Wednesday, April 12, 2006

Air UP, Oil DOWN, International Trade BOOMS

This morning, CNBC reported that AMR has raised all international fares, except Japan, by $20 round trip. The stated purpose is to offset higher fuel prices. Yesterday, inter-day, the May oil futures approached $70. This morning, oil is trading again in the high $68 range.

Respected oil economist, James Williams, estimates that the current oil price includes about $20 as a global risk premium. Earlier this year, his estimate was about $15 per barrel. All of the increase in price this year can be attributed to an increase in the risk premium.

According to Williams, drilling for more oil has reached a frenetic pace. The rig count has increased sharply since the lows made in 1999 and even Saudi Arabia is setting records for the number of rigs in use. Significantly, there has been a shift to more off shore drilling and a shift to more drilling for oil (versus natural gas wells). The costs to drill off shore are substantially higher than land based drilling but the prospects of hitting the "big one" are greater. There have been several significant strikes in recent months.

International tensions in Nigeria, Iran and Venezuela continue to cause concern but the turn in world wide excess production capacity has been made. Just a few years ago, the world had excess production capacity of over 8 million barrels per day. This gave OPEC the ability to increase the flow or decrease the flow in order to smooth out prices. Last year, excess capacity virtually disappeared. Excess production capacity is still woefully inadequate but the numbers are beginning to rise with current levels around 1 to 1.5 million barrels per day.

Yesterday, the IEA lowered its estimate of world wide demand by a miniscule 100,000 barrels per day. The direction of the move, not the magnitude, is the important point. This is the second reduction in recent weeks and it demonstrates that high prices are killing demand.

Of course, supply and demand are the long term keys to price. The risk premium has jacked up prices in the short run. Speculators will not hoard oil after it becomes clear that the intermediate term peak in price has been reached. We can only hope and pray that the Iran crisis is only a crisis of perception and not one in reality. The good news is that Iran needs to sell oil. The country would become very poor in short order were it to slow the marketing of its one major product.

I don't know the details of manufacturing production in the country but, even if items such as Persian rug's are of significant export value, the country is moving toward an isolated position. Around the war, it is interesting that Exxon and Conoco Phillips have been calling bluffs. If a country insist on an extraordinary share of revenues, such that the oil companies can not make a reasonable return on investment, these companies have shown a willingness to suspend investment on otherwise promising fields while looking for oil elsewhere.

Venezuela has huge reserves but Chavez has virtually wiped out the reasons to explore in his country. When heavy tar sands are included in Venezuelan reserves, the country has more reserves than Saudi Arabia. Sitting in the north of South America, these reserves are strategically located near US markets. Citgo is owned by Venezuela. While I am not a great believer in the effectiveness of boycotts, I make a point of not visiting Citgo stores. Chavez has broken agreement after agreement and has stolen the investments of others. Thieves, such as he, will continue to be bold for as long as excess production capacity is low. However, Saudi Arabia and others are working overtime to increase production capacity. Also, huge investments are being made world wide in alternative sources of energy. These range from investments in tar sands to nuclear power plants and to the 33 ethanol plants under construction in the "good old USA". The days of $20 risk premiums are numbered.

Don't take me wrong, I submit that gas at the pump prices will be high all summer. The per barrel oil price will remain high at least through hurricane season. My belief is that the risk premium will begin to fade by late fall. I believe prices will continue to moderate in 2007. My best guess is that oil will trade for less than $50 per barrel by the end of 2007.

The good news for my investment accounts is about air not oil. Many of my accounts have been enjoying a wild "Ken Fisher bucking bronco ride" on the backs of American Airlines (AMR) and Continental Airlines (CAL). These stocks have come from single digit prices to the $25 to $28 range in about 6 months! Capacity is very tight. Month to date, Continental Airlines (CAL) is flying at around 83% of capacity. This is about as high as it gets. Indeed, the last time load factors were this high was in the special circumstances that occurred in 1946 immediately after WWII. Full seats lead to higher prices for each and every seat. Full seats times higher prices per seat lead to dramatic revenue growth.

Last week, there was another round or two of domestic fare increases. This morning, the anouncement was about international fares. Fare increases are greeted with alarm by the inflation scare mongers. They are greeted with thanks by those who own shares in airline stocks. While DAL and NWAC continue to fight unions to lower cost and continue to cut flights while under bankruptcy protection, American Airlines (AMR) and Continental Airlines (CAL). are enjoying the resurgence of business.

International is the real story here. Currently, the majority of the industrialized world is enjoying economic recovery or even "boom times". Furthermore, the "boom times" are only half the international story. The second half is in regard to free trade. Despite the recent loud destructive talk by politicians about protectionism, country after country around the world has recognized that free trade benefits all who engage.

David Ricardo, a stock broker in England in 1790, was one of the first to appreciate the magnitude of the benefits of free trade. Ricardo correctly suggested that the "law of comparative advantage" requires specialization for efficient production of goods and services. We intuitively understand this law and live buy it. The carpenter builds houses and pays an accountant to file his taxes and he and the accountant visit a doctor if they are sick. In the same way that it is generally foolish to practice medicine on oneself, it is foolish not to engage in free trade.

Whenever I introduce a young person to economics I like to use the tried and true example of the orange grower in Florida and the wheat grower in Nebraska. The truth is that if they trade with one another they will both afford better diets.

The countries of the world were relatively isolated for many years after the great depression. Countries like the US, which have gradually reduced tariffs and opened their borders to free trade have seen an industrial and information revolution. These countries have even been able to invest billions in a cleaner environment. Countries which have "protected" their local work forces have suffered. The poorest people in the world live in places like Cameroon where tariffs on imported goods are high and where waste is committed upon resources and the environment. The decease does not kill but it debilitates. France is a good example. The youth of France have recently rioted in the streets, fighting to maintain protectionist laws. Their unemployment rate is around 21%.

Americans enjoy the benefits of free trade as do growing numbers of citizens in developing nations. Airplanes to and from these developing nations are flying full. Flights are being added. Flights within the US borders are being cut in order to add international routes, thus decreasing supply of seats within the US. The numbers are incredible. The recent year over year increase in people flying over the pacific ocean was approximately 25%. The recent year over year increase in people flying over the Atlantic ocean was approximately 22%.

If you want to make serious money, climb on board! Boeing is enjoying record orders for new planes. A new plane ordered today will be completed sometime in 2008. The early deliveries will not satisfy the growth in demand; look for three more years of rising prices in the airline business!