Brazil had clearly become the new “must-play” market for investors.

And then they had to go and spoil it all.

As promising a market as Brazil had become, it was the discovery of the massive Tupi oil field off of the country’s east coast – that really transformed Brazil into an investor’s dream. The oil and natural-gas reserves are located beneath heavy salt beds in deep offshore water. These reserves are 23,000 feet to 26,000 feet down, a depth that wasn’t even accessible until recently.

These Tupi reserves appear to contain at least 60 billion barrels of oil, worth $4 trillion at today’s prices. Tupi oil is expected to start hitting the market in 2011 or 2012. When that happens, it will revolutionize Brazil’s economy and its shift its balance of payments.

The exploration of the Tupi oil fields had been carried out by the Brazilian oil company Petroleo Brasileiro SA (NYSE ADR: PBR) – more commonly referred to as Petrobras – in partnership with some of the international majors. The contracts call for the Brazilian government to receive royalties on any oil found.

Brazil is now one of only three top oil-producing countries to not assert state ownership of its oil reserves. Canada and the United States are the others.

This was very reassuring for the international oil majors. They’re used to dealing with fruitcake kleptocratic regimes in Venezuela, Angola, Nigeria and most of the Middle East. As a result, the Tupi deposits generated real excitement both among oil companies and among international investors in general. The feeling was that Brazil was about to end its two centuries of failed economic hopes. Fueled by oil revenue and additional economic activity, Brazil appeared ready to claim its true destiny as a wealthy country.

Unfortunately, it wasn’t to be.

Although there are several reasons for this, a key culprit is the election scheduled for next year. Incumbent Brazilian President Luis Inacio “Lula” da Silva can’t run again. But he’d very much like to choose his successor. The most likely candidate: current Chief of Staff Dilma Rousseff.

Rousseff was put in charge of devising a scheme to capture more of the Tupi oil revenues for the Brazilian government and, nominally, the Brazilian people. Tales were spun of how the new revenue would finally eliminate Brazilian inequality, and bring its poorest citizens up to Western living standards.

The new system announced this month reflects this aspiration. A new state oil company, Petrosal, would be created to manage the reserves. Petrobras – aided by outside investor capital – would carry out production. And Petrosal and the outside investors would share the output.

This plan will imbue Petrosal with a lot of power. The company would control half the votes on the operating consortium. And it would have veto rights over production and capital expenditures.

The revenue would be managed by a new state fund. The fund would devote this new cash to poverty relief, education and infrastructure.

In the meantime, the existing royalty system would remain in place. Under this system, outside investors would pay both royalties and a production share. In one acknowledgement of marketplace realities, concessions already granted would not be torn up.

There are two major problems with this system. First, it makes life much more difficult and less profitable for oil companies wanting to invest in the Tupi oil field. Had Brazil torn up existing contracts, I believe the oil majors would have left. In the past two years, the world’s Big Oil firms already saw existing agreements torn up in Nigeria and Venezuela. There’s just no point investing large amounts of money under such risky conditions.

As it is, the new Brazil agreement applies only to new contracts. So I believe the oil companies will probably put up with this new system – at least as long as oil prices remain high. It’s not as if these firms have a lot of alternatives right now.

However, given how expensive it will be to extract this oil, if market prices drop, it may end up being difficult to attract Big Oil players.

The more dangerous problem is this fund, which is little more than a huge pool of money that politicians can play with.

As I mentioned, Brazil’s economy has been one of the world’s best performers. This year, in the face of a worldwide recession, Brazil’s gross domestic product (GDP) is expected to decline only 1%, according to the forecasting panel of The Economist magazine.

Inflation is 5% and the budget deficit is only 2.8% of GDP – both excellent figures in this difficult year. Brazil’s monetary policy is an example to the world, with short-term interest rates still at 8.65%, well above the inflation rate.

But this money pool plan puts that performance at risk.

Brazilian public spending is already 35% of GDP, very high for such a poor country. State bureaucrats have feather-bedded contracts guaranteed to them under the 1988 constitution. So this “slush fund” will just fuel Brazilian corruption, diverting still more of that country’s economy into the pockets of politicians, their friends and favoured interest groups.

It’s no use for Brazilian spin-doctors to point out that Norway and Alaska have funds of this nature. Norway and Alaska have small populations and relatively un-corrupt political cultures. This fund must inevitably represent at least 3%-5% of Brazilian GDP. And it will be mostly wasted, spent without the market having any say as to its use or destination.

I’ve been watching Brazil for more than 30 years; since I began travelling there for the merchant bank Hill Samuel [now part of Lloyd's Banking Group PLC (NYSE ADR: LYG)] in the late 1970s. It’s a maddening country: Just when you think the Brazilian authorities have finally got their act together, and that the country is ready to achieve the enormous economic growth predicted for it since at least 1900, something unexpected and foolish goes wrong.

This appears to have happened again. And that’s a real pity – for Brazil’s citizens, and for global investors.

Source: The World’s Most Exciting Market – Until They Spoiled it

Investment News Briefs Tuesday, September 1, 2009

If you’re looking for the next “Big Oil” play, bet on Beijing.  As we’ve been reporting for the past several years, China has been on a global commodities shopping spree, which includes locking up every source of oil that it can.

The Red Dragon has cut deals in Africa, South America Russia and the Middle East – and won’t stop there. Even the mainstream news media is finally becoming aware of this crucial trend.

But here’s the thing. It’s not enough just to know that this is happening. In order to profit, an investor really needs to understand why it’s happening – and to invest accordingly. Investors who lack this insight may make the strategic misstep of betting heavily (or exclusively) on the Western heavyweights – Exxon Mobil Corp. (NYSE: XOM), BP PLC (NYSE ADR: BP) or Royal Dutch Shell (NYSE ADR: RDS.A, RDS.B) – while ignoring the oil sector’s real growth story, which is China.

Just this year alone:

• China and Russia have signed a multi-billion-dollar, intergovernmental agreement to construct an oil line from Russia that will supply oil directly to China. Actually seven agreements in one, the terms depict a deal worth trillions of dollars – including a 20-year oil contract to pump Russian oil to the Chinese market. In return, China has agreed to provide a total of $25 billion in loansto Russian oil companies Transneft and OAO Rosneft Oil Co. China even gets a cut of Rosneft’s production, as part of the deal.
• In Africa, China’s CNOOC Ltd. (NYSE ADR: CEO) and Sinopec Shanghai Petrochemical Co. (NYSE ADR: SHI) are teaming up to buy a $1.3 billion stake in Angolan offshore development rights from U.S.-based Marathon Oil Corp. (NYSE: MRO). A key point of note: Angola – historically one of Exxon’s favorite investment targets – has recently overtaken Nigeria as Africa’s biggest oil producer.
• While noting that it’s hardly a done deal, The Wall Street Journaldid report earlier this month that China National Petroleum Corp. (CNPC) is interested in buying all or a part of Argentina’s YPF SA (NYSE ADR: YPF) for $14.5 billion.
• In Africa, China’s CNOOC Ltd. (NYSE ADR: CEO) and Sinopec Shanghai Petrochemical Co. (NYSE ADR: SHI) are teaming up to buy a $1.3 billion stake in Angolan offshore development rights from U.S.-based Marathon Oil Corp. (NYSE: MRO). A key point of note: Angola – historically one of Exxon’s favorite investment targets – has recently overtaken Nigeria as Africa’s biggest oil producer.
• Reports continue to circulate that CNPC will be taking the majority stake in Iraq’s Rumaila oilfield from BP. Rumaila is Iraq’s biggest oil field, producing more than a million barrels of crude oil per day.
• And China has become quite chummy with Brazil’s Petroleo Brasileiro (NYSE ADR: PBR). Petrobras is developing a huge new offshore field – one of the biggest new discoveries in decades, in fact – and any deal would include a production-supply agreement.

This flurry of deals hasn’t been a surprise to Money Morning readers. Even so, it’s worth taking a moment to look at some of the key catalysts behind many of these deals. Let’s look at the Top Three:

• Nervous Reserves: China is sitting on the world’s largest pile of cash – more than $2.3 trillion by some estimates. With an estimated 70% of that, or about $1.61 trillion, in U.S. dollars, there is no question it’s a huge source of financial firepower strength at a time when global markets are uncertain, if not downright weak. But it’s also a liability, too, in that China can’t diminish its high-concentration of greenback holdings without pushing the dollar off a cliff. So buying oil is a great way for China to diversify its reserves without kneecapping poor old Uncle Sam.
• Those Not-So-Free “Free” Markets: China has less faith in the “free” markets than the West does. Ironically, the United States and other Western powers are partly to blame for Beijing’s free-market skepticism. For instance, not only did the United Statesslam the door in China’s face when China tried to buy Unocal Corp. [now a part of Chevron Corp. (NYSE: CVX)]  a few years back, but when former U.S. President George W. Bush invaded Iraq, the war summarily cut off China’s ability to source oil from that Middle East member of the OPEC 12 (the Organization of the Oil Producing and Exporting Countries). Prior to the invasion, Beijing really didn’t consider the need to diversify China’s foreign-oil sources so our military action prompted their economic reaction. Now the genie’s out of the bottle.
• Peerless Perspective: China’s leaders know that they must lock up oil supplies at a time when the Western world can’t seemingly be bothered to understand that this is a zero-sum game. In other words, China views the global financial crisis as an opportunity to be exploited for economic gain and the security of its people, not as a problem to be solved. China understands the big picture, and even though we apparently painted it, the West doesn’t.  By scouring the earth for oil at a time when the West is hamstrung by the global financial crisis, not only is China able to strike more favorable deals at more favorable prices, but it’s locking up huge supplies of commodities for its own use for years, even decades, to come. In doing so – and this is the part of the equation so many experts don’t get – these resources are no longer available for our use here in the United States, which has major supply and pricing implications for this market.

Bamboozled by the Western media – which has perpetuated the “global-recession-means-lower-demand” story – it simply hasn’t dawned on most people here in the West that China doesn’t care about the majorlong-term impact this global buying spree will have on our economy.
Besides, this whole story thesis is flat out wrong. While the recession is definitely dampening our use of oil and gasoline, China’s oil demand is growing by more than 20% a year. And of the 8 million barrels a day that China already uses, half comes from imports. Beijing sees those as troubling statistics, which means that China:

• Absolutely must lock up as many significant external supplies oil as possible right now.
• And must accelerate its domestic exploration-and-processing efforts at warp speed.

Nor is this a static situation. China’s auto market is growing by 50% a year. It’s already the world’s largest, having passed the United States earlier this year. In fact, according to some estimates, China will have more cars on its roads in the next 20 years than all those we currently have in this country – even if you include the engine-less “restoration project” your next-door neighbor’s son has sitting under an oak tree in their back yard.

China’s never known high prices and its consumers haven’t either. So they don’t care like we do about what “price” is posted at the pump. Sure, you can argue as many Western analysts do, that China’s fuel is highly subsidized, but so what? That’s a moot point. Consumers who remember what it was like back when gasoline was 99 cents a gallon aren’t going to grouse about how it now costs $6 a gallon – these newly minted motorists will merely see gasoline as just part of the cost of having a car.

Because it understands its need for continual economic progress – as well as the role oil has to play to make that a reality – China is doing whatever it takes to guarantee future supplies, including structuring deals in ways that have caught Western companies by surprise. For instance, China’s companies are looking at how they can get a deal done by giving the other party something it actually needs. Moreover, in a move that’s as frustrating to Western leaders as it is surprising, many of these deals come with no strings attached. I suppose you could call it the “Red Dragon Option” – although Western firms would do well to embrace these as potential Harvard Business Review case studies.

After reading this overview, a U.S investor might want to conclude that China’s already got this one wrapped up and that “any resistance is futile.” But that’s not necessarily true. While China’s grown by leaps and bounds in terms of its financial sophistication when it comes to these deals, the country still lacks the relative exploration-and-production technology to go after the deep-water reserves and complicated fields where most of the still-undiscovered oil remains. Those are also the same kinds of locations where natural gas may be the better bet.

And that suggests that investments in both sectors – including deep-water drillers and companies that specialize in natural-gas liquification -may pay off for investors anxious to dine with the Red Dragon, instead of being listed as an entrée on the menu.

Source: Three Reasons China is Positioned to be the Oil Sector’s Next Big Profit Play

[Editor's Note: The global economic recovery will create an estimated $300 trillion worth of global-investing-profit opportunities. To find out how to capitalize and profit, you just need to know where to look.

]]> http://www.contrarianprofits.com/articles/three-reasons-china-is-positioned-to-be-the-oil-sector%e2%80%99s-next-big-profit-play/19976/feed 0 http://www.contrarianprofits.com/articles/with-one-of-the-hottest-economies-on-the-planet-brazil-is-finally-living-up-to-its-promise/19836 http://www.contrarianprofits.com/articles/with-one-of-the-hottest-economies-on-the-planet-brazil-is-finally-living-up-to-its-promise/19836#comments Wed, 12 Aug 2009 17:30:37 +0000 Jason Simpkins http://www.contrarianprofits.com/?p=19836 Brazilians used to joke that their country was the country of the future – and always would be because a new crisis seemed to crop up every time the economy came close to fulfilling its potential.

But given the economy’s strong performance following the financial meltdown that crushed economies the world over, it looks like Brazil’s time is now.

Brazil’s gross domestic product (GDP) contracted 0.8% year-over-year in the first quarter and 0.8% from the fourth quarter. That beat analysts’ expectations but wasn’t enough to keep the country from sliding into its first recession since 2003. However, the economy is already showing signs of recovery and many economists believe Brazil is already on the rebound and poised for a strong second half.

Brazil’s…

On Monday March 9, barely three months ago, I strongly recommended buying Diamond Offshore (NYSE: DO) as part of Money Morning’s “Buy, Sell, or Hold” feature.  Both the stock and the Standard & Poor’s 500 Index had both hit 52-week lows the Friday before.  But oil had already bottomed three weeks prior, and the lax fiscal and monetary policies of governments around the world seemed almost certain to promote reflation.

Additionally, since the earlier oil bottom, Diamond Offshore stock had been outperforming the market.

Diamond not only had compelling fundamentals, it sported an incredibly high dividend yield, particularly if you combined both the regular and the special dividend payouts. That made the stock a compelling buy.

Not only has Diamond Offshore’s stock turned around since that early-March recommendation, the U.S. stock market as a whole turned around.

Making an investment at a market bottom is a rare opportunity. It is both risky and difficult to try and time the market, but that is precisely what we have done with two of our Buy, Sell, or Hold recommendations. I recommended the iShares MSCI Brazil Index exchange traded fund (ETF) (NYSE: EWZ) on October 27, and the fund went on to appreciate 92% in the subsequent eight months.

Now, Diamond Offshore stock has climbed more than 60% from a March 9 bottom of $54.29 a share, to its current level above $90.

I have consistently advised readers to slowly build stakes in our recommendations over a period of time. And that strategy helps mitigate risk and take advantage of panic selling.  In the cases of the iShares Brazil ETF and Diamond Offshore, we were actually able to boost our profit exponentially by starting our investment at the very bottom.

Diamond Offshore’s special dividend yielded an incredible 13% when we bought it. Since the stock has run up in value, however, that same special dividend has been reduced to a 7.4% yield but remains considerably high.

As I pointed out in my previous recommendation, Diamond Offshore likely will keep paying the dividend in order to help recapitalize other holdings of its experienced and savvy majority holders. And some analysts question whether this is sustainable over the long-term.  Obviously, Diamond Offshore at some point will depart from this special dividend, but I don’t expect that to happen anytime soon.

Still, with the strong gains that we’ve seen so far, it would be prudent to take some profit by selling half of the position and allowing the rest to ride on a pure valuation and risk-management call.

Let me explain.

The whole investment was predicated on three general types of factors: Macroeconomic, company fundamentals and the special dividend.  And everything I expected worked like clockwork, without any negative surprise showing up from nowhere to derail our initial investment thesis.

On the macro side, all the factors we analyzed are playing out as we expected. Oil prices have been very supportive.  This is not only supported by the monetary and fiscal reflationary policies I have outlined but also by strong demand from China.  The monetary base expanded significantly.

The type of massive fiscal stimuli deployed by the United States and China is common knowledge.  And China is doing its part by supporting its economy with massive investment and taking advantage of its $2 trillion in foreign exchange reserves and to gobble up resources at low prices.

On the company-specific side, Diamond Offshore did indeed beat earnings expectations by a mile and expanded margins as we predicted.  This was aided by sharp rebound in oil prices and strong execution on the part of management.

Similarly, the dividends were paid out and the special dividend likely will stay in place for a few more quarters.

But even with all of this upside, there are many uncertainties about the market that are could reinforce headwinds and spur more profit taking.  The Iranian elections could result in a more moderate regime that might ease tensions in the Middle East and allow some rapprochement between Iran and the United States.  This might be conducive to lower oil prices, even though the risks of Iran’s continued pursuit of nuclear weapons under the veil of a nuclear electricity policy will remain.

The Federal Reserve’s balance sheet expansion and the large issuance of U.S. Treasuries is coming under criticism from many quarters and has already achieved the normalization of many financial markets.  We could see a slowdown in any of these stimuli deployments.

In addition, the heightened risks of inflation, dollar weakness, and interest rate increases in the longer term have brought long-term interest rates up.  Higher rates have already increased the cost of mortgages and put renewed pressure on the already badly hit housing market. Together with higher oil prices, this could put the brakes on future economic growth.  It does not mean that the recovery will stall, but continued increases in job losses, as is typical in recessions will keep damping prospects.

Profit-taking also poses a risk ahead of the earnings season, as the United States and other stock markets have seen strong gains over the past three months.  Should this transpire, we could see a counter-trend correction due to a temporary fly-to-safety into bonds for a while, a strengthening of the U.S. dollar, and a drop in commodity and pro-cyclical stocks.  This could affect Diamond Offshore in the short term.

We must also consider Diamond Offshore’s opportunistic purchase of a semi-submersible unit PetroRig I.  We will not have the price and terms of this deal until closes on or around June 25.

Some analysts believe that this purchase – or the possibility that Diamond will get more aggressive in serving Brazilian oil major Petroleo Brasileiro SA (NYSE ADR: PBR), also known as Petrobras –could jeopardize the special dividend, but I disagree.  The issuance of a $500 million, ten-year debt placement will cover this purchase and raise the operating and financial leverage of the company, thus raising the potential upside for earnings-per-share (EPS) in this new pro-cyclical bull market for commodities.  And I believe the recapitalization needs of the sister company in the group has some more length to go.

Recommendation: Having obtained already very strong profits, sell half of your holdings in Diamond Offshore Drilling Inc. (NYSE: DO) in light of heightened risks that could materialize. Set a 20% trailing stop on the remainder.  I have little doubt that over the long-term we can expect DO to consistently outperform the market.

(**)  Special Note of Disclosure: Horacio Marquez holds no interest inDiamond Offshore Drilling Inc. (NYSE: DO).

Source: Buy, Sell or Hold: Time to Take Profits on Diamond Offshore Drilling (NYSE: DO) ]]> http://www.contrarianprofits.com/articles/buy-sell-or-hold-time-to-take-profits-on-diamond-offshore-drilling-nyse-do/17904/feed 0 http://www.contrarianprofits.com/articles/brazil%e2%80%99s-national-commitment-to-energy-bankrolled-by-china/17868 http://www.contrarianprofits.com/articles/brazil%e2%80%99s-national-commitment-to-energy-bankrolled-by-china/17868#comments Fri, 12 Jun 2009 20:27:38 +0000 Byron King http://www.contrarianprofits.com/?p=17868 Brazil is making a national commitment to develop energy resources located far offshore in the South Atlantic. Indeed, no nation has ever advanced such an ambitious plan for long-term comprehensive offshore development. And it’s being bankrolled by China.

Much of Brazil’s South Atlantic development will require drilling wells in waters up to two miles deep, through four-five miles of rock beneath the seabed. The prize at the end will be oil deposits with reserves estimated in the tens of billions of barrels. With access to this offshore bounty, Brazil expects to take its place among the first ranks of energy-producing nations in the world.

Brazil’s state-controlled national oil company (NOC), Petroleo Brasileiro SA (NYSE:PBR) plans to spend over $175 billion in the…

Table of Contents:

• Oil Production: Why OPEC’s Keeping a Lid on Production
• Oil Prices: Why Crude Thrives on the Diving Dollar
• Oil Outlook: The Coming Oil Price Shock
• Investing in Oil: The Best Companies, Stocks and ETFs

Oil has staged an impressive rally since dropping below $35 a barrel in mid-February.
And while there remains a risk that prices will retreat further due to sluggish demand, there are also three very compelling reasons why oil is still a safe long-term bet:

• OPEC has made substantial progress in reducing the amount of oil on the market.
• The dollar has been made vulnerable by the U.S. Federal Reserve’s aggressive policy of quantitative easing.
• And low oil prices and tight credit have reduced global energy investment, putting future supply at risk.

There’s no question that downside risk remains. On April 13, the Paris-based International Energy Agency (IEA) lowered its demand forecast by 1 million barrels a day, and now expects the world will use about 83.4 million barrels per day in 2009. That would be 2.4 million barrels a day, or 2.8% less than last year.

But so far dwindling demand has failed to contain oil prices.

As Money Morning predicted in its annual outlook series, the first quarter was a volatile one, in which oil prices tested the low $30s before surging over $50 in recent market rally.

And analysts are almost completely united in the view that, despite its short-term volatility, declines in production, exploration and development, and the value of the dollar will drive oil prices substantially higher in the years ahead.

Oil Production: Why OPEC’s Keeping a Lid on Production

The members of OPEC generated tremendous revenue from oil prices that soared over $147 a barrel last year. However, just as the world’s top oil producers began looking for ways to spend their massive stockpiles of cash, prices began a plunge that would see crude lose more than three-quarters of its value.

In a desperate effort to put a floor under oil prices, OPEC – supplier of 40% of the world’s oil – has issued three production cuts totaling 4.2 million barrels per day (bpd), or nearly 12% of its capacity, since September.

While the cuts have not yet been able to return oil prices to the group’s desired price range of $60-$70 a barrel, the cartel abstained from making any further reductions at its latest meeting in March and even voiced optimism that crude would reach $60 a barrel by the end of the year.

“That suggests to us that not only does OPEC have the firepower to support this oil price, but there’s enough internal agreement between OPEC members that they can actually achieve it,” Tom Nelson, an analyst for the Guinness Atkinson Global Energy Fund told BusinessWeek.

Many analysts had speculated that OPEC members would ignore the quotas and continue to produce oil to generate income, thereby rendering the cuts ineffective. But OPEC’s discipline has proven many critics wrong.

Despite foot-dragging from Iran and Venezuela – two countries that rely heavily on oil revenue to fund massive social programs – OPEC has gotten about 80% compliance on the 4.2 million bpd production cut. Historically, the cartel only gets about 60% compliance on such cuts.

As of February, Saudi Arabia accounted for about 46% of the 3.4 million bpd decline in production, according to PFC Energy. And the United Arab Emirates have fully complied with their share of the cuts. Iran’s compliance by that time was only 33% and Venezuela had only adhered to half of its commitments.

Still, Abdallah El Badri, OPEC’s Secretary General, estimates the production cuts will take about 800,000 bpd of supply off the market, significantly reducing the overhang in global markets, BusinessWeek reported.

OPEC officials from Libya, Algeria, and Iraq have all said that oil prices will reach $60 a barrel by the end of the year.

“One of the reasons why OPEC felt able to roll over quotas was that they do appear to have set a floor for prices,” Mike Wittner, an analyst at Societe Generale SA (ADR: SCGLY), told Reuters. “According to a lot of the balances, including ours, if you have OPEC holding steady or cutting a bit more, you get a big, counter-seasonal stock draw in the third quarter.”

Oil Prices: Why Crude Thrives on the Diving Dollar

Crude futures doubled from July 2007 to July 2008, soaring from about $74 a barrel to a record-high $147 a barrel. Much of that rise can be attributed to supply and demand, but there was another catalyst for the soaring prices that few investors recognized: The rapid decline of the dollar.

From July 2007 to July 2008 the dollar plunged 16% against the euro. And as the dollar became less valuable the cost of commodities around the world skyrocketed.

At the time, inflation – not deflation – was the predominant concern among the world’s leading economists, as a decade of low interest rates and unconstrained lending in the United States sucked the life out of the dollar. And while inflation is nowhere near the levels it reached last year, it’s important to recognize that the policies of the U.S. Federal Reserve are no less inflationary.

The Fed has cut its benchmark lending rate to a range of 0%-0.25%, and soon after, Fed Chairman Ben S. Bernanke said the central bank would purchase up to $300 billion of longer-term Treasury securities and $750 billion of mortgage-backed securities as it pursues a policy of quantitative easing.

This announcement by the Fed, along with a corresponding rise in equities, has been the driving force behind oil’s recent rally.

Ultimately, the same fear of inflation that typically drives investors into the gold market is similarly buoying oil prices. And even though the dollar has yet to be seriously affected, there’s no ignoring the fact that the more than $1 trillion worth of government bonds and mortgage-backed securities injected into the market will imperil the dollar’s value.

Oil Outlook: The Coming Oil Price Shock

Now that a weak dollar and reduced production have bolstered oil prices, there is a growing concern about how much higher crude will climb once demand returns. Tighter lending conditions and a trough in oil prices have badly crimped investment and jeopardized future supplies.

More expensive energy projects such as oil sands have been put on hold and the number of drilling rigs at marginal shallow-water fields around the world has been scaled back to a three-year low.

Oil drilling activity dropped 43% in the 12 months through March, with year-over-year oil exploration in the United States alone down 38%. High bids for offshore drilling rights in the central Gulf of Mexico fell by more than 80% compared with last year.

OPEC has said that with oil generating substantially less revenue as many as 35 new projects could be delayed past 2013.

“I have often described unsustainably low oil prices as carrying the seeds of future spikes and volatility. In a low-price environment, the trend is often to focus on survival instead of expansion,” said Ali al-Naimi, the Saudi oil minister. “If we place a low priority on preparing for the future, that lack of action can come back to haunt us through supply shortages and another round of high prices.”

The current economic crisis could reduce future oil supply growth by 8 million bpd, according to a recent study by the Cambridge Energy Research Associates (CERA).

CERA now says that production will grow by just 7.5 million bpd over the next five years, down from the 14.5 million bpd increase it predicted last summer. According to the research group, as demand recovers throughout that span, production will struggle to keep up and a new commodities bull market, similar to the one seen in 2008 will begin.

“Seven consecutive years of rising oil prices – unprecedented in the history of the oil industry – have come crashing down, thus burying the notion that the commodity price cycle was a historical relic,” said the report.

CERA isn’t the only organization worried about the lack of investment in new oil projects, either. The International Energy Agency (IEA) – energy advisor to 28 industrialized nations – has also issued warnings about a coming supply crunch.

The IEA estimates daily oil demand will rise from the current level of 86 million barrels to 106 million barrels by 2030. To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years.

China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.  About 7 million bpd of additional capacity needs to be added to the market by 2015.

“Unless sufficient companies have the will and financial ability to invest through the down cycle, there is a real risk that supply growth may lag the eventual rebound of demand, leading to substantial price increases – possibly as early as this year,” Richard Jones, the IEA’s executive director said at a recent conference in London.

Jones estimates that as much as 2 million bpd of expected new oil production has already been deferred.

The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” – that will once again send oil prices up into the triple digits.

“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”
The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.

“Every bull market in oil is really born in the zenith of a bear market,” said Phil Flynn, an analyst at Alaron Trading Corp. “The cutbacks we see today are going to lead to a spike somewhere in the future. The big question is when it’s going to happen.”

Investing in Oil: The Best Companies, Stocks and ETFs

When it comes to investing, the oil sector poses some very clear risks, especially given the murky near-term outlook. However, there are a number of large-cap integrated oil companies that may offer some truly compelling values at current prices.

Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) are currently trading at multi-year lows, making them exceptionally cheap in both relative and absolute terms. These companies also have strong balance sheets (Exxon is “AAA”- rated and has more cash on its balance sheet than debt), generate strong cash flows, and have traditionally increased their dividends on a regular basis.

”Chevron is the kind of company that is capable of continuing to post large profits – propelling its share higher from current levels – even if oil-and-gas prices were to drop from current levels over the next three years,” Money Morning Contributing Editor Horacio Marquez said. “That’s because Chevron’s business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market ’spot’ prices were to decline. Also, the company’s production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.”USO

Offshore drillers, particularly those capable of drilling in the deepest waters, also offer value at current levels. Petroleo Brasileiro (PBR), also known as Petrobras, is particularly appealing, as it recently discovered one of the largest offshore oil fields on earth off the coast of Rio de Janeiro. Known as Carioca, the field could hold 33 billion barrels of oil and gas, making the world’s largest discovery in at least 32 years.

Keith Fitz-Gerald, Money Morning’s Investment Director, suggests investors look at China National Offshore Oil Corporation, or CNOOC Ltd. (ADR: CEO). The Hong Kong-based company recently got approval for a $29 billion exploration project in the South China Sea. The company expects to produce 50 million tons of oil equivalent per year from that region during the next 10-20 years. That would equal the production of China’s biggest project, the Daqing Oil Field.

Petrobras and CNOOC are also attractive because, as foreign companies, they will also get a boost from any devaluation in the U.S. dollar.

All of these companies have been hit hard by the combination of commodity-price weakness and credit market turmoil. But these operators do not require peak-cycle commodity prices to generate stellar results and have little or no credit-market exposure.

For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (USO), the iPath S&P GSCI Crude Oil Total Return Fund (OIL), or the United States Gasoline Fund LP (UGA).

Source: Three Big Reasons Oil Prices Will Rally Back Big Time

We have been raking in huge profits in all our cyclical and aggressive plays since we called the turnaround in Brazil last October 27:  Petroleo Brasileiro (NYSE: PBR) — known as Petrobras – Vale (NYSE: VALE), Apple Inc. (Nasdaq: AAPL), BHP Billiton Ltd. (NYSE: BHP), Research in Motion Ltd. (Nasdaq: RIMM), IBM (NYSE: IBM), Amazon.com Inc. (Nasdaq: AMZN),  Diamond Offshore Drilling Inc. (NYSE: DO), and Ciena Corp. (Nasdaq: CIEN) have all done splendid.

And over the longer term, all of these companies are going to continue delivering, with some obvious profit-taking bouts along the way.

One of such profit-taking episode could be starting right now.  And it could be driven by Standard & Poor’s recent downgrade of United Kingdom’s sovereign debt rating.  This was in turn followed by the comments coming out from PIMCO that suggest the United States’ debt rating could be in jeopardy.  Even though S&P minimized that possibility, when Bill Gross speaks, the bond markets listen.

General Mills met earnings expectations in March and raised its earnings outlook.  It has been benefiting from the drop in commodities prices, especially agricultural. In addition, the firm, like many in the consumer business, has suffered from a strong U.S. Dollar, which reduced the value of the profits abroad.  The nice thing about consumer staples is that, since people have to eat in good and bad times, these companies are not cyclicals, but rather suffer very little in downturns.

That has been the case for General Mills, which in the last report showed a 4% sales increase from the same quarter in the prior year.  And this sales increase was achieved despite a 6% drop in the sales of food service and bakery products, where the firm nonetheless managed to increase pricing.  But this sector is being de-emphasized with some divestment.

Just think about the solid brands that allow General Mills to dependably keep chugging along every quarter, increasing sales as the population grows. General Mills also boasts well established and new brands that keep increasing its market penetration around the world.   Since then, the dollar has corrected in value and the commodities prices have dropped. That will show up in next month’s earnings report and the stock should perform nicely.

The company is dominant with its Pillsbury brand, which has more than two-thirds of the market.  Cheerios, which has come under some scrutiny for health claims by the FDA, is the top cereal franchise in the ready-to-eat segment.  In addition, we are going to see hundreds of new products being launched soon.

The global story is only beginning for this company, even though they are already in China, and many other fast-growing emerging markets.  This international presence, which right now accounts for only 20% of the company’s total sales, is likely to grow much faster in the near future.  This will be achieved with joint ventures and by leveraging the brands that have the highest international penetration, like Nature valley and Haagen Dazs.

The stock is trading with a price-earnings ratio of only 16 times and an attractive dividend yield of 3.3%. But looking at the company’s growth, it is trading at only 13 times future earnings.  This is a low-risk proposition, as both the company earnings and the dividend appear to be very safe. In addition, the stock has a small short ratio that should diminish if we see profit-taking in the cyclical.

Last but not least, in addition to the short-term technical turning bullish at the end of April, as the stock crossed its 13-day and 50-day exponential averages to the upside, the long-term technicals have also turned bullish and the stock is still way oversold.

Recommendation: Buy General Mills Inc. (GIS) at the market and accumulate more if you see weakness (**).

(**) – Special Note of Disclosure: Horacio Marquez holds no interest General Mills Inc.

Source: Buy, Sell or Hold: General Mills Inc. (NYSE: GIS) is a Wholesome Company with Profit Coming Down the Pipeline

Exxon’s Azulao-1 well tapped a reservoir that reportedly contains as much as 8 billion barrels of recoverable oil, says Luiz Lemos, a partner at TozziniFreire Advogados, a Brazilian law firm that represents foreign energy companies.

“This is very huge,” Lemos told Bloomberg News.

So is the potential benefit for Brazil. If Lemos’ estimate is accurate, this new Azulao find will rival the nearby Tupi oil field as the largest discovery on this side of the planet since Mexico’s Cantarell field was discovered in 1976.

Lemos’ estimate is unconfirmed, but Exxon Mobil Chief Executive Officer Rex Tillerson described the find in January as “a huge potential resource.”

Exxon first notified Brazilian regulatory agency National Petroleum Agency that it discovered hydrocarbons in the reservoir, identified as BM-S-22, on Jan. 16. The world’s largest oil company operates the block with a 40% stake. Hess Corp. (HES) also holds a 40% interest and Brazilian state energy company Petroleo Brasileiro SA (ADR: PBR), known as Petrobras, holds the remaining 20%.

It was Petrobras that first triggered the rush on Brazil’s energy sector when, in November 2007, the company announced the Tupi discovery – an underwater field that could contain as much as 80 billion barrels of oil equivalent.

Petrobas actually downplayed the findings of the Tupi oil field before announcing last November that the reserve contained between 5 billion and 8 billion barrels of light oil and gas.

Petrobras will begin extract its first crude oil from Tupi on May 1. Initial output from the Tupi field is expected to be around 15,000 barrels per day, then rising to 30,000 barrels a day during a later stage of testing, and eventually reaching about 100,000 barrels per day by 2010, Reuters reported.

If Tupi lives up to analysts’ expectations, it will be very encouraging not just for development of Azulao, but also the Carioca reserve, another massive field expected to hold a large bounty of petroleum.

Last year, Haroldo Lima, the head of Brazil’s National Petroleum Agency, said Carioca could hold 33 billion barrels of oil and gas. Upon hearing the news, brokers and analysts rushed to tell their clients that Brazil, as one minister put it just months ago, was about to become the “new Saudi Arabia.”

Experts say that even 10 billion recoverable barrels of oil – whether they come from Tupi, Carioca, Azulao, or a combination of all three – would be a remarkable find and enough to catapult Brazil into the world’s oil-producing elite. Brazil currently has about 12 billion barrels of proven reserves, and could soon find itself nestled between Nigeria (with 36 billion barrels) and Venezuela (80 billion).

Foreign Oil Majors Flock to Brazil

As rich and expansive as Brazil’s oil reserves may be, they are also very difficult to access. The Carioca field, for instance, is 170 miles offshore, more than 6,000 feet below the surface of the water, and trapped beneath a shelf of salt 500 miles long and 125 miles wide.

There is no question that extraction will be costly, but even at today’s energy prices there’s no shortage of domestic and foreign companies ready to invest big money Brazil’s energy sector.

In fact, Manuel Ferreira de Oliveira, chief executive officer of Portugal’s Galp Energia SGPS SA, said March 4 that production at the Tupi sub-salt oil field in Brazil is viable — despite the slide in international oil prices.

“Production at Tupi is competitive, even at the actual level of oil prices,” Oliveira told the Estado news agency, on the same day that his company released its fourth-quarter earnings. “The projects in Brazil are going to gain strength this year and the next.”

Exxon said Thursday that it would continue investing in exploration and production at “record levels,” despite the economic downturn and plunging oil and gas prices that have reduced spending by some competitors.

Exxon will invest $29 billion this year, and reiterated plans to invest between $25 billion and $30 billion annually over the next five years.

The company is currently spending $79 million a day to search for oil fields, construct platforms and renovate refineries Bloomberg reported.

China is also looking to become a long-term partner in Brazil. China Development Bank last month agreed to lend Petrobras $10 billion to help finance deepwater oil exploration off the coast of Brazil.
Oil exploration will be carried out with the participation of Sinopec (ADR: SHI), the Chinese state oil company.

The contract will be finalized within the next two months so it can be signed when Brazilian President Luiz Inácio Lula da Silva visits China in May, according to Petrobras Chief Executive Officer Sergio Gabrielli.

In addition to the exploration partnership, the deal signed between Petrobras and Sinopec includes the supply of 60,000 to 100,000 barrels of oil per day in the current year. Petrobras also signed a memorandum of understanding with state company China National Petroleum Corporation (CNPC) for the supply of 40,000 to 60,000 barrels per day.

Last month, Petrobras announced plans to invest $174.4 billion in exploration and production.

Energy demand in Brazil is “already starting to recover,” Petrobras CEO Gabrielli told Reuters during an interview at a Brazilian investment conference. “Even the fall in demand during the last quarter of 2008 was within a range we could expect for that season.”

In addition to Exxon and Petrobras, the companies that stand to profit the most from Brazil’s energy renaissance are offshore drilling companies such as Transocean Ltd. (RIG) and Diamond Offshore Drilling Inc. (DO), which was recently recommended by Contributing Editor Horacio Marquez in his weekly “Buy, Sell or Hold” feature.

Devon Energy Corp. (DVN) also made headlines last week when it notified regulators that it found traces of natural gas in the Barreirinhas Basin. Larry Nichols, chief executive officer of Devon Energy, said Monday that prices for natural gas are close to recovering from their recent drubbing.

“When the recession ends and the economy starts booming, we’re going to have less natural gas than we do today and prices are going to spike back up,” Nichols said.

Source: Is Brazil the ‘New Saudi Arabia?’

This stock is just waiting to explode. He recommends you take advantage of this investing opportunity and says, “because of its strong dividend policies, investors will be well compensated while they wait for that oil-price rebound.”

This from Horacio:

In the face of the global financial meltdown, the price of oil has plummeted from a record high of almost $150 a barrel in July to less than $40 recently. And now it seems to be bottoming.

Clearly, this isn’t the precise moment to call a market bottom, but it is reasonable to think about a bottom around this range for a few reasons.

For starters, the forward curve of oil futures prices is showing a very marked upward slope, known in the commodities business as a forward curve in “contango.”  This means that – the farther out we go – the higher and higher oil futures prices climb. To see what we mean, let’s take a look at the projected price of oil as depicted by this graph.

A futures curve as upwardly skewed as this one provides a great opportunity for profits:  One can just buy oil today, sell it forward and hold it until December 2016 and make a guaranteed rate of return of about 62%.  In a year, you can make about 11% by just buying now, holding it and delivering in a year.  If you add some leverage to the transaction, you can make a nice return.

Some sophisticated players are doing just that: They’re buying oil, and are holding it in a tanker in port – with the obvious intent of capturing these profits.

However, this very favorable contango arbitrage is not going to last for long, as more players have been jumping into it, thus flattening the futures curve with time.  It is easy to see that, at some point, as oil gets absorbed into storage, and the curve gets inverted, the speculative players that shorted oil by selling futures long ago without having production or physical oil will be squeezed into covering at much higher spot prices.  This spike in spot prices situation will develop in less than a year, as demand recovers.

The slope of the curve also indicates widespread expectations for inflation.

From Stimulus to Inflation

The U.S. government has launched a huge stimulus package and its plan for a $3.6 trillion budget for fiscal 2010 will elevate the fiscal deficit to a staggering $1.75 trillion this year – a numbing 12.3% of gross domestic product (GDP).

And we have yet to deal with the massive social-security and health-care entitlement programs, which pose a huge fiscal threat ahead.

The financing of the announced deficits will come through issuance of U.S. Treasuries, which means that the U.S. Federal Reserve will have to monetize the debt. That is, the U.S. central bank will have to print money in order to make it available to buy the debt, since the level of issuance is so high that foreign buyers will not be able to purchase all the debt.

In addition, the Fed has already been very busy expanding its balance sheet in order to pump liquidity into the markets to buy mortgages and other assets. And it has already lowered its benchmark Federal Funds rate to a range of 0.00%-0.25%.

Why are the Fed and the government so intent in stimulating the economy?

The nightmare scenario for any central bank is falling into the so-called “liquidity trap” – a situation that exists when an economy’s asset prices enter a deflationary spiral and people reach the conclusion that by merely sitting in cash, even at a zero interest rate, they are getting richer by the day.  In that situation, monetary policy becomes ineffective, since rates are already at zero, and since it is very difficult to get out of that deflationary spiral.

That is precisely what happened in Japan during its “Lost Decade.” By the time the Japanese figured out that they needed to do something very dramatic in terms of stimulus, it was too late. The drop in prices had already created too many losses in the banking system and taken the entire system into bankruptcy.

Therefore, the theory goes, very aggressive monetary and fiscal action is needed right at the outset, in order to prevent the deflationary spiral and to actually generate some inflation.  At the same time that the United States, at the epicenter of the global crisis, is acting in this manner, countries around the rest of the world, which have been affected to different degrees, have launched their own stimulus initiatives.

China’s Stimulus Points to Strong Global Demand

China, which is at the forefront of global commodities demand, is of particular interest.  China needs to grow its economy at a minimum rate of 8% a year in order to employ the 18 million workers that join the labor force annually.  This is an imperative for a country that has dictatorial government, in order to avoid massive unrest.  That’s why in November, Beijing announced a $585 billion (4 trillion yuan) stimulus plan. It’s also why the country is taking such aggressive steps to assure access to supplies of key commodities.
Since then, the government has been aggressively buying long term access to commodities in such countries as Brazil and Australia.

Aluminum Corp. of China (NYSE ADR: ACH), otherwise known as Chinalco, has invested $19.5 billion in Rio Tinto PLC (NYSE ADR: RTP) to acquire stakes of up to 50% in nine of Rio’s mining assets.

China also struck a deal with Brazil’s Petrobras (NYSE ADR: PBR) for a long-term supply of oil.

China Development Bank, one of China’s largest state-owned enterprises, agreed to lend $10 billion to Petrobras for its ambitious deepwater-development program in order to ensure a long-term daily supply of 160,000 barrels oil. That followed a similar deal with two Russian giants. China Development Bank lent $15 billion to OAO Rosneft Oil Co., Russia’s state-owned oil company, and $10 billion to the Russian state pipeline monopoly Transneft (PINK: TRNFF). In return for the needed financing, Russia agreed to supply China with 15 million tons of oil annually for 20 years.

Hence, the outlook for commodities – given easy global monetary and fiscal policies, and a reflationary bias – is very favorable, and we are going to take advantage of it.

Enter Diamond Offshore Drilling Inc. (NYSE: DO).

Drilling for Profit

Diamond Offshore is the world’s second-largest driller by market capitalization, right after Transocean Ltd. (NYSE: RIG).  It has 31 floating rigs: nine sophisticated deepwater semi-submersibles, one drill ship for very deep water, and 21 other semi-submersibles.  In addition the firm owns only 13 jack-up rigs, of which only seven are in the Gulf of Mexico.

What I like about Diamond Offshore is its conservative, shrewd management and its commitment to shareholders.  The latter is especially ensured because of the situation of its controlling company, the New York conglomerate Loews Corp. (NYSE: L), which owns 54% of the Diamond Offshore’s stock.

Loews, run for half a century by the Tisch family, initially acquired Diamond Offshore’s assets in an opportunistic transaction in 1992.  It then sold 30% of the company to the public in 1995 and later acquired Arethusa (Offshore) Ltd. in 1996, using stock, a move that reduced its participation to the current 54%. Since that time, Diamond Offshore has been using its ample cash flow to repurchase shares from public hands.

Diamond Offshore, also referred to as DO, has been managed very wisely.  As the world’s No. 2 contract driller, DO has concentrated on the higher-priced equipment, that is, the semi-submersible rigs, which operate in deep waters.  And deep water, which require that higher-priced equipment, is where the biggest action is.

And since the specialized deepwater equipment is all taken, DO’s mid-depth equipment benefits because it can be adapted for use on bigger projects.

DO has minimized its exposure to jack-up rigs (those that rest on the ocean floor) and especially to work in the Gulf of Mexico, which has more competition and lower daily rates.

No wonder that DO’s fourth-quarter results handily beat analysts’ consensus estimates of $2.34 per share by posting operating earnings per share of $2.53.  Revenue also beat expectations, showing a 1% increase over the prior quarter.  The company also realized higher day rates and higher utilization rates.

These are all indications of strong management execution.  What is impressive about DO is that the company used the run-up in oil prices last year to enter into long-term contracts at very high prices, registering an impressive $10.3 billion backlog.  That gives Diamond Offshore a great earnings visibility going forward.

But the upside does not stop there.

There is a special situation in the making, because the Loews Group owns CNA Financial Corp. (NYSE: CNA), an insurance company that is trading at half of its book value.  You see, insurance companies have been hit hard financially by markdowns in their fixed-income and hedge-fund holdings, but Loews invested $1.25 billion in CNA last fall in a move to improve the company’s balance sheet.

And in order to be ready to defend debt ratings, a conservative management like Tisch has all the incentive in the world to keep maximizing Diamond Offshore profits to support CNA – should it be needed despite CNA’s current strong liquidity and financial flexibility.

DO recently paid one of its regular special dividends of $1.85 a share, bringing the dividend yield to almost 13%.  If this dividend is safe – and we believe that it is – this is a winning strategy for the group, given the current financial environment, and it will greatly help to maximize profits and cash flow from Diamond Offshore.

Mark Urness, a friend of mine at Calyon Financial, one of the leading energy research specialists on Wall Street, concurs with our assessment of this sky-high dividend. He estimates that DO will continue to offer the 12.5% dividend yield, which is unparalleled in the oilfield-services segment. We, like Mark, expect the company to distribute $8 a share in 2009 in the form of both the regular and the special dividends that DO has been using.

DO has been extremely disciplined with costs and with new investments, maximizing free-cash flow to almost $900 million last year.  In fact, with the ample backlog at higher prices of the contracts signed, DO should increase its free cash flow and net income to about $1.4 billion to $1.5 billion in 2009.

DO’s profit margins are impressive – and exorbitant – thanks to the shortage in rigs: Gross margins are 64% and operating margins are 54%.

These margins are likely to keep growing as management continues to execute thoroughly and oil prices rebound.  This strong growth in revenue and earnings – driven by DO’s savvy positioning in deepwater and mid-water rigs, and bolstered by rebounding oil prices thanks to global monetary and fiscal conditions – will surely help deliver much higher multiples than the meager six times earnings that Diamond Offshore’s shares are currently trading around these days.

Diamond Offshore’s shares closed Friday at $55.58. They are down 62% from their 52-week high of $147.77.

This cash-rich, profit-fountain company is a resounding “Strong Buy,” as its stock is waiting to explode to the upside.

Recommendation: Buy Diamond Offshore Drilling Inc. (NYSE: DO), a top player in its sector, and a company that is poised to capitalize on a projected resurgence in oil prices. Because of its strong dividend policies, investors will be well compensated while they wait for that oil-price rebound (**).

(**)  Special Note of Disclosure: Horacio Marquez holds no interest in Diamond Offshore Drilling Inc. (NYSE: DO).

Source: Buy, Sell, or Hold: Profit From the Projected Oil-Price Rebound With Diamond Offshore