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  THE
KWR INTERNATIONAL ADVISOR February
2005 Volume 6 Edition 1
In this issue:
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Global
Outlook: Precipitous Decline or Slow Economic Adjustment?
by
Scott B. MacDonald and Keith W. Rabin
NEW
YORK (KWR) The usual set of strikes in France, the possibility
that reform of Japan's postal bank will be diluted, and
apprehension that the Bush administration will not make
much headway on reducing the sea of red ink on the federal
fiscal ledger all point to one thing – a certain
warped convergence between the world’s major economies.
In a very simple sense, U.S., European, Japanese and
even the Chinese economies need each other – to
maintain a status quo that allows them to put off politically
painful and hardnosed economic reforms. The current system
of mutual support – the flow of funds from Asian
and European investors into the United States in the
form of Treasury and corporate bonds and, in return,
the active stance of U.S. consumers in buying imported
goods with that borrowed money, keeps Japanese, Germany
and French companies pumping out products, making profits
and workers employed. At some point the music in this
dance must come to an end and the band paid. Yet, this
day of reckoning could well be postponed for several
more years. While this will make the inevitable meltdown
all the more harsh -- until the carousel ride stops,
the party goes on.
The sad thing is all the players recognize the problems.
For the United States, it is a combination of large fiscal
and current account deficits, a top-heavy reliance on
the consumer, an alarming depletion of personal savings,
a pressing need for tort reform, and serious issues concerning
social security. For Japan, its is the government’s
massive build-up of debt to about 150 percent of GDP,
the need for further structural reforms such as postal
system privatization, a continuing reliance on the export
sector, and a rapidly aging population.
For the Europeans, in particular the continental giants
of France, Germany and Italy, critical reforms are required
in terms of labor markets, pension systems and competition
laws. Current efforts remain inadequate. Failure to reform
has resulted in anemic economic growth, higher-than-expected
government spending and deficits and, in some cases,
a failure to meet EU Growth and Stability Pact targets.
Europe also has to consider similar, though not as extreme,
demographic trends as Japan.
China has also bought into this system. It is in the
process of a massive economic transformation. For it’s
leadership to be successful, it must have strong economic
growth and some ability to distribute its national wealth.
To achieve this goal, China needs markets for its goods
and the ability to source industrial inputs such coal,
copper and oil. China also requires some degree of stability
in international currency markets, hence its glacier-like
approach to allowing its currency to float. If Europe,
the United States and Japan were to embark upon needed
reforms, economic growth in those countries could slow.
If that were to happen, the current great Chinese leap
forward which started in 1978 could sputter. Any major
slowdown could result in social unrest, perhaps even
upheaval.
What all of this means is that the United States, Europe,
Japan and China are locked into their current patterns
of economic growth. The nagging issues of high unemployment,
looming pension and social security crises, and untidy
fiscal accounts are likely to continue. As for China,
do not look for any floating of the currency in 2005
and for growth only to modify down to 8 percent in 2005
from last years, 9.6 percent. China will achieve a soft
landing, but is likely to be longer and bumpier than
many expect.
What keeps this system in place is that no one really
wants to see it collapse. Change will be painful for
everyone, so it remains easier to push the day of reckoning
further into the future, beyond current political terms.
The U.S. current account deficit will continue to be
a problem, with no one wanting to make the adjustments – in
terms of allowing the Euro or Yen to appreciate too much
to threaten growth. We have already seen a recent round
of squabbling between Europe and Asia over who will assume
the burden of another round of dollar weakening. In 2004
it fell more on Europe; now the Europeans want to see
the Asians pick up some of the adjustment burdens. Japan
was quick to indicate it might intervene in international
currency markets, especially if the dollar/yen ratio
drifts toward the 100 mark.
The results of failing to act on economic problems in
the world’s largest economies is likely to be one
of ongoing budget and current account deficits in the
United States, marked by periodic weakening in the U.S.
dollar. Japanese economic growth, while positive, is
likely to remain below its potential, and the nation
will struggle to deal with the public sector debt it
has taken on. As for Europe, the pressures on pension
and social services are likely to mount, as there will
be fewer people to support an aging population. And Europe’s
large economies will face strong pressures to move businesses
further East to countries like the Ukraine, with well
educated populations, but far lower wages and social
costs.
The ultimate result of this system is a long, range-bound
era of moderate to weak economic growth, eroded by a
lack of the changes badly required to address population
shifts and the necessary economic transition. At some
point, something may give – a plunge in the dollar
that does not stop, an unexpected currency move by China,
or a major financial meltdown caused by mistakes with
derivatives. Such a meltdown could be far worse than
anything seen in recent history due to the accumulation
of debt and structural inefficiencies – sadly all
of which could have been corrected at an earlier period.
From an investment standpoint, however, the key question
is whether we will see things unwind in a slow economic
crumble or a precipitous drop off the cliff. The former
would suggest the Fed is likely to continue or even reverse
its “measured pace” posture. Under that scenario,
current trends such as rising commodity prices, an out-performance
of emerging over developed markets and even perhaps the “bubble-like” appreciation
of U.S. real estate markets may continue for sometime.
A drop off the cliff, however – and many extremely
smart investors have patiently waited and underperformed
over several years believing this to be inevitable – would
have ominous implications.
While entirely possible – and even justified based
on the underlying fundamentals – it is hard to
see how anyone would benefit from an abrupt systemic
shock and major economic dislocation. This does not mean
it will not happen, and things could certainly get out
of hand. Massive liquidity, however, and the complementary
though admittedly dysfunctional relationship highlighted
above, does indicate that a more gradual adjustment is
entirely possible. While this does not eliminate the
potential for manic, volatile swings as we seek to determine
whether inflation or deflation will gain the upper hand.
It does, however, argue against a doomsday “imminent
depression” in the immediate future. These alternatives
have very different implications for both fixed income
and equity investors.
The
Bush Trade Policy Agenda in 2005
by Russell L. Smith and Caroline G. Cooper, Willkie Farr & Gallagher
LLP
WASHINGTON
(KWR) Trade and security policy often went hand-in-hand
during President George W. Bush’s first term
in office, particularly following the September 11,
2001 terrorist attacks. Trade policy was often used
as a tool to advance the President’s security
policy agenda. USTR Robert Zoellick pursued free trade
agreements (FTAs) with a range of countries, most of
which supported to one degree or another U.S. policy
in Afghanistan and Iraq. In 2004, the President added
a focus on the Middle East to the trade agenda, again
to further foreign and strategic policy goals. Perhaps
the only exceptions were the Central American Free
Trade Agreement (CAFTA) and bilateral FTAs with Panama,
Colombia, Ecuador, and Peru, which Bush and Zoellick
pressed to complete and began to negotiate, in part
because of the lack of any real progress on the broader
Free Trade Agreement of the Americas (FTAA). This was
in part to honor Bush’s 2000 campaign commitment
to focus on the southern hemisphere, which he otherwise
did not do during his first term.
The agenda also included what many regard as a good-faith
effort by Zoellick to revive the faltering Doha Development
Agenda negotiations. While still another agreement in principle
was reached on the keystone issue--agricultural subsidies--as
2004 closed, the prospects for successful and timely conclusion
of the Doha Round were still quite uncertain.
Will the second Bush term that began on January 20, 2005
mean more of the same on trade? The answer appears to be
a qualified yes. Bush and his new USTR, whoever that may
be, will need to broaden the scope of their trade activities
beyond strategic allies and politically helpful neighbors
to address fundamental bilateral, regional, and global trade
problems and opportunities. Bush and Zoellick have already
acknowledged this to some extent through their post-election
remarks, Zoellick’s global travels, and Bush’s
planned trip to Europe not long after Inauguration Day.
At the bilateral level, there is a recognition that trade
disputes with the EU need to be addressed more methodically.
Ideally they would be resolved, before they become full-blown
trade confrontations, since the damage that retaliatory tariffs
do to the trading relationship is often counterproductive
for both EU and U.S. companies, and in some cases does not
resolve the trade conflict at all. The same is true of the
seemingly endless question of duties on Canadian softwood
lumber, as well as disputes over a large number of dumping
law issues that affect dozens of U.S. trading partners.
The bilateral challenges also include China. The United States
has yet to settle upon an effective and constructive approach
to its huge and growing trading relationship with China.
USTR and the U.S. Commerce Department simultaneously praise
and excoriate China on trade issues, pressure China to restrict
textile and apparel exports, and then reportedly challenge
China’s announced apparel export tax as both insufficient
and potentially WTO-illegal. Beyond official Administration
ambivalence, many Members of the U.S. Congress have now substituted
China for Japan as the scapegoat for all U.S. manufacturing
competitiveness problems.
China is the target of a substantial
flow of U.S. dumping cases, and the United States appears
ready to trigger special safeguard measures to place new
quotas of Chinese apparel exports. At the same time, U.S.
retailers and their customers demand the inexpensive consumer
goods that are the backbone of China’s capitalist economic
development, and major U.S. companies (autos, for example)
grow more and more uncomfortable with the risk that a souring
of the trade relationship will be taken out on their facilities
in China. The nature of China as a strategic rival, as well
as a massive trading partner and potential market, is not
the same as that of Japan when it began to be perceived as
a trade “problem.” The Bush Administration would
be well advised not to view its approach to Japan--regular
pressure and threats with the occasional confrontation--as
a template for China. The emergence of China as a major economic
and strategic force in the world, with a clear impact on
U.S. policy, demands a more orderly and measured U.S. approach
to the bilateral relationship.
Beyond China, the rest of Asia should and will receive more
attention in the second Bush term. Japan is emerging, albeit
slowly, from it recession, and the U.S.-Korea trade relationship
needs to be nurtured. Korea is hopeful of progress on an
FTA with the United States, and as noted by USTR, there is
a potential for such progress if some threshold issues (telecommunications
and pharmaceuticals, for example) can be taken “off
the table.” U.S. assistance to the countries devastated
by the December 2004 tsunami is almost inevitably going to
have a trade and development component, which, hopefully,
will go far toward enhancing the perception of the United
States in the region. While the issues in the U.S.-Thailand
FTA negotiations are difficult, there appears to be a relatively
cooperative spirit on both sides and a natural alliance that
indicates that an agreement is possible by the end of 2005
or just thereafter.
At the global level, without strong leadership from the United
States, the Doha Round will not move forward. The Hong Kong
Ministerial at the end of 2005 may define whether the DDA
is a success or a failure. While all the major parties profess
to support the elimination of agricultural subsidies, the
devil is definitely in the details. The personality and determination
of the new USTR will be by far the most important element
in determining whether any substantive agreements can be
reached. Zoellick was willing to take significant political
risks, make controversial concessions, and “carry the
ball” virtually alone simply to keep the DDA alive
and achieve an agreement in principle. Whether the new USTR
can or will do the same is open to serious question. If not,
recent history indicates that no other country can or will
provide such leadership.
At home, Bush and his trade officials will also face some
challenges that could affect how they conduct themselves
abroad. President Bush will inform Congress that he wishes
to extend his negotiating flexibility under Trade Promotion
Authority (TPA) for two additional years, and Congress will
have the opportunity to vote this down. While the risk of
defeat is small, the debate may be quite bitter and some
of the proposals that are thrown up as a “price” for
the extension may be most unattractive. Again, the worst
of these will be rejected, but the experience of the last
three decades in U.S. trade legislation has been that the
integrity of U.S. trade laws and of the openness of U.S.
markets is degraded to some extent whenever Congress takes
up Presidential negotiating authority.
While there will be efforts to repeal the WTO-illegal Byrd
Amendment, which pays dumping duties to supporters of dumping
petitions, the entrenched opposition to such repeal in the
U.S. Congress is substantial. Again the price of repeal or
change in the law, if it introduces further bias in U.S.
dumping or other trade remedy laws, may ultimately be more
distasteful than living with Byrd. Such is the reality of
the very unreliable political support for true free trade
principles in the Congress today.
Finally, to conclude on a positive note, free trade principles
should prevail when Congress reviews U.S. participation in
the WTO. Any Member of Congress may call for the U.S. to
withdraw from the WTO every five years, and the second such
anniversary comes in 2005. It is inevitable that a number
of Members of Congress may introduce a withdrawal resolution,
but the necessity that neither the President nor the Republican
leadership in Congress be embarrassed by the passage of such
a resolution virtually guarantees its defeat.
This analysis indicates that the second Bush term, whatever
its other priorities, will give more attention to trade than
in the first term, and that it will be forced to deal with
more complicated and difficult trade issues as well. It is
always possible that the Administration, by simple lack of
commitment or talent, will not give trade the appropriate
attention, but that inattention will come at great peril
to U.S. long-term economic strength and global influence.
Bidding
War – Investors Still have an Appetite
for Korea
by Scott B. MacDonald
NEW
YORK (KWR) Although Korea’s economic performance
over the past year has not been as robust as
it has been in the past and the North Korean
issue still looms like a dark cloud on the horizon,
foreign investors still appear to have a strong
interest in buying into this market. This was
recently underscored by a bidding war over Korea
First Bank. In early January a bid by London-based
HSBC was beaten by a $3.3 billion offer from
Standard Chartered Plc, another UK-based bank,
which makes two-thirds of its earnings in the
region, and a strong tradition and operating
presence in Asian markets. The winners in this
deal are San Francisco-based buy-out firm Newbridge
Capital and the South Korean government. Standard
Chartered’s determination to win Korea
First reflects an understanding that the East
Asian nation is increasingly a service driven
economy and there will be an attractive market
for more sophisticated financial products.
International banks are looking at South Korean market
given that there are around $44 billion of annual banking
fees generated in the country. That is more than three
times the amount generated in Hong Kong, one of Asia’s
more developed economies. Along these lines, Korea
First is attractive – it holds six percent of
the market, has 404 branches spread across the country,
and is profitable. The bank has 1.1 million credit
cards issued and 2,100 automated cash machines. There
are a little over 5,000 employees. The purchase will
allow Standard Chartered a platform upon which to compete
with Citigroup and HSBC, both of which are already
active in this East Asian country.
Clearly Standard Charted felt compelled to act. In
2004, the UK bank sold its 9.8 percent holding in South
Korea’s Koram to Citigroup after the U.S. bank
beat Standard Chartered’s bid for the entire
bank. Koram sold for $3 billion. However, Korea First
has solidified Standard Chartered’s position
in a key Asian economy. Indeed, after the purchase,
South Korea will account for 16 percent of Standard
Chartered’s revenue and about 22 percent of its
asset base. The expectation is that Korea will soon
bypass Hong Kong as the bank’s largest market
by revenue, assets and branches. As Standard Chartered’s
CEO Mervyn Davies stated: “South Korea’s
population of about 48 million people gives the country
a very strong banking revenue pool.”
Standard Chartered’s action is being questioned – economic
growth in South Korea is slowing to under five percent
and many of Korea’s credit card holders have
built up high levels of debt. LG Card, the nation’s
major credit card company, is struggling to stave off
bankruptcy caused by too many deadbeat creditors. In
addition, the some are concerned that Korean companies
are likely to hold back on spending plans and might
borrow less in anticipation that there will be a slow
patch in the economy. Yet, Standard Chartered plans
to capture 10 percent of the market and sees South
Korea as a market where it must be involved.
South Korea is increasingly attractive for international
banks. The country has a high level of GDP per capita,
is developing a credit card culture (despite LG Card’s
problems), and has a sizeable population. Citigroup
has Koram and Standard Chatered has Korea First. The
next battle over bank ownership could come up in November
2005, when the U.S. firm Lone Star has the option to
sell its 51 percent share of Korea Exchange Bank, Korea’s
fifth largest lender and worth $5 billion. The challenge
for foreign banks is multiple – they have to
be sensitive to the local business culture, maintain
a high level of transparency and disclosure, and know
how to market new products. As seen by the large-scale
introduction of business cards and relatively substantial
problems with deadbeat borrowers, Korea’s financial
markets still offer some challenges. All the same,
the purchases of Korean banks and the prices being
gained reflect that the country’s banking system
has come a long way since the dark days of 1997-98.
China-Taiwan Relations in 2005: Bluster but (Probably) No
Blows
by
Jean-Marc F. Blanchard, Ph.D. Senior Consultant
SAN
FRANCISCO (KWR) China-Taiwan relations started
the year auspiciously with an agreement this month
for cross-Strait charter flights, the first direct
air services between the two antagonists since
1949. Many have heralded this accord as evidence
that China is now willing to adopt a more moderate
stance towards Taiwan. The agreement came in the
wake of the positive outcome, at least from the
perspective of China-Taiwan relations, of Taiwan’s
December 2004 legislative elections. This election
gave a majority of seats in Taiwan’s parliament
to the Guomindang and its allies while handing
a defeat to Taiwanese President Chen Shui-bian’s
independence minded Democratic Progressive Party
(DPP) and its allies. Pundits forecast that the
composition of the new parliament will, at a minimum,
restrain President Chen from moves towards Taiwanese
independence such as the pursuit of a new constitution.
One should not exaggerate, however, the implications
of the DPP’s electoral loss. First, the DPP
actually gained seats and maintained its position
as the largest party in the legislature. Second,
demographic trends in Taiwan will continue to bolster
the number of ethnic Taiwanese relative to the
number of ethnic Chinese. Third, Taiwanese policymakers
have grown increasingly comfortable advancing political
proposals that would further separate China and
Taiwan from one another. These proposals include
the renaming of Taiwan, its state-owned enterprises
and overseas offices, as well as a public campaign
to get the U.S. to abandon its one-China policy.
To the north, existing trends also are problematic.
For its part, China seems increasingly keen to
assert its right to Taiwan. To illustrate, in late
December 2004, the Standing Committee of China’s
National People’s Congress approved a draft
anti-secession law directed at Taiwan while China’s
military released a white paper stating that it
has a “sacred responsibility” to crush
Taiwanese moves towards independence “whatever
the cost.” Furthermore, China’s military
build-up, which entails the acquisition of military
capabilities that enhance its ability to coerce
Taiwan, will continue unabated. Finally, the Chinese
regime faces daunting political, economic, and
social issues that will challenge its ability to
maintain domestic political stability. This is
consequential because it gives Chinese policymakers
incentives to act aggressively to bolster their
domestic standing.
Many assume that economic interdependence between
China and Taiwan and between China and the rest
of the world will guarantee peaceful cross-Strait
relations. These “commercial liberals” reason
that Chinese leaders, who deeply want to sustain
economic growth to provide legitimacy for the Chinese
Communist Party (CCP), employment for China’s
huge labor pools, and funds for China’s military
development, would be averse to taking action against
Taiwan because it would endanger China’s
external economic linkages. They further argue
that economic interdependence eventually will synchronize
Chinese and Taiwanese identities and interests.
One should not place great faith in commercial
liberal thinking, however. First, the work of international
relations specialists demonstrates that economic
linkages have little power to deter policymakers
from waging war where the highest national interests
(e.g., territorial integrity) are involved. Second,
extensive economic intercourse does not automatically
synchronize national identities or interests. Even
now, many Europeans still see themselves as French,
Italian, or Polish rather than European.
Ultimately, the course of China-Taiwan relations
in 2005 will depend greatly upon domestic political
developments in China. Recent reports suggest that
Chinese President Hu Jintao has consolidated his
position in the CCP’s political hierarchy.
Not only has he assumed control of the powerful
Central Military Commission, but he also has put
his allies into key political and military positions.
If true, these developments are a positive for
cross-Strait relations because external Chinese
aggressiveness historically has occurred in concert
with the country’s domestic political problems
or the leadership’s domestic political woes.
If, however, domestic political competition threatens
Hu or domestic problems threaten the regime, then
2005 could be a very rocky year indeed for China-Taiwan
relations.
Shifting outside China, it is clear that American
policies will exert a tremendous effect on the
cross-Strait dynamic. On the bright side, there
are those in the Bush Administration who seek to
preserve the status quo. On the other hand, there
are many in the Administration and in Congress
who champion greater support for Taiwan. If the
balance of power swings in favor of the moderate
camp, then the U.S. likely will exert a dampening
influence on China-Taiwan frictions in 2005. Conversely,
if the balance of power swings in favor of the
latter camp, then the U.S. likely will fan cross-Strait
tensions.
Japan also is critical to China-Taiwan relations.
One reason is that Japanese forces are part of
the implicit deterrent against Chinese military
action against Taiwan. Another reason is that Sino-Japanese
economic ties must enter into the calculations
of Chinese leaders contemplating aggressive action
against Taiwan, although they are no guarantee
of restraint. A final reason is that Japan’s
growing efforts to assert itself internationally,
manifested by its increasing role in UN peacekeeping
operations and adoption of a more realpolitik stance
towards China and China’s allies, will exacerbate
Chinese sensitivities about Taiwan. This is so
because a more “normal” Japan is likely
to take a more independent stance with respect
to Taiwan. As well, a more “normal” Japan
places pressure on Chinese leaders not to back
down on Taiwan lest they seem weak in Japanese
eyes.
According to the Chinese calendar, 2005 is the
Year of the Green Wooden Rooster. Chinese astrologers
note that roosters are blunt, flamboyant, and self-assured
and that the Year of the Green Wooden Rooster is
expected to entail conflict. For the reasons discussed
above, China-Taiwan relations will manifest a number
of Rooster and Rooster-year characteristics in
2005. These frictions should not explode into military
conflict, provided that the domestic political
situation in China remains stable, the U.S. ameliorates
rather than accentuates conflict between the two
protagonists, and China-Japan relations do not
dramatically deteriorate. Unfortunately, uncertainties
in each of these areas make it difficult to predict
with any confidence whether relations between China
and Taiwan will end the year on as positive a note
as they began it.
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Contact: Dwight Ingalsbe email: ingalsbe@epfr.com
by
Scott B. MacDonald
NEW
YORK (KWR) The political map of Eurasia is
changing. Following the victory of the Western-oriented
presidential candidate in Ukraine in December
2004, in what was a highly controversial
election, Russian President Vladimir Putin
is further consolidating his power at home
and the more liberal members of his government
are being shunted aside. The process of creating
a more hardline government started earlier
than the Ukraine election, but events in
Russia’s neighbor re-emphasized that
the Eurasian landmass is still very much
in play in terms of political ideas. Along
these lines, it should be alarming to the
West and Asia that there is a shift from
the democratic-capitalist experiment started
under Boris Yeltsin to a soft authoritarianism
dominated by strong nationalists, who have
a marked preference for a larger role of
the state in guiding the economy. While Russia
has not quite returned to the state sitting
at the commanding heights of the economy,
it is certainly moving in that direction.
Moreover, the nationalists are deeply concerned
that the West is seeking to encroach further
into what should be Russia’s sphere
of influence.
Since the fall of the Soviet Union in the
early 1990s, Russia’s international
position has been highly challenged. Moscow
lost control over its former empire in Central
Asia, NATO and the European Union rolled
the border back several thousand miles, and
American influence became a factor in the
Caspian Sea region’s oil fields. The
once greatly feared Russian military struggled
against a spirited Chechen uprising and terrorism.
And at home, Russia’s leaders presided
over a difficult and painful transformation
that entailed an overhaul of an inefficient
state-dominated economy, a feeble banking
sector, and a weak grasp of market economics
(including the idea of rule of law). That
is beginning to change. Russia is beginning
to re-assert itself.
President Vladimir Putin is remaking Russia’s
role in the world. While he has consolidated
his position at home by breaking the power
of the oligarchs (the big business barons
that came out of the 1990s), he is pushing
a stronger, more vocal Russian agenda in
its relations with its neighbors. Russia
has been vocal about the disputed elections
in Ukraine -- clearly favoring the pro-Russian
candidate, critical of the U.S. “soft” approach
in Afghanistan and for having moderates from
the Taliban in the government, and is seeking
to rekindle trade relations with India. The
Russian military is also getting a weapons
system upgrade.
Putin is also working to repay Russia’s
Paris Club debt over the next 2-3 years,
removing one possible area of economic weakness.
In addition, higher energy prices are providing
a nice cash inflow – Russia now has
over $110 billion in foreign exchange reserves
and the budget and current account are both
in surplus. It is very possible that Russia
will be upgraded by S&P in early 2005,
making it fully investment grade.
What does this mean? Going forward, the United
States, Europe, China and Japan are going
to have to pay more attention to Moscow.
Russian natural gas and oil is attractive
to those nations and this means power. Indeed,
Western Europe is increasingly dependent
on Russian natural gas for its energy needs.
Putin is demonstrating to Washington, Tokyo,
Berlin and Beijing that the Russian bear
is back. Although Russian power is still
no match for European economic and U.S. military
power, it is growing and Russian national
interests are increasingly going to be a
factor. This ranges from trade and investment
to the war against international terrorism
and North Asian energy politics. The recent
crisis in Ukraine underscores that although
the old Cold War is over, the potential for
a New Cold War remains.
We expect to see a more assertive Russia
dealing with Europe, which will point out
its energy dependence, playing off Japan
and China over energy in North Asia, and
a more pronounced role in the Middle East
vis-à-vis the United States. Russia
also wants and needs greater foreign investment.
Russia now lags Eastern Europe and even parts
of Latin America in terms of investment inflows.
While much of this can be played out within
the current framework of international relations,
Russia’s desire to once again be seen
as a player is one more factor for Washington
and Tokyo to calculate in what is becoming
an increasingly more complicated international
environment.
KWR
VIEWPOINTS
Featured
Guest Opinion
U.S.
Stock Market Outlook –2005:
Storm Clouds on the Horizon?
by
Mark Reiner, The Doctor's
Investment
Fund, LLC
 NEW
YORK -- Volatility is likely
to increase in the equities
market in 2005 from the
historically low levels
witnessed last year. This
confluence of events will
likely add to uncertainty,
making it a bear market
year.
Equity investors are currently
complacent. Their optimism is
reflected in record high investment
advisor bullishness, low levels
of equity derivatives volatility
and a surge of insider sales.
Late last year, insiders were
selling approximately $60 in
stock for every dollar purchased.
This is troubling, as corporate
management is generally more
astute about their respective
businesses, than perpetually
optimistic Wall Street analysts.
While equity markets had been
contained in a very narrow trading
band for much of last year, the
reelection of President Bush
proved to be the catalyst for
a relief rally, which measured
approximately 5% on a monthly
closing basis. Post election
rallies are common in bear markets.
During the last secular bear
market of the 1970-80s, we experienced
four post-election rallies. Each
peaked during the following January,
followed by harsh declines that
did not bottom until the following
year. The average move of these
four rallies was 5.92% with subsequent
declines measuring approximately
34%. These rallies occurred during
periods of rising short-term
rates and an expanding economy
-- conditions similar to the
current environment.
Bear markets have spectacular
rallies, designed to suck investors
in, whereas bull markets have
violent corrections to shake
out as many shareholders as possible
before resuming their steady
climb. The market has recently
been contained to a narrow trading
range, marking approximately
a 50% retracement of its previous
drop. Historical patterns from
previous bear markets suggest
the market may stall at this
juncture, before resuming the
next leg down of the bear market.
Subsequent to the president’s
reelection, the US Dollar weakened
markedly, while US equities continued
to rise. This dollar weakness
can be attributed to the twin
deficits and record low consumer
solvency. There is also concern
amongst foreigners, that the
U.S. will not be able to finance
its current account deficit as
foreign inflows lag the liabilities
generated.
The dollar fell approximately
30% during Bush’s first
term. The trajectory of this
move is more than the “adjustment”,
called for by many politicians
and journalists. If this trend
continues, a number of U.S. trading
partners could be thrown into
recession. In a worst-case scenario,
the dollar could lose its status
as the world’s reserve
currency, with ominous implications.
That is not a far-fetched thesis,
as the English pound had been
the world’s reserve currency
earlier this century. The pound
lost its prized status, as England
became the world’s largest
debtor. During the last year,
a number of OPEC members proposed
that oil should be priced in
Euros and as world economic power
and concentration moves to the
Asian block, there remains the
possibility of a drastic change
in world currency supremacy.
A major propellant extending
this rally has been the president’s
plan to privatize Social Security.
This proposal has created more
greed in the market, as Wall
Street strategists extrapolate
an insatiable demand for equities.
If this measure passes, there
will be a supply of securities
to meet the investment dollars,
as Wall Street has traditionally
been more than willing to issue
new issues for public consumption.
However, most individuals are
not capable of prudently managing
their portfolios and this initiative
may lead to financial hardship
for many intended participants.
We have recently witnessed a
return of the public investor
to the equities market. This
group had been sitting on the
sidelines, after being devastated
by the puncturing of the NASDAQ
bubble. Today, however, many
have been actively purchasing
many new “dream tickets”,
such as satellite radio stocks,
new internet concepts and stun-gun
plays. This type of activity
is not the foundation of a sustained
market advance. It is usually
witnessed as the market enters
its last leg, prior to rolling
over.
Even more worrisome is the additional
debt burden this proposal would
put on the system. Adding retirement
accounts in place of Social Security
could cost the government close
to $2 trillion over the next
decade, since these accounts
would not go towards paying current
retirees. To fund this expenditure,
the government would have to
borrow additional funds. As the
president promised he would not
increase taxes, passage of this
proposal would be an additional
fiscal burden.
To date, foreigners have been
the largest purchaser of U.S.
debt. This has helped to stabilize
interest rates. As the dollar
continues to decline, their purchasing
habits may change, and they will
look to be compensated for additional
currency risk and the potential
for principle erosion. Any sudden
or significant change is likely
to have a negative impact. It
would be wise to remember upward
movement in interest rates and
a precipitous dollar decline
were the primary causes of the
1987 correction.
Short-term rates have backed
up at an unprecedented rate since
the summer. While base rates
were at a 46-year low when this
move started -- the speed of
the increase and rate of change
is alarming. Changes in monetary
policy take approximately six
to nine months to impact the
economy. Having assumed record
levels of adjustable debt, U.S.
consumers may be forced to drastically
change their spending habits.
This would have a dramatic impact
-- as consumer spending has been
responsible for 70% of GDP growth.
A forecasted slow down of the
economy is also reflected in
a narrowing yield-curve since
the Federal Reserve Board embarked
on a policy change. On June 30th,
the overnight cost of capital
was 1% and the 10-year Treasury
note was yielding 4.60%. Last
month -- with 2.25% overnight
rates, the 10-year note yielded
4.15%. The 30-year US Treasury
bond also had a commensurate
drop in yield. If the economy
was truly expanding, intermediate
and longer term rates would have
had commensurate increases. One
might imagine, however, the change
in relative rates is expressing
the reality of the economy as
opposed to the hope currently
reflected in stock prices.
Other factors the market will
have to wrestle with during the
new-year include Alan Greenspan’s
retirement, a possible economic
slowdown in China, a permanently
higher floor for the price in
energy, inflationary pressures
and the end of the re-finance
boom. In addition, FASB 123,
takes affect on 06/15/04. This
regulation requires public companies
to expense stock options in their
current financial statements.
It is projected that this expense
will impact S and P 500 earnings
by 3-5 percent. At a minimum
this means these are additional
elements of risk that will enter
the equation.
While the current direction remains
to be seen, investors would be
well advised to consider that
the bear market we entered in
2000 may again resume over the
coming year. As the honeymoon
period for the re-election continues
to fade, and investors start
to focus on trouble within the
U.S. economy, it is unclear whether
it will be possible to sustain
the optimism now prevalent within
the investment community.
For
more information on CSFB DNA'S new SD+ Information
Service
click on the banner above
Special
Section: ENERGY DYNAMICS
Asian
Energy Buyers Launch New Regional
Grouping
by Kumar
Amitav Chaliha
NEW DELHI (KWR) At face value, nothing concrete emerged from the first
roundtable of Asian and Middle East ministers on regional oil
and gas cooperation in New Delhi on January 6, except the usual
proclamations on the importance of stability and security in
oil supplies.
However, the confab marked the political launch of a possible new regional
grouping, which is being dubbed the Asian Energy Forum or Asian Energy
Agency. "We have made a start and this is going to continue," Mani
Shankar Aiyar, India's petroleum minister and host of the conference,
said. Aiyar said that getting all the oil ministers under one roof to
discuss Asian energy cooperation was an achievement in itself.
Saudi Arabia has offered to hold the next Asian roundtable, with Japan
acting as the co-host. Tokyo has also agreed to hold the third conference,
with Qatar as co-host, while Kuwait would host the fourth meeting, with
Korea as co-host. Aiyar could not confirm if the ministers of producing
and consuming countries would meet once or twice a year. The date for
the second meeting has not been set, but it would likely be next year,
Saudi Oil Minister Ali Naimi told reporters.
"An Asian dialogue is indispensable and is aimed at evolving an
Asian consensus," Aiyar said in his concluding remarks.
Aiyar, a career diplomat, argued that Asia is emerging as an important
production and consumption center. The Middle East accounts for nearly
70% of Asian crude imports, but Asia still behaves as if it were a residual
consumer of Asian oil production, said Aiyar.
The Indian minister stressed the need for the emergence of an Asian crude
benchmark and development of a regional spot market.
He also said that Asian countries should invest in the Middle East region,
which need an estimated $1.6 trillion in investments in upstream, midstream
and downstream, and stressed to create strategic storage facilities to
avoid oil shocks.
Saudi Minister Naimi said that Asia should continue to depend on the
Middle East instead of diversifying supplies in the name of security.
"
I'd like to assure our customers in Asia that Saudi Arabia is both capable
of, and committed to, meeting the petroleum needs of its Asian partners," Naimi
told the conference. "We closely monitor growth of petroleum demand
in Asia to anticipate future needs so we can meet them without delay."
Saudi Arabia ships more than 4.5 million barrels per day to Asia, representing
nearly 60% of its crude exports and 20% of Asia's current consumption.
Naimi also said the kingdom is dedicated to maintaining spare production
capacity of 1.5 million-2 million barrels per day (bpd) should the need
arise. He invited India to submit bids for gas exploration and investments
in downstream.
For its part, Saudi Arabia is actively pursuing investments in refining
capacity in Asia, Naimi said, pointing to investments in South Korea,
Japan, Philippines and China.
"
Restructuring of the industry in some Asian countries has brought more
opportunities for joint investment in downstream activities," Naimi
said. "We'll continue looking for partners across the continent
for refining and marketing investments. We've the capacity to supply
crude to our joint ventures throughout Asia."
Kuwaiti officials also stressed the importance of Asia as a key consumer
of Middle East crude.
UAE Oil Minister Mohamed al-Hamili said that the Middle East is expected
to increase its production capacity to 40 million bpd by 2020 from around
25 million bpd today. He reinforced Saudi Arabia's view that Asia will
continue as a key market for Middle East crude.
Iran's Bijan Zangeneh floated the idea of creating an Asian Bank for
Energy Development to invest in oil infrastructure in Asia. Zangeneh
said the oil majors are not the commercial agents for countries such
as China, India, Japan and Korea, and said these large consumers should
invest in developing petroleum resources in the main producing countries.
The oil consuming countries led by Japan, South Korea and China stressed
the need for stability and security of supplies through mutual investments,
stockpiling and the forging of an Asian energy policy. Japan suggested
that a combination of stockpiling crude -- it has 73 days of storage
-- energy conservation measures, spare upstream capacity, and increased
upstream investment is needed to ensure supply security. Tokyo stressed
the need for transparency in crude prices to avoid paying a premium.
Zhang Xiaoqiang, vice chairman of China's National Development and Reform
Commission, noted that his country imported more than 2.6 million bpd,
with domestic production estimated at 3.5 million bpd. He said that China
was not responsible for a spurt in global crude prices last year, because
it imports less than 40% of its total consumption.
Korean officials mooted the idea of creating a joint oil stockpile for
Asia, storing supplies in countries where facilities are available. They
also stressed the need for an Asian energy policy forum at the ministerial
level, saying that organizations such as the International Energy Agency
do not take care of Asian interests.
Asian
Oil Demand Poised to Slow after
a Record 2004
by
Kumar Amitav Chaliha
NEW
DELHI (KWR) Asia's oil demand growth is expected
to slow in 2005, as key markets including China,
India, Japan and South Korea appear poised
to grow at slower rates as their economies
cool and alternative sources of fuel are consumed
in place of expensive crude, according to Facts,
a US-based oil consulting firm.
Facts chief economist Jeffery Brown said in a report
on Asia-Pacific demand that 2004 had been a record
year for Asia with oil demand growth of 1.019 million
barrels per day (bpd). Brown expects growth from
2005 to 2010 to slow to 600,000 bpd to 800,000 bpd.
China was the driving force behind Asia's demand
growth for 2004, contributing 737,000 bpd, equivalent
to 72.3% of the region's total increase in consumption,
with its "robust economic performance and the
corresponding growth in petroleum use in almost every
sector of the economy." Brown said that he expects
China's incremental demand for oil to slow in 2005
on forecasts of slower economic growth.
He also said China's power shortages in 2004 had
temporarily boosted oil demand for power generation.
More coal- and gas-fired power plants are scheduled
to come on line in China this year, which would significantly
impact oil demand for power generation. Over the
long run, Brown believes a sustainable growth rate
for Chinese oil demand is 350,000 bpd to 400,000
bpd.
Other key countries including India, Japan and South
Korea will most likely to post little or negative
growth in oil demand, Brown said.
India's oil demand growth has been stagnant, at just
141,000 bpd in 2004. Brown said India's "inter-fuel
substitution away from oil, which contributed to
slow growth over the period 2000-03, has reached
a peak" and demand should increase by between
70,000 bpd and 90,000 bpd from 2005 to 2010.
Japanese oil demand is expected to dip in the coming
years, in large part due to its mature economy and
shrinking population.
South Korea will follow Japan's footsteps and show
a fall in demand, again largely as a result of the
country's mature economy. South Korea is expected
to have a growth rate of 40,000 bpd this year, according
to Facts.
Smaller countries such as Thailand and Indonesia
will show continued growth, assuming their governments
maintain subsidies on high oil prices. Both countries
have been working to reduce subsidies without affecting
the local economy. Government officials in Thailand
and Indonesia are finding it increasingly difficult
to sustain the costs in the current high price environment.
Fruitful
Year Predicted for Foreign Oil and Gas Firms
in the Middle East
by
Kumar Amitav Chaliha
NEW
DEHLI (KWR) After a slow 2004, this year
could prove to be a period of progress in
oil and gas developments in the Middle East,
with the conclusion of many large deals for
upstream developments and a greater role
for foreign companies in the region, according
to UK consultants Wood Mackenzie (Woodmac).
Spiraling oil prices in 2004 brought to light the
scarcity of global spare capacity as OPEC producers
pumped oil at maximum rates to cool markets. But
while several deals were completed, there was "little
progress with the 'big oil' opportunities in Iraq,
Kuwait, Abu Dhabi and Iran," said a recent
report by Woodmac. Major projects were delayed
by factors such as security in Iraq, political
wrangling in Kuwait and protracted negotiations
in Iran.
With sustained growth in oil demand and high oil
prices, 2005 shows signs of being a more successful
year for the Middle East in terms of concluding
contracts, said the report. This year could "be
the year which sees the international majors assume
a more pivotal role in the growth of OPEC production
capacity," Woodmac predicted.
"Based on current status of negotiations and
the perceived desire for progress, we expect the
Yadavaran
project in Iran, the Upper Zakum development project
in Abu Dhabi and Project Kuwait to proceed to contract
agreement in 2005," Woodmac said. Other pending
contracts include liquefied natural gas ventures
in Iran and gas projects in Syria.
Still, Woodmac stopped short of unbridled optimism,
cautioning that regional or global events could "intervene
to dictate otherwise."
Domestic politics remain "the primary influence" on
the progress of expansion projects, the report
said, "whether it be parliamentary wrangling
in Kuwait, presidential elections in Iran or the
new ruler in Abu Dhabi. While developments in the
oil market and the prevailing oil price will influence
considerations, it is policies which will dictate
the pace. This makes forecasting developments in
2005 a precarious business."
In Saudi Arabia, state Saudi Aramco has the technology
to maintain and increase capacity, so the question
is one of cost rather than capability, noted Colin
Lothian, senior Middle East energy consultant at
Woodmac. Saudi Arabia late last year confirmed
its intention to increase capacity to 12.5 million
barrels per day.
Manouchehr Takin, upstream analyst at the Center
for Global Energy Studies in London, noted that: "History
has shown that plans can change, depending on events
and unknown factors," but he also agreed that
the Middle East should progress this year in the
development of its vast hydrocarbon resources.
As an example, "Iran needs to open and expand
its oil and gas industry. … Even the most
conservative in Iran recognize that business needs
to be pragmatic and de-politicized," Takin
suggested. "The environment in Iran and in
other Middle Eastern countries needs to be more
geared towards business."
Of the significant deals signed in 2004, most were
gas projects. In Saudi Arabia, three gas exploration
licenses were awarded to Russian Lukoil, China's
Sinopec and an Eni/Repsol joint venture, with Aramco
taking 20% of each deal. These contracts followed
the award of the South Rub al-Khali exploration
block to Royal Dutch/Shell and Total in 2003.
In Qatar last year, Shell signed an integrated
development and production sharing agreement for
the Pearl gas-to-liquids (GTL) project. The deal
signed in July 2004 will see the installation of
gas production facilities with a capacity for 140,000
barrels per day (bpd) of GTL products. The first
phase of the two-stage project is expected to be
completed in 2009.
Elsewhere, Iran awarded the South Azadegan block
to a Japanese consortium led by Inpex as well as
three exploration blocks -- the Tousan Block to
Brazil's Petrobras, and the Iran-Mehr and Forooz
Blocks to Repsol.
Petroleum Development Oman -- in which Shell has
a 34% interest -- saw its concession extended for
a further 40 years. PDO is 60% owned by the government,
with Total holding 4% and independent Partex the
remaining 2%. The concession that covers nearly
114,000 square kilometers accounts for more than
two-thirds of the sultanate's production.
However, ongoing security issues, domestic politics
and poor regulatory and fiscal systems in Iraq,
Kuwait and Iran, respectively, continued to hold
up the finalization of major projects, Woodmac
said.
"The buybacks offered in Iran limit rates
of return and do not offer the international investor
entitlement
to oil production," said Woodmac consultant
Lothian.
"Top managers in the National Iranian Oil
Co. feel handicapped in negotiating more attractive
terms
for foreign investors for fear of being reprimanded
by the politicians," another analyst said.
Iraq is a different case, in that security issues
are the greatest hindrance to utilizing its vast
resources more effectively. However, observers
are watching the development of its contractual
terms and fiscal regime, according to Woodmac.
"They have a model contract which is very
similar to the Iranian buyback called the development
and
production contract, which was modified in 2000," said
Lothian. "It will be interesting to see if
they will use this model or whether they will revert
back to the production sharing agreement to attract
inward investment."
In Kuwait, the long-awaited Project Kuwait, which
would enlist foreign companies to develop crude
production in the north, has been the subject of
intense political debate in parliament. Woodmac
does not see approval being given before mid-2005.
Success stories are apparent in Oman and Qatar,
however.
"Qatar recognized an opportunity and grabbed
it firmly with both hands. They developed fiscal
terms
which were sufficiently attractive to international
companies to invest under and have seen this approach
bear fruit," Lothian said.
Likewise,Oman's contractual models have been modified
several times over the years, noted Lothian, who
believes that the Omanis' willingness to talk to
international companies sets a good example for
neighboring countries.
Oman's latest initiative is to offer alliance contracts
-- structured as service agreements giving a high
degree of autonomy to the contractor -- to operate
17 small fields within the Nimr-Karim cluster in
the south of the sultanate. The cluster currently
holds 70 million barrels of oil yet to be recovered,
with current production of 16,000 bpd.
Further ahead, there is a possibility that Oman
will relinquish some of its acreage in the medium
term to help reverse the country's decline in production,
observers say.
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Jet
Fuel Markets in Asia Take Tsunami Effect
in Stride
by
Kumar Amitav Chaliha
NEW
DELHI (KWR) Relief efforts in the wake of
the Asian tsunami are prompting a temporary
upsurge in US military needs in the Indian
Ocean and parts of the Pacific. The fact
that commercial airlines are also involved
in relief missions is offsetting any decline
from cancelled flights to the afflicted areas.
Logistical constraints pose the biggest hurdle
to supply lines, as countries redouble their
financial commitment to the world's largest-ever
humanitarian mission.
The Defense Energy Support Center (DESC), the Pentagon's
fuel purchasing arm, is relying on the flexibility
of its fuel purchasing system to see it through
a temporary upsurge in demand in the Indian Ocean
and Pacific theaters. To support an increase in
Department of Defense jet fuel usage, the DESC
has engaged in two to three supplemental into-plane
contracts at airports in the affected regions.
In areas where the DESC has no current into-plane
contracts, military pilots have been purchasing
fuel with the Department of Defense's aviation
fuel card. Known as the Aviation Into-Plane Reimbursement
(AIR) Card, this system of military credit card
payment provides refueling flexibility and is heavily
relied upon in times of crisis.
Into-plane contracts at commercial airfields account
for a relatively small 6% of the Pentagon's annual
jet fuel purchases of 98 million barrels, most
of which are procured through an extensive network
of bulk jet fuel contracts with suppliers around
the world. Airport facilities in parts of Indonesia
and other regions affected by the tsunami are not
equipped to support such a massive airlift, in
terms of the size and scope of their fuel facilities.
The US military has been concentrating its efforts
in the hardest-hit parts of Indonesia, where C-40
cargo planes have been landing in Banda Aceh to
distribute food, water and medical supplies.
Commercial carriers demonstrated remarkable agility
in dealing with the SARS crisis in 2003, and that
experience will serve them well in coping with
this latest challenge. Airlines operated additional
services to bring travelers home after the disaster
struck. They are now working to overcome the tsunami's
impact with competitively-priced fares and efforts
to divert travelers to alternative destinations,
according to the Sydney-based Centre for Asia Pacific
Aviation. It said that airlines and tourism associations
were reporting little or no operational impact
from the disaster. Moreover, the growing role of
low-cost airlines serving destinations in southern
Thailand should lure travelers back to resorts
such as Phuket following a temporary hiatus.
Commercial carriers were also using their aircraft
for relief missions. Among others, AirAsia offered
seats for relief and rescue workers, Austrian Airlines
operated nine relief services to the area, while
Indian Airlines has been providing relief services
from Chennai to the Andaman islands. Qantas operated
humanitarian flights to Thailand and Sri Lanka,
carrying medical teams and equipment and bringing
passengers back to Australia. Many carriers have
waived cancellations fees through end January on
flights booked to the affected areas. Lufthansa
said the tsunami had no impact on forward bookings
and its schedules remain unchanged.
India’s state-owned Indian Oil Corporation
(IOC), which accounts for the largest share of
refueling services at airports across India, said
that its personnel have been working around the
clock at southern locations since December 26 to
refuel aircraft involved in relief efforts. IOC
has re-deployed staff from other departments to
assist in aircraft and helicopter refueling for
government officials and the Navy, Air Force and
Coast Guard. IOC is the only company that sells
jet fuel and other products in the southern Andaman
and Nicobar Islands, which were hard-hit by the
tsunami. It operates a refueling station at Car
Nicobar for the Indian Army and Navy, which was
badly damaged and forced military planes to divert
to nearby Port Blair for refueling. In the southern
part of the country, IOC said that it had moved
aviation fuel facilities to parts of Tamil Nadu
and Andhra Pradesh.
"We have already positioned backup manpower
and fuel storage at these places to help fuel the
aircraft
involved in search and rescue as well as relief
measures. Until the situation is normal, Indian
Oil will continue to enforce a "non-stop" refueling
system with adequate manpower and material support," said
N.G. Kannan, director of marketing for IOC. The
Indian Ministry of Tourism pointed out that rather
than spurring a drop-off in tourism, the tsunami
had prompted an upsurge in interest in travel to
India, with the Home Ministry approving visas on
arrival for foreigners during this period.
With Asian cargo markets currently awash in jet
fuel, the region should be able to handle the rise
in offtake from the relief efforts without an upward
price correction, market sources say. Traders expect
that the "tsunami effect" of displaced
jet fuel usage will be taken in stride given the
currently weak outlook for jet fuel across Asia.
High refinery margins in Japan and South Korea
have prompted refiners in those countries to produce
flat out, helping to replenish stock levels. Mild
winter weather so far has kept inventories ample
and put a lid on regional demand. "We should
see some shifting of demand patterns around the
region from the tsunami, with military planes refueling
in places that don't normally see a lot of commercial
activity. This displacement effect should be easily
absorbed by the market," said one trader.
Equity
Spotlight: TransMontaigne, Inc. (AMEX:
TMG)
Pending
Restructuring Play in the Energy Sector
to Unlock Shareholder Value
by
Mark Reiner, The Doctor's
Investment
Fund, LLC
NEW
YORK (KWR) TransMontaigne Inc. (AMEX: TMG)
is a refined petroleum products distribution
and supply company, whose principal activities
consist of three business segments. These
include: 1) terminal, pipeline and tug
and barge operations, 2) supply, distribution
and marketing and 3) supply chain management
services.
Background:
TMG has assembled an asset infrastructure, using
common carrier pipelines to distribute refined
petroleum products. TMG also provides integrated
terminal, transportation, storage, supply, distribution
and marketing services to refiners, wholesalers,
distributors, marketers and industrial and commercial
end users.
TMG owns and operates terminal infrastructure
utilizing pipelines, tankers, barges, rail cars
and trucks to company owned or third party facilities.
At company owned terminals, TMG provides throughput,
storage, injection and distribution related services
to distributors, marketers, retail gasoline station
operators and industrial and commercial end-users.
TMG operates 55 terminals with an aggregate capacity
of approximately 21.4 million barrels.
In the supply, distribution and marketing segment,
TMG purchases refined product primarily from
refineries along the Gulf Coast and schedules
them for delivery to company-owned terminals,
as well as terminals owned by third parties,
in the Gulf Coast, Midwest and East Coast regions
of the United States. TMG then sells this product
primarily through rack spot, contract and bulk
sales to cruise ship operators, commercial and
industrial end-users, independent retailers,
distributors, marketers, government entities
and other wholesalers of refined petroleum products.
The supply, distribution and marketing
operations and their terminal,
pipeline and barge operations
have synergistic characteristics in that they
each utilize and benefit from each other. This
creates opportunities to achieve additional
value
that could not be realized if each segment
were operated independently.
Due to recent historical price volatility associated
with energy prices, many companies and governmental
agencies have opted to outsource their energy
purchasing function. These end users need to
focus on their core competencies and to reduce
price volatility. This trend is creating a
growth business in the energy supply management/logistics
sector. TMG offers services that include fuel
supply, monitoring, excise tax administration,
and price management solutions. This allows
customers
to obtain fuel supply management functions
from a single source. TMG is the only significant
independent fuel supply chain management services
provider in the U.S. offering this extensive
suite of services.
Catalyst: This past July, TMG hired UBS to
assist the company in evaluating strategic
alternatives
to enhance shareholder value As a result, TMG
announced on September 22nd, that its Board
had authorized management to pursue the formation
of a new Master Limited Partnership (MLP) to
hold their qualifying assets. TMG would be
the
General Partner of the new MLP. It is anticipated
that the new MLP initially would own certain
TMG terminal, pipeline and tug and barge businesses
while TMG would retain the distribution and
marketing business.
In a press release at that time, the company
stated "It became obvious to the Board that
the existing MLPs that participated in the Company's
evaluation of its strategic alternatives were
unwilling to share with TMG's shareholders the
economic benefits that an acquisition of TMG's
extensive terminaling network would have provided
to their MLP unit holders and their respective
general partners. Consequently, forming our own
MLP allows our current shareholders to share
in both of those economic benefits.”
Given that the regulatory approval process
for a transaction of this kind can take up
to about
six months, TMG’s GP/MLP transaction is
likely to materialize during the first half of
05, once it receives necessary regulatory approvals.,
To date, there has been no further company announcements
or guidance, however, in recent conversations
with the firm, it was noted that. the transaction
is moving along, as per their public announcement.
There are several alternatives as to how the
transaction may occur. Options include an IPO
for the MLP, a spin-off of to TMG shareholders,
or possibly a hybrid of the two. TMG shareholders
may become owners in the General Partner, which
should retain a large percentage of the new
MLP, as per previous transactions in this sector.
Based upon previous cases, it might be expected
that the total valuation of these new holdings
will trade higher than the current security.
A new public issue of the MLP should also bring
attention of this company to the investment
community.
There are a number of precedent GP/MLP structures
in the public market. Some examples include
Holly Corp/ Holly Partners, Crosstex Energy/Crosstex
Energy, LP and Kaneb Services/ Kaneb Partners,
L.P. These deals were structured in a unique
fashion, as the GP retained a majority interest
in the MLP. The GP’s sole source of income
is the cash flow from the distributions of the
MLP plus incentive distribution rights, which
entitle the GP to a higher percentage of future
cash flows from the MLP, once certain hurdles
are attained. This structure motivates the GP,
to make accretive acquisitions for the MLP, with
the goal of increasing the terminal value of
the MLP’s cash flow.
Management of TMG has proved adept at accretive
acquisitions. The company expanded in 2003,
with the acquisition of facilities in Florida
and
Virginia. Both of these transactions have proved
accretive to date. Management credited these
acquisitions for the increase in net operating
margins for fiscal year 2004.
There are approximately 30 natural resource/
energy related MLPs that are publicly traded.
MLPs appear to be more complex and daunting
to investors. These structures are in essence
just
corporate-type entities that are taxed at the
unit holder level, thus avoiding double taxation.
Historically, MLPs are operations that were
spun out of major corporations to reduce debt
or to
reallocate assets to faster growth areas. MLPs
are usually steady, high-cash flow businesses
that do not require large amounts of capital
spending to sustain competitiveness within
their businesses.
TMG’s new structure is likely to help to
attract a new group of income-oriented shareholders,
while strengthening its balance sheet. It will
also enable TMG to arbitrage the differences
between public markets pricing versus the private
market for energy facility transactions. In addition,
it will be able to generate additional cash flows
from these potential transactions. Private market
deals in this industry are currently transpiring
at 7 times cash flow, while the average energy
MLP is trading at 14 times cash flow. Based on
these metrics, management will have the flexibility
to exploit this discrepancy and facilitate more
accretive deals going forward. Approximately
25% of TMG’s equity is owned by management,
creating an incentive to enhance current value
and increase current income for shareholders.
An additional catalyst is the recently signed
product agreement with Morgan Stanley Capital
Group (MSCG). In the Sept 22nd press release,
the Board of Directors announced their authorization
to management to procure long-term supply agreements
from one or more major refined petroleum product
suppliers. A long-term supply agreement would
eliminate the need for the Company to manage
the commodity price risks associated with its
sizable inventory positions. This would stabilize
the Company's marketing and distribution margins.
In November, TMG signed a 7-year, product supply
agreement with MSCG. Under the terms of the
agreement, MSCG will be the exclusive supplier
of gasoline
and distillate to TMG terminals connected to
the Colonial and Plantation Pipelines and its
Florida waterborne terminals at market-based
rates. MSCG will begin supplying certain TMG
terminals in January 2005 with complete implementation
expected in February.
The supply agreement
expires on December 31, 2011, subject to provisions
for
early termination. In connection with this
agreement, TMG issued warrants allowing MSCG
to purchase
5,500,000 shares of TMG common stock at an
exercise price equal to $6.60 per share, subject
to adjustments
in accordance with the terms and conditions
of the warrant certificate.
This transaction should prove beneficial to
TMG for a number of reasons. The agreement
will strengthen
TMG’s balance sheet, as less working capital
will be deployed in procuring and carrying a
volatile commodity, This should lead to more
consistent earnings and cash flow streams. TMG
has an extensive risk management operation, however,
lost money on hedging over the last three years,
as there is no perfect correlation between the
cash petroleum and futures market for energy
products. In addition, the equity relationship
with MSCG should provide an incentive for MSCG
to bring potential acquisitions and deal flow
to TMG in the future.
This transaction is also likely to help TMG
attain higher margins, which should lead to
a higher
multiple for their share price. Below is a
breakdown of gross margins for the firm’s two main
segments for the last three years:
Supply, Distribution and Marketing:
| |
|
2004 |
2003 |
2002 |
| |
Gross Sales |
11,215,351 |
8,241,001 |
6,001,170 |
| Cost of products sold |
(11,060,105 |
(8,072,877 |
(5,875,791 |
| |
|
|
| |
|
Net margin before other direct
costs and expenses |
155,246 |
168,124 |
125,379 |
| Other direct costs and exoenses |
|
|
|
| |
Net losses on risk management
activities |
(54,739) |
(84,146) |
(56,826) |
| |
Change in unrealized gains
(losses) on derivative contracts |
(25,323) |
(21,460) |
194 |
| |
Lower of cost or market write-downs
on base operating inventory volumes |
(5,334) |
(12,435) |
N.A. |
| |
|
|
| |
|
Net operating margins |
$69,850 |
$50,083 |
$68,747 |
Terminals, Tugs, Barges and Pipelines:
| |
|
2004
|
|
2003
|
|
2002
|
| Throughput
fees |
$
|
32,019
|
$
|
30,359
|
$
|
26,544
|
| Storage fees |
|
36,036
|
|
25,979
|
|
18,053
|
| Additive injection
fees, net |
|
7,908
|
|
7,921
|
|
6,611
|
| Pipeline transportation
fees |
|
7,073
|
|
5,758
|
|
6,492
|
| Tugs and barges |
|
11,667
|
|
4,335
|
|
N.A.
|
| Management fees
and cost reimbursements |
|
4,975
|
|
4,461
|
|
4,899
|
| Other |
|
9,562
|
|
8,154
|
|
5,686
|
| |
|
| Revenue |
|
109,240
|
|
86,967
|
|
68,285
|
| Less direct operating
costs and expenses |
|
(53,966)
|
|
(39,175)
|
|
(32,567)
|
| |
|
| Net operating
margins |
$
|
55,274
|
$
|
47,792
|
$
|
35,718
|
Within
this data, one can see that
the margins
in the infrastructure business are consistent
and fall with
in the context
of a traditional
MLP.
As a result of the proposed transaction, the securities
that are issued to current TMG shareholders, via
the new structure are likely to trade at a premium
to the current market value of TMG. Today, the
unknown variable is the exact structure of the
new entity, as per the prorating of GP or MLP to
the current TMG shareholder.
Finally, this deal is likely to create more investor
and institutional awareness of this $11 billion
dollar company -- which to date -- has been largely
unrecognized and undervalued by the market. This
is evidenced by its meager EV/EBITDA ratio of 6.43,
whereas its peer group is trading at much higher
multiples.
This company profile
is not intended as investment advice or as an
offer or solicitation with respect to the purchase
or sale of this or any other security. While
believed to be accurate, it should not be construed as offering a guarantee
as to the accuracy or completeness of the information contained herein and
should be checked independently by the reader before it is used to make any
business or investment decision. All opinions and estimates included are subject
to change without notice and the author as well as KWR International, Inc.
staff, consultants and other newsletter contributors to the KWR International
may or may not have a long or short position in any security or option mentioned
in this newsletter.
Letters
to the Editor
In
response to the lead article in our last
issue:
Gentlemen: Many thanks for your very
astute analysis of the election.
However, I believe you dismiss
what I call the "core value" vote at
your own peril. While I agree that foreign policy,
ie: the war; was a critical factor, the 20 plus
percent who stated their concerns about moral
or core values as a reason for favoring Bush
was real, and the President would not have won
without them. While I would not categorize all
liberals as secular nor all conservatives as
religious, the data seem to indicate that Bush
was seen as having certain principle beliefs
and in sticking to them, while Kerry was seen
as vascillating on whatever it is that he believes,
ie: abortion, gays, etc. Many red state voters
apparently saw this difference as important.
Ronn Cupp
Dear
Dr. MacDonald,
I was puzzled by your analysis about
what Bush needs to do in order to avoid
the stain of
previous Republican presidents from the gilded
age. Particularly
since in his first term he has done nothing
but enact policies that will only make the
growing
inequalities in America even greater.
You seem to pre-suppose that Republican leadership
won't necessarily make the needed choices
to address our problems, but that just maybe
it
could happen!. That given hard choices they
just might adopt a pragmatic rather than
an ideological
approach to governance. Oh! If only that
were possible! Unfortunately, there is almost
no
chance that Bush and his advisors will choose
a flexible
pragmatic approach to solve problems. They
are single mindedly driven by a radical market
ideology
and militaristic foreign policy and nothing
can shake their faith. Any suggestions or
realities to the contrary are simply ignored.
These people
are true believers in their own magic. So
if you don't believe as they do save your
breath.
Americans had a chance to chart a different
path and they fucked up. That's the best
description that I can think of. Working
families had a
chance
to look out for their own economic interests
and they chose not to. There is a price for
this lack of insight.
We are already sliding into another gilded
age, which is masked to a considerable degree
by the
New Deal and Great Society social safety
nets enacted by past Democratic administrations.
In other words it hasn't become as obvious
yet to
many working people, unlike in the previous
gilded age, when there were no safety nets
and everyone
but the Republican presidents and Wall Street
Bankers knew about it or cared. Bush and
his
ideologues don't care either. Working people
will be paying the price.
Expect things to get worse over the next
four years because of either neglect or worse
yet,
irrelevant and destructive policies pretending
to solve our social problems. A good example
is the Medicare prescription drug bill. Every
healthcare expert who understands it knows
that it's a bad bill. The nonpartisan American
Association
of Retired People called it a bad piece of
legislation that will need significant modification
before
it comes into effect in 2006. And they initially
supported it because seniors need affordable
prescription drug coverage and they just
wanted to get a bill passed, one that would
be changed
later. Unfortunately they failed to realize
that you need people in government who also
care about
the effect rather than just the headline.
Make no mistake about it the best these people
could do for us over the next four years
is nothing at all. But they're to arrogant
for
that. Sooner
or later the Democrats will eventually inherit
their mess. I hope that when they do, that
like FDR they shame them and publicly ridicule
them
every time they open their mouths.
Sincerely,
Gary Anderson
Kalispell, Mt. US
EMERGING
MARKET BRIEFS
 Indonesia – S&P
Upgrades the Sovereign: Standard and Poor’s
earlier this week upgraded Indonesia's foreign
currency rating by one notch, to B+, and its local
currency rating by two notches, to BB. S&P
also left its outlook unchanged, at Positive. This
differs from the example of S&P’s upgrade
of Pakistan to B+ last month, in which S&P
lowered its outlook to Stable. Moody’s rating
for Indonesia is B, but with only a Stable outlook.
S&P was the first credit rating agency to rate
Indonesia, having initiated coverage on the country
in July 1992 with a BBB- rating, which was somewhat
controversial at the time. Fitch rates Indonesia
at B+ with a Positive Outlook. S&P cited Indonesia’s
macroeconomic stability, steadfast fiscal management,
and favorable foreign liquidity position. This
positive outlook suggests that a further upgrade
could be on the way once the administration of
President Yudhoyono and Vice President Jusuf Kalla
articulates a clear-cut economic strategy for economic
recovery and demonstrates observable progress in
implementing it. In addition to macroeconomic stability,
the voters of Indonesia want to see a recovery
in investment and employment soon. Vice President
Kalla’s recent political coup of gaining
the chairmanship of the Golkar political party
would appear to have greatly increased his status
and influence in the new government. We only hope
that Kalla’s role in the new government contributes
to, rather than detracts from, the coherence of
government policy.
Philippines – That Old Problem, The Budget Deficit
Just Won’t Go Away: One of the most persistent problems
facing Philippine governments over the past two decades
has been the budget deficit. For a number of reasons, the
government has been unable to close the gap. Most recently,
the International Monetary Fund (IMF) recommended to the
Philippine government the undertaking of up-front fiscal
adjustment to keep budget within target despite projected
slower economic growth for next year. According to Masahiko
Takeda, head of the IMF Post-Program Monitoring Mission: "GDP
has been robust in 2004, but is expected to be moderate
in 2005. We are currently reviewing our 4.2 per cent GDP
projection for the Philippines."
Takeda also noted the IMF took into consideration inflation,
which has risen sharply in 2004 due to supply shocks in
such commodities as meat and oil. Inflation is expected
to rise above the target of 4-5% in 2004-2005. "The
outlook for exports and global oil prices is also highly
uncertain," he said. "Combined with the possibilities
for rating actions, these uncertainties highlight the case
for rapid implementation of the government’s reform
agenda." With this, Takeda cited the need for early
implementation of high quality measures to raise government
revenues that can help maintain investors, confidence.
The increase in generation tariffs provisionally awarded
to the National Power Corporation (Napocor) in September
is also the first major step in this regard, he noted.
The administration has identified eight legislative tax
measures for Congressional approval that could generate
P83.4 billion in revenues. Some of these measures, including
the two-percent tariff imposed on fuel imports and additional
taxes on alcohol and tobacco products, were expected to
reduce the government’s budget deficit. Congress
was expected to approve before year-end these two measures
and another bill that seeks to reform the Bureau of Internal
Revenue through the lateral attrition law. Of these bills,
only the one on alcohol and tobacco excise taxes has so
far been passed by the House.
In view of this, Takeda said the mission looks forward
to the further strengthening of alcohol and tobacco taxes
as well as "the passage of more substantive revenue-raising
measures in the coming months." Nevertheless, he commended
authorities for their efforts in making sure that big-ticket
measures for 2005 will be approved by Congress. "A
large initial reduction in the deficit would send a strong
signal to the markets of the authorities commitment to
balancing the budget".
For
pictures and updates of our recent Japan Small Company
Investment Conference, click above
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