Wednesday, August 26, 2009

Offshore Development and the Economic Nonrecovery

Agora Financial
Agora Financial's Outstanding Investments

August 26, 2009

Offshore Development and the Economic Nonrecovery

Dear Outstanding Investments Reader:

To quote Prime Minister Vladimir Putin, I've been working "like a galley slave." Except instead of running Russia, I've merely been writing and editing your next issue of Outstanding Investments.

The main investment article in the October issue concerns one of the world's best long-term plays in the deep-water development sector. This firm is already an offshore champ. It's set to do even greater things over the next couple of decades. So the recommendation in the October issue is destined to be a core energy holding. Watch your e-mail for the release in the next few days.

The Best Investment Themes -- Stick With the Basics

While I'm on the subject, a few readers have written to ask what I believe are the best investment themes. By now, you should have detected a certain trend in my investment recommendations. I'm focusing on precious metals and energy plays.

Yes, I know. Some readers have written to remind me that the stock market is (ahem…) "moving up." So why am I not looking more broadly for investment ideas than just precious metals and energy? The short answer is that I don't trust the recent rally. I think the rally is a bear market bounce. It's smoke and mirrors. So stick with the basics.

What are the basics? Cash, especially any cash that you'll need in the next two years or so for things like buying a home, paying big bills, college tuition, medical or nursing care for a relative, etc. Don't put the "milk money" at risk, so to speak. Then I like precious metals, meaning the physical metals like coins or bullion, as well as high-quality mining shares. And finally there's energy, including energy technology ideas such as oil service and equipment companies.

The bottom line is that I like precious metals and "real" energy plays because I believe gold, silver, oil, etc. will hold their values going forward better than anything else. Keep in mind that eventually cash will depreciate. The monetary future is that the value of the U.S. dollar will decline, as I'll discuss below. So for the long haul, you want things that people will value long into the future -- precious metals, energy and energy technology.

Good News From Offshore

You don't have to look too far to see where the big money is being spent and where the opportunities for profit are happening. There are astonishing things offshore.

Just this week, for example, StatoilHydro ASA (STO: NYSE) awarded Houston-based FMC Technologies Inc. (FTI: NYSE) a $73 million contract for a project off the coast of Norway. FMC will manufacture and supply subsea equipment for Statoil's Gullfaks oil and gas field in the North Sea. Deliveries of eight subsea trees and associated equipment to Statoil will begin in the second quarter of 2010. This follows on the heels of a $30 million contract from Statoil to FMC in June.

The trade press is filled with announcements for these kinds of contract awards. These are big-ticket awards for complex subsea equipment and related services to the likes of FMC Technologies, Cameron Intl. (CAM: NYSE) and the VetcoGray division of General Electric (GE: NYSE).

Meanwhile, some of the deepest and most complex wells in the world are being designed, drilled and constructed by companies like Halliburton (HAL: NYSE), Baker Hughes (BHI: NYSE) and Schlumberger.

Deep Water Getting Deeper

Where is the future taking us? In the past month, the offshore driller Transocean took delivery of a new ultra-deep-water drilling ship named Discoverer Clear Leader. This sixth-generation drill ship is currently under long-term contract to Chevron.

The new vessel is 835 feet long and 125 feet wide, or about the size of a World War II aircraft carrier. It generates 40 Megawatts of power, enough to light about 40,000 homes. The derrick is 226 feet high. The ship can drill wells in 12,000 feet of water, which is the depth of seafloor where the Titanic sank. The ship can operate and hold its position steady in waves up to 30 feet high.

Clear Leader can drill to a total depth of 40,000 feet, which surpasses the limits of any previous technology. By comparison, almost no airliners fly above 40,000 feet altitude. So imagine flying across the country and looking down at the ground from, say, 36,000 feet. Now imagine you're on a ship at sea, dangling a drill string that goes farther than that into the earth.

The Clear Leader drill ship expands Chevron's ability to search for and develop new sources of energy. Chevron is already a world leader in deep-water drilling capabilities. In fact, Chevron holds the current world water-depth drilling record of 10,011 feet, set in the Gulf of Mexico.

If you want to see an excellent animation of deep-water drilling from Transocean, here's a nice visual demonstration that gives you a perspective on what it's all about. It's cool imagery, although it doesn't get into the complexity of how the drilling targets are selected or how the total drilling process and eventual subsea development unfold. But it's a pretty neat animation.

Follow the Oil

I hope you can see why the deep-water developers, and equipment and service suppliers, are such a unique brood. There are just so few of these kinds of companies out there, and it's such a difficult technical field. But deep water is where the "big" oil is being found these days (along with unconventional plays like oil sands). So for investment purposes, we need to follow the oil.

Is the Overall Market Half Empty or Half Full?

One of our OI readers is a banker in Boston. He e-mailed me to ask why I can't "just chill out." This reader believes that the economy is set for a "slow, steady rise over the next couple of years." He points to many new breakthroughs and budding technologies in the arena of energy, biotech and computing, among others, that will "create entire new industries."

OK, yes. There are many new scientific and technological breakthroughs happening out there. The world is blessed with a lot of smart, visionary people who are pushing back entire frontiers of knowledge. There are SOME things that are going to be quite different in the next two years, five years, 10 years and more. (My colleague Patrick Cox tracks these developments in his newsletter, Breakthrough Technology Alertyou can find out more of his latest findings here.)

Just a few weeks ago, Exxon Mobil made a deal to invest $600 million into research on algae-based fuel. That's not much for Exxon Mobil. It's less than the cost of a single offshore platform. Then again, $600 million can buy a lot of research and development in the field of biotech.

Obviously, Exxon Mobil is making a statement about what it believes is the future for third-generation biofuels. (For second-generation biofuels from cellulosic waste, Weyerhaeuser, WY: NYSE, is doing great work.) One of these days, you won't be putting a tiger in your tank. You'll be putting fuel made from dead bugs. Hmmm… "Put dead bugs in your tank?" Better run that one past the marketing people.

I hope that Exxon Mobil is wildly successful in putting dead bugs in peoples' gas tanks. But I don't think that new technology alone is going to turn things around. Economic progress is more than just technological. It's cultural, as well. There are political, environmental and capital issues.

That is, right now, the overall state of the economic glass is that it's more half empty than it's half full. I can't share the happiness of Wall Street traders and the political class of cheerleaders and enablers.

Things in the economy are still not well. I don't buy into the "green shoots" theory of the recovering economy. There are too many bad decisions being made at the highest levels. These bad decisions will not help the economy get well.

"Record Red Forecast"

Just reading the newspapers gives me a daily diet of economic gloom. For example, my pessimism for today (Aug. 26) started with the headline of my local newspaper this morning. The Pittsburgh Tribune Review delivered a banner message, "Record Red Forecast at $1.58 Trillion." (I think they printed the newspaper before the word came out that Sen. Ted Kennedy died.)

Then for a national perspective, I looked at The Wall Street Journal, which published a slightly different alliteration, "Decade of Debt: $9 Trillion." And finally, for an international view, the Financial Times summed it all up in characteristic British understatement, with, "U.S. Says Debt Outlook Worsening." Oh, you don't say.

The big problem -- obviously, the headline issue -- with the U.S. economy is too much debt. (That's the BIG problem. There's a long list of other problems after that.) And the debt problem is getting worse, not better.

Ubiquitous Indebtedness -- an Empire of Consumption

Debt is ubiquitous across U.S. society. Debt permeates the culture. Practically the whole nation has bitten off more than it can chew. Within the past two generations, the U.S. economy has transformed from what Harvard historian Charles Maier calls an "empire of production" (which is what won the Second World War, for example) to an "empire of consumption."

The lunch bucket-toting factory worker, or the beam-walking riveter constructing a skyscraper, symbolized the former empire of production. Those iconic workers are no more. They've been replaced by the image of vast tracts of McHouses blanketing the landscape. Or of parking lots filled with new cars outside coast-to-coast malls, with their owners inside maxing out their credit cards.

It's the difference between an economy that creates surplus capital and an economy that consumes capital to gross deficit. Professor Andrew Bacevich of Boston University summed it up this way in his recent book, The Limits of Power. "The evil genius of the empire of production was Henry Ford. In the empire of consumption, Ford's counterpart was Walt Disney."

Come to think of it, we should be so fortunate as to be indebted just because we collectively took too many trips to Disneyland. As a nation, the U.S. has borrowed and spent far beyond its means. You know what I mean. I don't have to get into the details on that point. In particular, the political class just can't seem to say no.

Permanent Job Losses

The other side of that debt coin is a widespread inability to repay. Households are so deep in debt that they've stopped buying, and I don't care what the so-called consumer confidence surveys say. Less buying means that business profits are down. Where businesses are showing profits, a lot of it is because they are goosing the bottom lines through layoffs and spending cuts.

Layoffs? That's putting it mildly. Many of the recent job losses are permanent. They're structural. It's not just the good old days, when the company said, "Go home and we'll call you back in a few months." No, in many cases, the jobs are gone forever.

It's not just factory jobs, either. Those jobs were the first to go. The U.S. economy lost millions of its old-line factory jobs over the past 25 years or so. It brought us into the age of the Rust Belt. Some economists and deep thinkers bragged about how this was somehow "good" for America. (Call me old-fashioned, but I could never quite figure that out.)

Now people with white collars are getting hit with permanent job losses in sectors like banking and law. Many parts of the nation's financial districts are the new Rust Belts of America.

There are former lawyers waiting on tables, stealing jobs from the traditional class of table servers, starving artists. At many silk-stocking firms, even the formerly sacrosanct legal "billable hour" is under attack. And I know doctors and architects who've been laid off.

So joblessness is up, and it's not about to come down anytime soon. With joblessness up, tax collections are down across the board. Unemployment compensation accounts are running out of money. Public assistance accounts are running down. Some states want to give early release to prisoners to save the costs of incarceration.

In Michigan, for example, some counties are no longer repaving the roads. They just grind the asphalt to gravel and save the cost of paving. It's a foretaste of things to come, I believe.

Indebtedness Is Not Cured

I don't see where the problems of indebtedness have been cured. We're not even close. Maybe it's my inner bankruptcy attorney at work. Where's the wipeout? Where's the discharge? How has all that bad paper out there been voided? It hasn't.

So this brings me back to why I like precious metals and energy. It's the Real McCoy. It's nobody else's liability. If there's anything like safety in this economy, I believe that it's in precious metals and energy.

That's all for now. Thanks for reading…

Byron W. King

P.S. Do you want to come to New Orleans between Oct. 8 and 11? I'll be speaking at the 2009 New Orleans Investment Conference. It's the old Jim Blanchard Gold Conference, now updated for the current economic environment. Among the list of speakers are Rick Rule, Doug Casey, Marc Faber, Frank Holmes, Stephen Leeb, Robert Prechter, Robert Ringer, Peter Schiff, Mark Skousen, John Williams and many others. Check out the conference agenda, and I'll see you down in the Big Easy.

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