Sunday, September 25, 2005

Crude Oil fell from a peak of $78+ to under $60 as of this morning’s trading. A sense of “well, we don’t have to worry about energy anymore” has descended upon mankind. As the famous game show host used to say: “EEGHGHGH!!! Wrong! Thanks for playing!”

“All I know is what I read in the newspapers” – Will Rogers

If all you know is what you read in the newspapers, you have been misinformed. For the past 20 years Crude Oil (and its derivative products) experienced a seasonal decline in price each Fall, averaging nearly 20%. This year’s decline was earlier and steeper than expected, but in hindsight, the steepness of the rise in price was warranted at that time considering the supply risks – and the steepness of the decline was warranted by the removal, even if temporary, of these risks. Further, several large hedge funds have experienced tremendous losses on heavily leveraged positions, and were forced to sell billions of dollars of commodities and securities positions in less than 2 weeks. The futures market has prices in the mid 70’s going out 5 years. In other words, the pros think controlling oil in the mid 70’s for the next 5 years is going to make them money – and that the price will be higher than the contract price (otherwise one would buy at the spot price).

After review of the supply numbers for the U.S. for January to August, 2005 vs the same period for 2006

(You can review U.S. domestic production and imports yourself, just go to: and

total supply actually went down. . The U.S. Energy Information Agency (“EIA”) reports that demand was 20.73 million barrels per day (“mbpd”) in 2004, 20.66 mbpd in 2005, and expects 20.66 mbpd in 2006. Let me be the first to point out that NOT ALL OF THE NUMEBRS ADD UP PERFECTLY (the data sources are disparate, but it’s the trend we are looking for)… but if imports are down, and domestic production is down, and demand is flat… why are inventories “high”? Maybe they are not. Total supply is not the correct method of measurement – the number of day’s supply is the correct unit of measure.

“OECD inventories began the second quarter at the upper end of their past 5-year range for this time of year. However, when measured on the basis of how many days of demand the current supply could meet, OECD inventories were only in the middle of their observed 5-year range. By the end of 2007, EIA projects days of supply of OECD inventories to finish at the bottom of the 5-year range for that time of year, which is expected to make the market even tighter.” U.S. Department of Energy, Energy Information Agency, 9/12/06

At times like this it is important to “keep your eye on the ball”, the supply/demand equation. For better or worse, circumstances have not improved on this front and the energy dilemma is still with us, and not to put too sharp a point on it…

China, India… China, India… Chindia… there is no doubt that these gigantic populations are going to drive the majority of the increased energy demand picture over the next decade. Here is something the market (and those screwy newspaper reporters) has not factored into the demand equation. The collapse of the Soviet Union and subsequent economic fallout depressed the consumption of the countries of the Former Soviet Union (“FSU”) by at least 4.3 mpbd during the 1991 – 2005 period.

“In retrospect, the best way to review key fundamentals is to look carefully at changes in global supply and demand, and where they’ve come from. Between 1991 and 2005, global demand for oil grew by 16.6 million b/d. More astonishing is that non-FSU demand grew from 58.9 million b/d in 1991 to 79.8 million barrels a day in 2005. In other words, outside the unanticipated collapse of the Former Soviet Union, the rest of the world's oil demand grew by 20.9 million barrels a day in just 14 years (35%; 2.5% per year) vs. the projection by many oil pundits that oil demand growth was certainly slowing down.

In the meantime, non-OPEC oil supply, outside the FSU, grew in that same 14 years, but only by a modest 6.7 million b/d, from 31 to million b/d to 37.7 million b/d. That’s less than 0.5 mbd per year. Too many important regions peaked and went into decline. Had the FSU not been able to grow from 10.4 million to 11.6 million b/d and OPEC grown from 25.6 million to 34.2 million b/d, the world economy would likely have been in very hot water.” - Matt Simmons, Author, “Twilight in the Desert: The coming Saudi Oil Crash and the World Economy”

And therein lies the rub. Supply is simply not going to be able to keep up with demand in this brave new world of Russian, Chinese, and Indian ascension. The U.S. has 2 % of the world’s oil and consumes nearly 25% of world’s annual production. One does not need a background in mathematics to visualize the intersection of the 2 sloping lines on that graph.

Last year we told our clients that the big story in business for 2006 would be energy - so far, so good. The oil depletion issue, “Peak Oil”, if you will, was considered the lunatic fringe in 2005. In 2006 it has been covered by Forbes, Fortune, Business Week, CNN, CNBC, and The Wall Street Journal, and nearly every daily on the globe. Also, it has been derided by the likes of OPEC, the Oil Minister of Saudi Arabia, Big Oil, and other special interest groups. I would like to point out that these are the same entities that spent BIZZILIONS OF $$$$$$ over the past 2 decades trying to convince the public that global warming was not caused by CO2 emissions emanating from their product…


Why, indeed? Denial. The implications of this issue are simply mind boggling. If these scientists and academics are correct, it is likely the new car you purchased in 2007 will outlive its fuel supply. If and when this dawns on John Q. Public… well, how do you figure that works out for GM, Ford, and those far flung suburban developments 50 miles from the nearest employment center? It is just too inconvenient to consider; denial is a lot easier. If, however, you are not into denial, there is a convention hosted by Boston University this October 26 and 27 on the subject of “Peak Oil”. Scientists, Physicists, and Mathematicians from Princeton, Cal-Tech, and Oxford University, among others, will be presenting. Guess how many members of the U.S. Congress will be there? One, the Honorable Roscoe Bartlett, R- Maryland. Guess what his background is? He’s a scientist. If you are interested in attending please call me.

OPEC? Watch what they do, and why – not what they say. OPEC is irrelevant at this point. What’s the point of a cartel if you are pumping as fast as you can? Only a fool thinks they intend to cut production with prices anywhere over $40 per barrel… not to mention the fact that Saudi Arabia has ordered so many drilling rigs that the daily rental price has more than doubled worldwide! Now why would you want to develop more production capacity if you are going to cut production? Somebody, please, give that CNBC reporter a V8!!!

Real Estate

The residential market in South Florida is at the beginning stages of a 5 – 10 year correction. It is not as bad as Japan, 1992, but its pretty bad. And its not just current “prices, supply, and demand”. Healthcare and construction have been the only legs on the stool, and construction is in contraction. Healthcare? It has been great, but I cannot see how things can improve in the coming years – this is as good as it gets. Government reimbursement drives the industry and growth from this quarter is coming to an end. Did I mention your potential employees cannot afford to live here on what you pay them? Commercial property investors might get some relief in the form of lower, long-term interest rates, but it’s a catch 22. To get the lower rates, the housing correction (crash?) would have to get worse. You might get some relief on debt service, but your vacancy rates are going higher still. And if rates were to go higher? I don’t even want to think about it. Let me remind you that the most beautifully designed building, at the finest location, brilliantly financed – without tenants is on the fast track to foreclosure. If you have any doubts about this, call me, and I will tell you the story of the Resolution Trust Corporation.

Guess what the best performing Real Estate asset class for past 12 months was: Agricultural property. Yep. Not those shimmering condos in Miami overlooking the bay, it was a cornfield overlooking a feedlot full of manure – go figure. Now, who told you about this last year? Who put his money where his moth is and bought a farm early this year? The same guy who wrote in early 2005 that speculators in South Florida single-family homes had lost their marbles… but I won’t mention any names…

The Real Estate industry has a boom and bust cycle to it. It is as good as it gets during the boom. The bust is tough on your nerves. Where are we at this time in the cycle? Residential is a no-brainer. Office? Industrial? Retail? There is no substitute for knowing your market, but under no circumstance are the prices properties are being offered in our market cheap, leaving no room for error, and worse should the economy enter a recession.

Speaking of recession. One of the reason I write this newsletter is to market my perspicacious acumen by letting it all hang out in this forum and then letting prospects see how my prognostications worked out. I think a recession is highly likely, if not unavoidable. There, I said it. Next year you can either call me an idiot, or a genius. But call me. I need the business.

The U.S. Dollar

The Dollar can’t make up its mind – but I can. If rates go lower the dollar gets killed. If rates go higher, the dollar has already gotten killed and the Fed is trying to save it and will kill everything else in doing so. A decline in the dollar’s value can be a good thing for real estate, Gold, Silver, and Oil. I say, “can be” in regard to real estate investors. The U.S. Dollar heading south is good for Oil and the precious metals in nearly all circumstances, but that is not necessarily so for Real Estate. For the rest of us, it is not so good. If you actually have assets, this is quite the conundrum.

The Financial Markets

The bond market tells me we are headed for a recession. The equity market tells me we are in the “Goldy Locks” zone – neither too hot nor too cold. They can’t both be right. If the economy is going to continue to expand at the clip expressed by the stock market’s gains, the bond market would be taking some serious heat and long rates would be headed much higher. After 20 years at this I firmly believe that the bond market participants do much better homework.

Tuesday, September 20, 2005


As we discussed in our September 6, 2005, comments, the Federal Reserve raised its target for the Fed Funds Rate to 3.75%. The Fed gave some lip service to Katrina, but kept the rest of the language from their recent announcements intact. With the 2 year T-note yielding, at this moment, 4%, and the 10 year T-bond yielding 4.29%, the yield curve is flat enough that: A. We are heading into a recession; or, B. The longer end of the curve is going to rise in yield and fall in price. We are squarely in the “B” camp.

Real Estate:

For you Real Estate speculators out there: We would prefer to jump out of a 3rd floor condo unit’s window rather than buy the unit (it would be a coin toss if faced with the 4th floor). Single-family investment properties in South Florida are dead money for the foreseeable future, just as they were from 1990 – 1999.

Commercial properties? The prime rate - now 6.75%, and we expect 7.25% no later than Q1, 2006 – is the benchmark for corporate borrowers and commercial mortgages. The average yield spread for a commercial mortgage in South Florida is 1.5 – 2.0 % over prime, giving us 8.25 – 8.75 % commercial mortgage rates, and asking cap rates of 7.5%. No wonder these properties are not moving! The Fed has clearly stated their intentions, in our opinion. They intend to move the long end of the yield curve higher – by any means necessary. There is no relief in sight for either commercial or residential property investors in South Florida - interest rates are going the wrong way, insurance costs are spiking, as are energy costs (read your FPL bill lately?), the supply issues are horrendous (of course, a nice category 5 landfall would adjust those nasty supply issues quite nicely), and that is before green Real Estate investors come to the conclusion that (unlike financial instruments) left unattended their investments will rust in the rain, and rent yields are barley above the cost of taxes and insurance in many cases. The rent yield issue is going to get worse, in my opinion. As I have stated before, South Florida has become Real Estate centric. As this market corrects, a lot of space now rented to people working in the industry is going to be on the market, further worsening bleak rental yields.