Thursday, June 05, 2008


Time and again the "little UN countries" have voted against the USA . This week, the 35 member governing board of the IAEA voted to support continued sanctions against Iran. Iran has no friends. The goose is cooked.

One can find information on the Internet that makes it look like the sanctions against Iran are failing. For example, Coke and Pepsi products are all over the country. Coke and Pepsi won exemptions to the Iranian sanctions because the corn syrup they sell to local bottlers was ruled an agricultural product. The irony is that this corn syrup has gone up rapidly in price because we are using our corn as fuel.

In addition to exempted products, there are smuggled products in Iran. Dell computers, Apple phones and many other US products are available. The central bank of Iran reports inflation rates of 20% but they do not capture the black market prices of these smuggled goods, unless they are stolen, black market goods tend to be very expensive. The 70 million people in Iran learned to enjoy a "western life style" prior to the 1979 over throw of the Shah. By last winter, shortages were common, but sanctions really got tough around May 5, 2008. It took a lot of diplomacy to get India, China and Russia to lend their support, but the oil spigot has been partially closed for a month.

A lot can happen, but the goose is cooked. It is just a matter of time. US and Israel are rattling sabers again and negotiations seem to have stalled, but the oil market is telling an important story. After prices jumped to $135 when the embargo started, they have since fallen to $122 while oil sits in VLCC's parked off the coast of Iran. No one is willing to buy a good portion of Iran's oil and the world is getting along fine without it. The wholesale price of gasoline dropped 11 cents today after US inventories rose by 2.9 million barrels.

Israeli leaders say it is time to use military force to prevent the building of nuclear bombs. US leaders seem comfortable with the power of the sanctions. It seems safe to assume that if Iran cannot ship its oil that it cannot receive shipments of gasoline. The news, here and there, is limited. Even though Iran has shut down its FARS news agency, it seems that at least a portion of this this story will reach the Iranian public soon. Protest for the removal of Amadenijhad will result.

The west wants to give Iran a chance to save face and make a deal before it is common knowledge that they have little other choice. The information published by FARS before the shut down implied that the oil was parked off the coast because Iran has been holding out for a better price. Yeah, right!


Big investors, such as Bill Gates, who has announced the sell of 300,000 shares, are selling out of ethanol companies. Oil futures have dropped from $135 to $122 in 10 days or so. The turn in auto sales has been remarkable.

In 1981 80% of vehicles sold in America were cars and 20% were light trucks. In 1996, 56% of vehicles sold were cars and 44% were light trucks. In 2001, sales were 50/50. In 2004, cars bottomed at 44% and trucks peaked at 56%. Last month, we fell all the way back to 1995 levels. (Data from Wards Transportation Data Book.) Last month, 57% of all vehicles sold were cars and only 43% were trucks. For the first time since 1992, Camry and Corolla sales exceeded Ford F series sales. Two other models exceeded F series sales for the first time ever, the Honda Accord and the Honda Civic. GM announced another 40 plus mpg car and Ford announced a new Fiesta plant. Guess what? The Fiesta plant will not be in the USA, but in Mexico city. Ford's most automated plant is in Brazil and Ford and GM rank number 1 and number 2 in car sales in Russia. The big story is that fuel efficient cars are reducing the projected demand for more oil. A mile driven in a Corolla instead of in a Ford SUV is a reduction of gasoline demand in the neighborhood of 60%! (My guesstimates, 38 mpg for the Corolla and 15 mpg for the truck.)

Today, UAUA announced a reduction of no less than 21% of its capacity. This is the kind of cut that upsets the apple cart. It is the kind of cut that has a big impact on the price of fuel and the price of fares. A Credit Suisse analyst immediately changed his negative tune. He says this cut is a major step toward profitability and it means that airlines will have pricing power well into 2009. Also today, privately held Spirit Airlines announced a closure at one airport and substantial reductions at others for a total reduction in the range of 40 to 60%.

Also, India and Malaysia just gave a couple of billion people bad news. Fuel subsides were cut; prices are headed up; demand is headed down. China appears to be preparing another 1.5 billion people for equally bad news. Oil bulls have enjoyed saying the demand growth is coming from China and India, what will they say now?

When the oil price broke in 1985, it dropped 60% in 3 months!

When the oil price broke in 1980, it dropped 40% in 22 months.

When the oil price broke in 1991, it dropped 50% in 6 months.

When the oil price broke in 2000, it dropped 46% in 12 months.

I doubt that the break will be as large this time but you never know. The price break at the end of 1985 and the beginning of 1986 was during a mid cycle slow down and there was not a recession. The other three drops were during recessions.

Stratfor reports that inflation in Vietnam has reached 25%! This is the kind of number that hits right at the tail end of an economic slowdown. The above story of the airlines is available to clear up the inflation misinformation provided by TV pundits. The cut back of 21% of UAUA's capacity means that airlines can continue to dramatically raise prices as they have done for the past several months. The route cutting by Spirit Airlines will give the surviving companies on these routes the ability to raise fares by substantial amounts. It is the cut back of capacity during a slow down that allows the remaining products to be priced up so high. Businesses are forced to raise prices as much as they can on sales in order to keep total revenues up.


The best of times have arrived for the strong airlines. As they watch the weakest routes or companies being cut, they are facing falling fuel costs and pricing power at the same time. With the possible exception of Frontier (which is still operating under Chapter 11), the airlines that have gone busted in the past few months will not restart. Funding for new entrants should be scarce for years to come. Oil prices are not likely to go so low as to make $6,000 an hour small jets affordable again. The business has changed.

Wall Street will focus on the possibility of world wide recession as news such as the Vietnam news comes. Vietnam and others might have to use draconian money management to get inflation under control. This is going to keep a wall of worry in front of the market. The airline stocks will ultimately climb that wall of worry. The Credit Suisse analyst will not be the only one to revise his estimates.

DAL does not appear to be going along with the $15 first bag fee. This is no big deal as the cost to benefit ratio is marginal. Who wants every passenger to be stuffing the overheads to the brim? On the other hand, the most recent BA fare increases, including $218 on long haul flights, is huge. It remains to be seen if such a big jump will hold on the first attempt, but, in any event, fares are going up and profits will be restored.