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Energy
Takes Spotlight
Last
week’s debate over OPEC production cuts joined this week’s total
meltdown of on-line energy trading as Enron was brought to the brink of
bankruptcy. In all likelihood, Enron will become a relic of the
deregulation experiment. Of course, life goes on. However,
we have seen another illustration of how much faster the world is today,
compared with only a single decade ago. This past April, Enron was
seemingly in control of natural gas and electricity. Now, the life
support system is ready to be turned off.
In
the two books I have written, I emphasize “structural change.”
This is not a unique concept, but rather a neglected one because
of its simplicity. Consider that ancient history is segmented into
various ages, i.e. the Stone Age, Bronze Age, colonialism, mercantilism,
Industrial Revolution, etc. Each of these terms defines specific
socioeconomic change that altered the way humans conduct their lives and
business. When worthy of a historical name, the impact is
profound. Happy was the man who invented the wheel!
Energy
markets have undergone several structural alterations that have impacted
the way we do business. These include everything from conservation
to production and consumption. However, few of us take the time to
realize that energy markets are extremely new relative to overall
history. After all, how long has the use of crude oil been in
existence? Liquid fuels have only been in widespread use since the
turn of last century. The automobile came onto the scene in the
early 1900s.
For
the most part, the United States was energy self-sufficient through the
1950s. OPEC was not a factor until the late 1960s and after the
boycott of the early 1970s. Thereafter, energy markets rapidly
adjusted to reflect a global market and high volatility. When
energy futures were introduced at that time, there was virtually no
interest. In fact, the New York Mercantile Exchange had to
struggle to keep the pits open. However, the Iran hostage
situation altered perspectives and energy speculation under the Carter
Administration asserted some dominance.
I
bring this history to your attention because OPEC’s control over
energy was a structural phenomenon for more than three decades.
Interestingly, energy deregulation under President Reagan tapped the
first chinks in OPEC’s armor. As far back as Gorbachev’s
famous meeting with former President Bush in Malta, I saw the potential
for a producer price war. The crude oil plunge of 1985/86
demonstrated how sensitive energy markets were (and are) to supply.
While demand can change modestly, it is clear that supply-side forces
make the final price determination. Extreme weather or a booming
economy has very little overall impact upon average consumption.
Thus, the timing of OPEC’s production cuts accentuate any modest
demand variations.
As
Russia builds capacity along with OPEC and non-OPEC producers, the
ability to regulate price through quotas diminishes. At some
stage, control becomes diluted to the point where it is every producer
for himself. This is more the case during a recession. Keep
in mind that OPEC and Russia are hard pressed for cash. In
particular, OPEC’s investments have gone south with the rest of us.
High volume works better than high price in the near-term.
Absent
a Middle East battlefield, I believe energy prices will continue
lower… possibly below the teens. It is a formula that is
good for producers and good for the industrialized world. Simply
put, everyone needs price relief.
The
“flag” formation exhibits an upward slope and implies exhaustion at
$20.00 resistance. If we use the flag as a measuring
consolidation, the downside objective is $14.00. Russia and Mexico
appear less than enthusiastic about joining OPEC’s cause. At the
same time, Northeast temperatures have been extremely moderate and the
“leafing” season has ended.
The
demise of Enron suggests that the secondary cash trading market is
consolidating. Enron represented an electronic middleman that was
able to take advantage of political stupidity. I stand by my
position that the California energy crisis is nothing more than an
intelligence crisis. If stupidity were a commodity, I would have
been long California all the way.
Any
time such a crisis suddenly develops without significant consumption
changes, it is safe to assume forces are artificial. Indeed, California
was like a squirrel caught on a highway. Every move placed them in
front of a moving car. Without Enron, energy trading will
continue. Better use of futures for hedging coupled with a return
of transportation resources to primary companies will inject the system
with a potent vaccine against spot shortages and manipulations.
The
Enron formula does not work. This is not to say that the industry
requires more regulation. It simply exemplifies the fact that
excessive middleman intervention in such a broad market is destined for
failure. The billions Enron was carving out of the market will be
returned. I believe it will appear as lower natural gas and
electricity. In the end, nothing works as efficiently as the free
market.
There
are a number of companies developing Internet facilities for energy
trading at the consumer level. Herein lies the key to ultimate
efficiency. When the eBay of energy finally gains a foothold, it
will change the way we consume and the way utilities and energy
companies deliver.
Global
Impact
Despite
a weak outlook for Europe, the Euro Currency jumped above 8850
resistance. As mentioned in my chart commentary, I wanted to be
long the Euro, but I interpreted the chart as bearish. Alas, my
instincts were correct. Further, the chart interpretation was
probably tainted by the amount of gloom publicized in the media.
My
assumption that the previous downward channel was being cloned was
incorrect… for now. With the breakout above the current
consolidation, we can interpret the pattern as a reversal flag.
While we pushed above the 20-day average, we have not challenged the 40.
Last
week, I was inclined to postpone my Euro enthusiasm until the next year.
Now, I am not as certain. If you view the movement from July’s
low to the present, we see a massive “wedge” that could also be
interpreted as a reversal flag. The convergence of lows and highs
suggests a consensus is forming around 8850. However, a breakout
above 8950 violates the wedge and suggests a new bull leg. This is
what I have been anxiously awaiting. This is the third time
I have been bounced from my conviction that the Euro Currency will
regain against the Dollar.
If
T-bonds are any indication, there is a possibility the September/October
pattern is being repeated. I was fortunate to buck the apparent
chart formation in favor of a suspicion the bond would support at 10216.
Little did I know the 30-year was about to be retired. The plunge
from 112½ made little sense unless you believed the FED was finished
liquefying. The other side of the story was the theory that stocks
had bottomed and it was time to switch from low interest to better
appreciation potential.
Once
again, we face the dilemma. I am inclined to favor the bond
despite news that durables had a pop in October. You have to
believe that this would happen after the September experience. The
question is how durable goods orders are doing relative to October last
year and the year before.
Cocoa,
Sugar, and Cotton
While
most traders are fixated on stocks, bonds, and currencies, cocoa, sugar,
and cotton are showing signs of recovery. After making major lows,
cocoa sprung to life as fundamentals suggested deficit production and
the appearance of Black Pod disease. Whether the disease is real
or mostly rumor is not as relevant as the fact that processors were
caught short. After a few buying sprees, cocoa continued drifting
lower to the point where the major U.S. and European grinders believe
they could buy as needed. When prices jumped above $1100, it was
apparent that a reversal was in place and supplies would need to be
secured. Since cocoa is generally a thin market, the combination
of technical strength and fundamental uncertainty flamed the advance.
We
were fortunate to enter cocoa on the turn. Admittedly, I was not
expecting as powerful an advance. The attempt at consolidation
below 1320 looked like a possible retracement. But, today’s
explosion foreclosed any attempt to buy on a dip.
Sugar
displays a more subtle and comfortable advance. After making an
almost perfect “V” bottom, sugar has been steadily moving forward.
Today’s challenge of 770 resistance was interesting because the drop
below yesterday’s range suggested all eyes were focused upon the same
objective. Still, buyers viewed the dip as an opportunity as seen
by the impressive recovery to close on the highs. Fundamentals do
not suggest an appreciable rise above 800. Given today’s
resistance near 770, I am suspicious of anything above 800, for now.
Finally,
cotton has been teasing me ever since it dropped below 30¢.
Perhaps I have too much history under my belt. The last time I saw
cotton plunge to unbelievable lows, it shot up to unbelievable highs.
Circumstances were different because we were approaching the spring.
I recall a delicious July/October spread.
October
has formed another “pennant” and the gap at 4300 seems like a
reasonable objective. Even at 3900, cotton is cheap. To put
it in the ground, we need to see 4500. Cotton is an expensive
crop.
The
downside argument remains oversupply and recession. China
allegedly needs less U.S. supply. Don’t be surprised to
see 4500 hold advances back.u
Email:
Phil@commodex.com
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