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Random Thoughts on Oil and Multiple Equilibria Supply/Demand Points February 23, 2009

Posted by DustinRJay in Uncategorized.
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8 comments

Oil prices have tumbled dramatically from $147.27 on July 11, 2008 to $38.00 on February 23, 2009.  Many experts have weighed in that oil prices were a speculative bubble.  The rationale for higher oil prices stemmed from emerging demand from China and India, coupled with oil supply being relatively flat in response to higher and higher prices and was featured in a number of bullish economic reports, most notably Merrill Lynch and CIBC.

Since then, oil demand has dropped, and oil prices have declined.  Small changes in supply/demand dramatically impact price, (e.g. consumption is down ~5%, yet prices are down more considerably).  Petroleum product infrastructure has been designed for transportation and piping, not storage.

There is a fat tail risk for energy company bankruptcies.  Companies that expanded and acquired heavily and drilled many new wells in a high commodity price environment, may no longer payback the original capital investment borrowed due to poor netbacks.  AJM, McDaniel, Sproule have price decks that result in higher asset valuations, due to oil contango but this is based on a paper valuation that I do not believe fully reflects that the global economy has entered the worst economic recession since World War II.  It may take 2 years to determine bankrupt energy companies from healthy ones as future oil barrels have a high degree of price uncertainty.  The following quickie back of the envelope economics illustrates the difficult economic hurdles the Alberta energy industry currently faces:

Alberta Back of The Envelope Oil Economics

Average new oil well drill production:  Assume 28.3 bbl/oil
Average annual decline: 18% year over year
Average well reserves estimate: 41,300 bbl (as calculated)
Well Cost Estimate: $1,000,000
Tie-In and Facility Cost: $300,000 (estimated average cost per success well)

Edmonton Par: $46.40/bbl
Finding & Development Cost: $31/bbl (as calculated above)
Operating Costs: $14/bbl (estimated based on companies such as Pengrowth and Husky)
Royalties (estimated 20%): $9/bbl
Plus corporate economic hurdle = You Do The Math!

In general, prices are high enough to cover operating costs, but not enough for capital investments.  For the most part, the stock market is very focused on earnings growth and therefore rate is king.  Bondholders require coupon payments, and therefore shutting in production to increase asset value may not be an option due to high debt loads.

When demand increases, there could be a second oil price shock resulting in yet more economic turmoil.  Prices could rapidly climb as current prices are more reflective of operating costs, and would need to shift upward substantially to incorporate finding and development costs and adequately compensate investors (shift in supply/demand equilibria point).

It is likely less expensive to increase production through acquisitions than drilling.  A well capitalized energy company could evaluate shutting in production to increase asset value (as in general, prices are too low to drill), and use existing cash reserves to acquire depressed natural resource assets.

An Open Letter to Diane Colley-Urquhart February 15, 2009

Posted by DustinRJay in Uncategorized.
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6 comments

On September 9, 2008, Calgary city council debated and approved $25 million in funding to be allotted for two pedestrian bridges in downtown Calgary.  This issue was revisited on January 12, 2009, when yourself and three other aldermen put forth a motion to halt the design of the bridge and the motion subsequently failed.

Calgary’s extensive pathway system and pedestrian bridges around the river are a primary reason why I chose and enjoy living in Calgary.  Currently, the pedestrian bridges are a part of my daily commute and habitat.  Calgary spends 4% of it’s transportation capital budget on pedestrians and cyclists and 0.37% of it’s operating transportation budget on pedestrians and cyclists.  This is disproportionately less than the 7% of people that use biking and cycling as the primary mode to get to work and is a minimal part of the overall transportation budget.

Calgary also spends much more costs due to suburban sprawl.  The cost of roads and interchanges, maintenance including snow removal, public transit, water and sewer is much higher in comparison to the revenue generated for low density suburban areas versus a high rise downtown condo tower.  To further illustrate my point, the estimated cost of the pedestrian bridges is small in comparison to the $2100 million cost estimate for Calgary’s ring road.

Although I’m not a city planner, it seems intuitive that from a city efficiency standpoint that a high density building could have up to a 20xfold increase in profitability, thus decreasing the tax burden on residents.  Alternatively, the extra profits generated from high density may be used to increase the overall quality of life for the surrounding residents.

Example:

Arriva 42
200 units per half city block
1/2 city block

Bridlewood Suburban Area
20 units per block
10 city blocks

The revenue generated in each example would be roughly the same, but the city’s cost would be much higher for the equivalent suburban area.

Recently, a private enterprise has entered an agreement to purchase the Shawnee Golf Course for purposing of developing residential real estate.  Subsequently, you submitted a motion requesting that city administration evaluate the option of using public funds to purchase and operate the golf course.  The Canadian Federation of Independent Business has requested that the City of Calgary embark on a plan to sell it’s golf courses to private enterprise.  Higher density residential zoning would increase the tax efficiency of the city of Calgary and allow private enterprise to develop an opportunity.  This is counter to your previous arguments regarding the pedestrian bridges that you were acting as an advocate on behalf of Calgary’s taxpayers.

I believe that by supporting private enterprise and transit orientated development , that public funding can be better targeted at improving quality of life for all Calgarians.

In summary, I fully support the development of the bridges and believe that city council should avoid NAMBIism and adhere to these policies:

  • Council should encourage development that minimizes sprawl to reduce the overall cost to taxpayers
  • Council should attempt to allocate equitable infrastructure funding that is proportional to the tax revenue generated
  • Council should not needlessly revisit projects that have already received approval unless there has been a significant new development

References:

Diane Colley-Urquhart’s website

Santiago Calatrava – YouTube Video

Santiago Calatrava – Wikipedia

Trendsetter or Trendfollower? February 3, 2009

Posted by DustinRJay in stock market, stocks, Uncategorized, volatility.
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6 comments

The following analysis was performed to backtest the S&P 500 against two investment strategies.  A common belief is that the 50 day moving average (SMA) is indicative of a resistance level or support level for the market.  When the price crosses above it’s 50 day moving average it means that investors are willing to pay more for the stock than the average of the previous 50 days and is typically regarding as a technical bullish signal.

The trading strategies analyzed are:

  • Buy and hold
  • Only buy when the S&P 500 crosses above the 50 day moving average, sell when the price drops below the 50 day moving average.

The following graph shows the value of an initial $100 investment on a logarithmic scale, as it is easier to identify relative percentage changes.  What this sort of analysis reveals are that:

  • Investment returns are about the same over long periods of time:  e.g. Buy and hold strategy had a 49 fold return versus the 44 fold return of the SMA strategy.
  • SMA strategy is out of the market or allocated to cash over a significant period of time compared to the buy and hold strategy
  • Risk profile is vastly different over the short term (especially in volatile bear markets):  e.g. Buy and hold strategy lost 31% since the Lehman failure on Septeber 15, 2008 versus 5% for the SMA strategy
  • Transaction costs add up and shouldn’t be ignored:  The SMA strategy would have had resulted in 881 different transactions over the time period analyzed.  At a ballpark cost of $5/trade, the SMA trading strategy would have cost $4405 resulting in returns being entirely eroded.

Trendsetter or Trendfollower?

Based on this, different demographics may have different investment objectives.  It makes sense in general for young people to have a more aggressive portfolio as to fully expose themselves to the full upside of the market over long periods of time, similarily it makes sense for older people to have a more conservative portfolio that is geared towards capital preservation.  In the current market, I am looking to change my allocation from a moderately conservative portfolio to something more aggressive.  Generational lows in US housing sales and vehichle sales should support a floor to certain sectors of economic growth.  In addition, credit market spreads (leading indicator) have improved greatly since the Lehman bankruptcy in September  and price to earnings ratios seem relatively close to fair value given the large expected drop in corporate earnings.

In summary, paying attention to the SMA may be useful for people looking to reallocate money into a higher returning investment with most of the upside exposure, yet wanting to avoid the potential for more drops in a volatile bear stock market.