employee base and restaurant at once and, if done correctly, this will completely change the customer experience.

 

The changes that are about to unfold at the Bistro are going to be significant and incorporate a number of different initiatives.  While some of the design elements will require closer consideration, there are some less drastic but impactful initiatives like an upgraded music system, a new look for employees, upgraded wine list, new specialty cocktails, craft beer and new menu items that will help elevate the customer experience.    Sushi is on is on the radar screen and the company should be testing some products soon.  The focus is on stepping up every element of the bistro from food, to the bar experience and the employees. 

 

 

THE NEW MENU

 

The key aspect of getting customer traffic is lowering menu prices at lunch, to compete more effectively with other parts of the casual dining landscape.  For instance, P.F. Chang’s is forced to compete, in some markets, with the effective $6 lunch price point that has shaken up casual dining so much over the past year.   For the past three months the company has been testing 20 lunch combos under $10. We expect the company to launch the test to the balance of the system in 2012.

 

In the Phoenix market, the company is testing the new lunch menu and seeing some success.  In a departure from its past the company is testing TV as a medium to tell consumers about the new lunch menu.  We believe this test is being met with success and that this will be an integral part of the company strategy when they launch the new menu in 2Q12.

 

PFCB – THE QUEEN MARY - pfcb lunch combo

 

 

PEI WEI

 

The company currently has a new Pei Wei Asian Market under construction.  For me, if there is a future for Pei Wei, the new incarnation will likely be it.  Chipotle’s management is confident that they can translate their company’s operational efficiency to the Asian category.  PFCB management needs to assume that CMG’s confidence is well-placed and prepare accordingly.  The fast casual category has taken share from competitors across the restaurant space, particularly at lunch, and Pei Wei has to be altered in a way that the concept can be competitive if CMG’s strategy plays out.

 

This prospect is not lost on management but, despite the pending changes to the service style at Pei Wei, management is expecting to open 16-20 locations in the Los Angeles, Florida, D.C., Baltimore, and Philadelphia markets.   Why management is making this decision, to grow the Pei Wei unit count, confuses us, but as we pointed out earlier, Pei Wei is not the crux of the overall story.

 

 

A SMALL POSITIVE - GLOBAL BRAND DEVELOPMENT

 

The GBD business unit encompasses home menu frozen products, International Bistro Restaurants and Pei Wei International Restaurants (coming in 2012) and select alternative venues which for now which is airport Pei Wei locations.   In 2011 the business went from break even to making $0.06 in EPS and should accelerate in the coming years.  The company opened eight international restaurants in 2011, bringing the total restaurant to 17.  By the end of 2011 the company will have four partners operating the 17 international Bistro locations with a presence in Hawaii, Mexico, Kuwait, the UAE, and Puerto Rico. By the end of next year that will grow to six partners/affiliates which are expected to open 10 to 15.  The new restaurants will be in the Philippines, Lebanon, Jordon, Chile, Canada, and Bahrain. 

 

 

GUIDANCE

 

What we know:

  1. Incremental pre-opening costs due to increased unit growth.  16-20 FY12 openings versus 5 in 2011.  3-5 new Bistro units in FY12.  All in, incremental pre-opening costs will cause roughly $0.06 in EPS pressure in 2012.
  2. Labor pressure, particularly at Pei Wei as the new store development is ramped up
  3. Commodity inflation of 4-6%
  4. G&A in the range of $78-$79 million
  5. Somewhere between $0.20 and $0.24 of incremental year-over-year pressure just based on the change in share based compensation in 2011 versus 2012.

What we don’t know:

  1. Revenue assumptions including SSS trends for both brands (January is looking better for the industry)
  2. Operating margins
  3. Tax rate
  4. EPS range

What a game we play.  We can do all this work and over the next two weeks it’s come down to what guidance is for 2012 and what management’s tone is when discussing the initiatives that they are putting in place to resurrect the brand.   PFCB’s CEO, Rick Federico, is one of the most respected restaurant CEOs I know.  He has built a great company and now he has an opportunity to achieve what Howard Schultz and Steve Jobs have done: turn around the company he founded.

 

Mr. Federico took a big risk with his “Irvine project” given how expensive it was to carry out but a few years down the road, management may look at Irvine as the anchor without which the brand could not have been turned around.

 

PFCB – THE QUEEN MARY - bistro pod1

 

PFCB – THE QUEEN MARY - peiwei pod1

 

PFCB – THE QUEEN MARY - pfcb pod2

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.30%
  • SHORT SIGNALS 78.51%

THE M3: COTAI APPLICATIONS; S'PORE CASINO FINE; S'PORE VISITATION

The Macau Metro Monitor, February 6, 2012

 

 

TWO COTAI GRANTS TO BE APPROVED Macau Daily Times

Two of three Cotai land grant applications could be approved within this year, Lands and Public Works Bureau (DSSOPT) director Jaime Carion said.  WYNN, SJM, and MGM have all submitted applications for a land concession in Cotai.  

 

Carion stressed that the approval process of these projects was difficult, especially when it comes to the calculation of land premiums, overall construction area and fire safety hazards.  “In terms of the proposal the operators submitted to the government, they have to be do-able technically, architecturally and legally – then we enter the approval process,” Carion explained.

 

MBS, RWS FINED FOR NOT COMPLYING FULLY WITH SOCIAL SAFEGUARD REQUIREMENTS Today Online

The Casino Regulatory Authority of Singapore (CRA) has fined Marina Bay Sands S$255k and Resorts World Sentosa S$130k for breaching the Casino Control Act from Oct 28, 2010 to April 30, 2011 and from Aug 15 2010 to April 30, 2011, respectively.  RWS was also separately censured for five cases of similar breaches.

The breaches include the failure to prevent Singapore citizens and permanent residents without valid entry levies, miniors and those with an exclusion order from entering and/or remaining on the casino premises.

INTERNATIONAL VISITOR ARRIVALS BY REGION/COUNTRY OF RESIDENCE STB

Singapore visitor arrivals rose 6.4% YoY in Nov 2011, the lowest monthly visitor growth since Oct 2009.  Mainland China visitors grew 7% in Nov 2011.

 

THE M3: COTAI APPLICATIONS; S'PORE CASINO FINE; S'PORE VISITATION - SPORE


THE HEDGEYE DAILY OUTLOOK

 

TODAY’S S&P 500 SET-UP – February 6, 2012

 

As we look at today’s set up for the S&P 500, the range is 26 points or -1.78% downside to 1321 and 0.16% upside to 1347. 

 

SECTOR AND GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - one

 

THE HEDGEYE DAILY OUTLOOK - tho

 

THE HEDGEYE DAILY OUTLOOK - three

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 1713 (1303) 
  • VOLUME: NYSE 905.31 (11.71%)
  • VIX:  17.10 -4.89% YTD PERFORMANCE: -26.92%
  • SPX PUT/CALL RATIO: 1.29 from 1.99 (35.18%)

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 45.58
  • 3-MONTH T-BILL YIELD: 0.07%
  • 10-Year: 1.92 from 1.92
  • YIELD CURVE: 1.69 from 1.69

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:55am: St. Louis Fed President James Bullard speaks on inflation targeting in Chicago; media Q&A
  • 11am: Export inspections: corn, soybeans, wheat
  • 11:30am: U.S. to sell $33b 3-month, $31b 6-month bills
  • 12:15pm: Dallas Fed President Richard Fisher speaks at Institute of International Finance on economy, monetary outlook
  • 12:15pm: IMF’s Olivier Blanchard speaks on global outlook at Carnegie Endowment for International Peace

GOVERNMENT:

  • VP Joe Biden speaks at Florida State University on tuition
  • 11am: House Majority Leader Eric Cantor, R-Va.; House Majority Whip Kevin McCarthy, R-Calif.; speak on economic growth, job creation at YG Network event
  • Congress:
    • House Rules Committee meets on line-item veto, budget transparency, 5pm

WHAT TO WATCH: 

  • Greek PM Lucas Papademos, party leaders agreed to spending cuts this year equal to 1.5% of GDP
  • Micron Technology CEO Steve Appleton’s death may delay DRAM industry consolidation
  • States must decide by today on proposed $25b nationwide settlement over foreclosure practices; some balking on bank liability releases
  • Lawmakers in the European Parliament’s economic and monetary affairs committee will discuss proposals to toughen rules against insider trading
  • PepsiCo said to seek to recruit former Wal-Mart executive Brian Cornell for key job
  • Great Atlantic and Pacific Tea Co. reorganization plan set for approval at confirmation hearing
  • AMR’s American Airlines may try to buy rival after leaving Chapter 11, CEO Tom Horton said
  • HTC forecast lower 1Q rev. that trails est.
  • U.S. will work with allies to put “immense pressure” on Syrian President Bashar al-Assad to step down after Russia vetoed resolution seeking to end fighting
  • Mitt Romney wins Nevada caucuses; Gingrich vows to press on

     EARNINGS:

    • CNA Financial (CNA) 6am, $0.70
    • Humana (HUM) 6am, $1.21
    • Loews (L) 6am, $0.90
    • Towers Watson & Co (TW) 6am, $1.20
    • Hasbro (HAS) 6:30am, $1.05
    • Nielsen Holdings (NLSN) 6:30am, $0.49
    • Lazard Ltd (LAZ) 7am, $0.38
    • HCA Holdings (HCA) 8am, $0.76
    • Sysco (SYY) 8am, $0.44
    • UDR (UDR) 8am, $0.34
    • National Retail Properties (NNN) 8:30am, $0.40
    • USG (USG) 8:30am, $(0.72)
    • NCR (NCR) 4pm, $0.56
    • Torchmark (TMK) 4pm, $1.24
    • Unum Group (UNM) 4pm, $0.75
    • Veeco Instruments (VECO) 4pm, $0.65
    • American Capital (AGNC) 4:01pm, $1.16
    • Anadarko Petroleum (APC) 4:01pm, $0.63
    • Coinstar (CSTR) 4:01pm, $0.65
    • Yum! Brands (YUM) 4:02pm, $0.74
    • Amylin Pharmaceuticals (AMLN) 4:05pm, $(4.23)
    • Leggett & Platt (LEG) 4:05pm, $0.21
    • PMC-Sierra (PMCS) 4:05pm, $0.13
    • PartnerRe (PRE) 4:05pm, $(2.09)
    • Dun & Bradstree (DNB) 4:15pm, $2.11
    • BRE Properties (BRE) 4:30pm, $0.56
    • Pioneer Natural Resources Co (PXD) 4:30pm, $1.04

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)


GOLD – down another -1.2% this morning after getting beat up a bit on Friday. We should remind people that what goes straight up will eventually come down, but Gold is a buy on red provided that UST Yields remain in a Bearish Formation (10s = 1.91% this morning, continuing to signal that US Growth Slowing in FEB vs JAN is the call to make). Gold’s immediate-term TRADE support = $1685. We’ll buy that and UST bonds on weakness.

  • Speculators Raised Bullish Wagers to 12-Week High: Commodities
  • Gold Declines in London as Stronger Dollar Cuts Investor Demand
  • Crude Declines on Greece Concern; Brent Crude Premium Widens
  • Copper Falls as Euro-Region Debt Crisis May Sap Chinese Growth
  • Wheat Gains on Concern Low Temperatures Damaged European Crops
  • Coffee Falls as Brazil’s Output Seen Increasing 17%; Sugar Rises
  • U.K. Gas Rises to 5-Year High as Cold, Exports Sap Storage
  • Aramco Cuts Most Asia Premiums; Iran Inspected: Persian Gulf Oil
  • Naphtha Crack Rebounds; Gunvor Buys Fuel Cargoes: Oil Products
  • Iran Crude Ban Difficult Without India, China: Chart of the Day
  • Hedge Funds Bullish on Gas Before Rally Fizzles: Energy Markets
  • Noble Names Former Goldman Asia Chief Alireza as Next CEO
  • Nine U.K. Power Plants Shut: Feb. 6 Generator Report (Table)
  • Speculators’ Bullish Bets at 12-Week High
  • Iran Sanctions Bid Targets Oil, Tanker Companies to Cut Exports
  • BHP Billiton Coal Workers in Australia Vote to Resume Strikes
  • O’Malley Plans U.S. IPO After Wrong Way Bet on Petroplus: Energy

THE HEDGEYE DAILY OUTLOOK - four

 

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - ffive

 

 

EUROPEAN MARKETS


FRANCE – keep an eye on the CAC because it just failed at its long-term TAIL line 3503 resistance this morning. Unlike Germany’s DAX (up +14% YTD and comfortably above long-term TAIL support of 6501), the CAC, MIB, and IBEX indices remain bearish TAILS. If they all continue to fail here and the Greek thing isn’t “news” anymore, what happens next?


THE HEDGEYE DAILY OUTLOOK - six

 

 

ASIAN MARKETS


CHINA – interesting, but not surprising, to see Chinese stocks fail at intermediate-term TREND resistance of 2342 on the Shanghai Comp last night; this week we’ll get inflation data out of China (Wed) and there’s a good chance its inflationary (sequentially) vs what we’d been calling Deflating The Inflation (DEC).

 

THE HEDGEYE DAILY OUTLOOK - seven

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - eight

 

 

 

The Hedgeye Macro Team

 


Black Gold

This note was originally published at 8am on February 01, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

"In my humble opinion, we should now have reached peak oil. So it is high time to close this critical chapter in the history of international oil industry and bid the mighty peak farewell."  

- Ali Samsam Bakhtiari, Vice President of the National Iranian Oil Company 

 

To say that oil makes the world go ’round is an understatement.   Every day we consume almost 85 million barrels of oil.  At $112 per barrel, the current price of Brent oil, this is $9.3 billion of oil consumed every day, or $3.4 trillion per year. Global GDP is estimated at just over $65 trillion, so the cost of oil itself, setting aside additional refining, distribution, and marketing costs for oil and oil products, is more than 5.2% of global GDP.

 

A meaningful move in the price of oil has a clear and definite impact, all things equal, on GDP.  While it is not a zero-sum game, as global consumers spend more on oil and energy products, they clearly spend less in other areas. 

 

The value of the U.S. dollar is a key driver of the direction of oil.  In fact, the correlation of Brent to the U.S. dollar on a three year duration is -0.67.  Globally, oil is priced in U.S. dollars, so dollar down equates to oil up, and vice versa. 

 

As we’ve reiterated many times, dovish U.S. monetary policy is a key driver of the price of the U.S. dollar.  In turn, as noted above, the U.S. dollar inversely drives the price of global commodities priced in U.S. dollars.   Keith has started calling this The Bernanke Tax.   By keeping interest rates and monetary policy at levels not seen even in the Great Depression, Chairman Bernanke is explicitly adopting a weak dollar policy.  As oil and other commodities prices inflate, they take global GDP share.  Unfortunately, what’s good for the oil company, is negative for the consumer.

 

In the United States, The Bernanke Tax is seen most directly on purchases of gasoline for motor vehicles.  According to a recent report in Scientific American, Americans spent more than $490 billion on gasoline in 2011.  This was an increase of more than $100 billion over 2010, despite the number of miles being driven in the United States remaining relatively flat.  In aggregate, U.S. consumption of oil as a percentage of GDP very closely parallels the global numbers at just over 5%.

 

The other key factor, setting aside geopolitical concerns for the time being, in analyzing oil is global supply, specifically the idea of peak oil.  U.S. geologist M. King Hubbert is widely considered the father of peak oil theory.  Hubbert first created peak oil models in 1956 to accurately predict that United States oil production would peak between 1965 and 1970.   Models have since been used to predict, with reasonable accuracy, the peak of various fields and regions around the global.

 

Tomorrow, at 11am EST we will be hosting a conference call with geologist and renowned peak oil theorist, Jeffrey Brown, in a presentation call titled, “Peak Oil: Fact or Fiction?”.  (If you don’t subscribe to our energy vertical and would like details on the call, please email sales@hedgeye.com .  Obviously our research isn’t pro bono, but our Head of Sales Jen Kane will work with you.) Jeffrey has prepared a detailed presentation that outlines the case and support for peak oil, and much higher oil prices. 

 

Despite the rapidly accelerating price of oil over the last decade, the concept that global oil production is peaking is far from mainstream.  In fact, investors polled at a Credit Suisse energy conference revealed that 94% of investors believe that peak oil is at least twenty years or more away or will never occur.  As well, energy company earnings only make up 12% of SP500 earnings versus 30% in 1980.

 

Peak oil advocates point to a multitude of supporting evidence to defend their case.  The historical evidence revolves around looking at the production of a number of the world’s largest oil producing areas, most notably the North Sea and the continental United States.  An analysis of the peaking of these oil producing areas follow very similar patterns of decline, which are supporting evidence of M. King Hubbert’s models.  In effect, oil is a finite resource, which on a global basis has very predictable decline patterns.

 

The other, and more obvious, support for peak oil is simply the price of oil. Over the course of the last decade, the price of Brent oil is up 454%.  In a typical commodity market without supply constraints, or really any type of market for that matter, production should increase to create greater supply to offset dramatic price hikes.  In the last decade global oil producers have seemingly been able to grow production at a level that offset accelerating prices.  The domestic natural gas market is the contra example of this as accelerating prices routinely lead to more production and a natural correction in price. 

 

The counter case for peak oil is that there is more oil out there, we simply have to explore to find it and invest to get it out of the ground.  In fact, our friend the ever thoughtful Peter Orszag, recent penned an article for Bloomberg flagging the impact that development of fracking technology in the United States has had on oil production by increasing access to so called “tight oil”.  As Orszag writes:

 

“In 2010, oil companies produced 5.5 million barrels per day of domestic crude [in the U.S.].  The Energy Information Administration estimates that figure will rise to 6.7 million barrels per day by 2020, mostly because of the continued development of tight oil, in combination with the development of offshore resources in the Gulf of Mexico.” 

 

Assuming that EIA’s forecasts prove correct, U.S. oil production is on a path to grow 22% over the next decade and reach aggregate daily production levels not seen since 1994.  If this occurs, the idea of peak oil becomes seriously questionable.

 

So, is peak oil fact, or fiction? We will dig into this debate tomorrow morning at 11 am EST with peak oil expert Jeffrey Brown.  While these types of discussions are rarely conclusive, this conference call will outline the key theory behind peak oil, which will enable us to evaluate its validity as data points reveal themselves in the coming years.

 

Regardless of the side you are on in the peak oil debate, J. Paul Getty left us with one truism about oil:

 

“Formula for success: rise early, work hard, strike oil.”

 

I’d actually add to that slightly:

 

“Formula for success: rise early, work hard, strike oil, AND subscribe to Hedgeye.”


Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Black Gold - peak oil early look chart

 

Black Gold - VP heut


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