We don’t have to like the changes underway, but we do have to respond to them intelligently if we hope to preserve and increase our wealth. The time has come for us “free market” aficionados to dry our tears and try to figure out what to do next.

The federal government’s attempts to reshape the U.S. economy will provide numerous profit opportunities. Take, for instance, the inevitable move toward taxing carbon emissions. Attaching a price to carbon dioxide would, obviously, increase utility bills (and the price of anything made with electricity). As a result, consumers of energy would try to avoid this taxation by utilizing cleaner sources of energy.

Right now, many natural gas-fired power plants are brought online only at times of peak demand, while coal is considered a “base load” fuel since it’s cheaper. But a carbon tax would raise the price of coal (and the extra carbon it emits) closer to the price of natural gas. So it’s seems likely that carbon taxes or any other “climate change” legislation that comes from the Obama Administration will favor natural gas-fired electricity at the expense of coal.

Assuming the political popularity of natural gas will keep growing, and that solar and wind power production cannot increase fast enough to be meaningful (even with heavy subsidies), it makes sense that natural gas-focused exploration and production (E&P) companies and their critical suppliers like National-Oilwell Varco (NYSE: NOV) will enjoy years of attractive growth opportunities. NOV has an attractive business selling brand-new, highly efficient rigs built for shale gas drilling.

At the moment, a glut of natural gas has produced a drop in number of drilling rigs operating in the U.S. This drop was already discounted by the crash in the oil service stocks last fall. But the faster the rig count falls, the faster the gas glut will dissipate as 2009 wears on. If demand for natural gas rebounds later in 2009, while supply is falling, then prices could move much higher in a short period of time. I’m going to keep monitoring the supply situation closely because I think it will yield several good trading opportunities this year. And the best way to get a handle on supply is to follow where and how the smartest companies are investing.

I recently tuned in to several Webcast presentations made at the BMO Capital Markets North American Unconventional Gas Conference. The larger presenters included Talisman Energy, Comstock Resources, Southwestern Energy, Ultra Petroleum, and Range Resources — several of the visionary early movers into shale gas drilling.

These companies employ cutting-edge technology in the natural gas industry. As a group, they delivered much of the production growth the U.S. has enjoyed in recent years. We can’t do without this shale growth. Keep in mind that virtually all new electric power plants brought online in recent years have been gas-fired plants.

Most of the premier shale gas plays (Barnett, Marcellus, Fayetteville, Haynesville, etc.) can be booked into reserves and brought online at cash costs between $2-4 per million cubic feet of gas. With natural gas prices currently at $5.50, the economics of adding to shale gas reserves and production makes sense. Even if they don’t immediately hook up newly drilled wells to gathering pipelines, most of these exploration-and-production companies will still want to drill at a fairly rapid clip to book new proved reserves in 2009.

The E&P industry, like most others, contains the “haves” and “have-nots.” The haves tend to be public companies with premium valuations that reflect their huge inventories of low-cost drilling opportunities. The have-nots tend to be private highly leveraged companies that hit the accelerator on any resource that looked economic in the high-price environment. Many of them are releasing low-end rigs and will not survive this downturn.

Ultra Petroleum is certainly at the top of the “haves” list. It controls tons of acreage in the obscenely profitable Jonah and Pinedale fields in Wyoming. Because its acreage is so cheap to develop, it can keep expending production very quickly, and incremental returns on invested capital are enormous.

The same goes for Range Resources. Range is a first mover and considered an expert in developing the Marcellus Shale. It looks to have locked up most of the highest-quality acreage in the Marcellus. The Marcellus is definitely promising, but it has different characteristics across its wide geography. Range has the most profitable gas wells because it has the most experience, expertise, and proprietary seismic data. At the BMO conference, Range estimated that its Marcellus wells have the potential to earn 20% internal rates of return at $4 natural gas.

The good news if you’re exposed to E&P or service stocks exposed to shale gas: The stocks have already crashed in anticipation of an ugly environment for natural gas pricing, production, and drilling in 2009 and 2010. If conditions stabilize, rather than continue collapsing, many of the stocks exposed to growth in shale gas drilling — including NOV — should regain plenty of lost ground.

The big concern with NOV recently was J.P. Morgan’s downgrade. I read J.P. Morgan’s report and agree with many of its points. But I disagree with its method of getting to a $31 price target for NOV (I think $31 is much too conservative). It gets to $31 through a discounted cash flow model in which it assumes 2009-2011 returns on invested capital will average 8%. This is down dramatically from the 2005-2008 average of 16% and equal to the 2002-2004 average of 8%. I have two issues with this:

1) Hardly any company was investing in rig equipment during 2002-2004. The upturn in day rates didn’t really gain traction until 2004. On the next up cycle, most of the world’s drilling fleet will be approaching 30 years of age. So many of the oldest rigs will be scrapped and there could be a shortage of newer, more productive rigs that NOV helps create.

2) J.P. Morgan gives no consideration to NOV’s greatly strengthened negotiating position relative to its customers, since it scooped up several competitors. It is a one-stop shop for equipment and consumables for every E&P and drilling company worldwide. It can afford to take advantage of this down cycle with more cheap acquisitions. Such moves won’t dilute shareholder value — thanks to its strong balance sheet and cash flow.

3) J.P. Morgan gives no credit to NOV for its excellent integration of Grant Prideco — a company with very attractive growth prospects (considering that its product lines are levered to the strongest trends in oil and gas production, including stronger drill bits and better drill pipe).

So J.P. Morgan reflects the bear case on NOV, yet it still gets to a $31 price target.

J.P. Morgan’s target implies that NOV should trade at 3 times its estimated 2009 EBITDA, in line with the offshore drillers. In my view, NOV deserves to trade at more than twice the EBITDA multiple of the drillers, since it’s a far less capital-intensive business model. NOV will not be generating losses during this downturn, nor will it be forced to spend a lot on maintenance capital expenditures (as drillers must, depending on the age and shape of their fleet).

I expect the market to come around to this view when NOV reports earnings in early February. Sure, the segments of NOV’s business that are the most sensitive to the rig count will slow in 2009, but the stock market excessively discounted this slowdown when it hammered the NOV share price from its crash from $92 last July to $18 in November.

At the current quote of $25.62, NOV is a very cheap stock that could easily rebound to the mid-$30s in the coming months. I think the trend for NOV will be up over the next month or two as the market anticipates that 2009 and 2010 earnings will not be as bad as previously expected.

Source: Investing for Comrades, 101

This from The Sovereign Society:

Put simply: If things don’t start improving quickly in South Africa, it’s poised to become the next – and perhaps most noteworthy – failed state in all of Africa. Think Zimbabwe, but multiply the chaos as South Africa has long been the best and last hope for Africans striving to build and maintain a modern and efficient market economy.

1. Global economies, most specifically emerging global economies, have been brought to a halt by declining levels of demand. South African resources are particularly exposed to demand destruction as the global recession spreads. Frozen credit markets have tied the hands of economies once turning heavily to South Africa for its natural resource production.

Declining commodity prices alone will certainly send tremors throughout South Africa. Accessibility of credit will put a damper on new South African projects, and sharply lower commodity prices will make such projects increasingly less profitable.

This ultimately means a severe drop off of capital inflows. Up until this point, South Africa’s appealing growth story was still in its infancy.

The country made hay off the commodity bull market and South Africa’s currency is stamped with a fairly attractive yield. But the collapsing global financial system will stop South African growth dead in its tracks. At that point we’ll learn just how improved the booming global economy allowed South Africa to become.

Unfortunately, there are plenty of pieces that still don’t fit together. To that point…

2. Political and social unrest has frequented the African continent. Though South Africa is considered a democracy, it’s effectively a one-party state ruled by the African National Congress (ANC). Political and social pressures are quickly encroaching.

The ANC is a Marxist-like organization that has aggressive redistribution policies. It has instituted a draconian affirmative action program to increase black employment. But this has led to massive incompetency in key sectors of the economy and a “brain drain” out of South Africa.

The reality is, unemployment for many black workers in the townships has not improved much at all. And these efforts to empower more nonwhites will likely unwind dramatically as the economy deteriorates like it did a decade ago.

In fact, life of squalor and poverty for many South Africans has gotten worse over the past several years. Social stability has spiraled downward and crime is rampant throughout all levels of society. But because the poor don’t have the wherewithal to hire private guards, they are victimized repeatedly by roving gangs of thugs. It is a sad awful existence that has not improved despite the ANC guaranteeing it would.

And as the business cycle turns down, we expect the ANC to try to ramp-up its efforts to redistribute wealth in an attempt to damper rising social unrest. The impact of which will only hollow out South Africa’s economy even more, further weakening what once was a vibrant and efficient economy.

Given these items, we think the South African rand is extremely overvalued. It represents a crisis currency in the making. This is truly big game territory. For when the market finally recognizes this country’s deep and profound economic, political and structural problems, South Africa’s currency will face a world of pain.

Source: Markets Sink Again, and Best Opportunities Still Reside on the Short Side…