The FBI may probe the causes of the MF Global bankruptcy (Reuters)

Sinopec (NYSE: SNP) may buy a stake in Galp Energia SGPS SA  (Bloomberg)

Douglas A. McIntyre

The mainland’s major index, the Shanghai Composite, has fallen 17% in the past year. Between the two markets are the listings of giants China Mobile (NYSE: CHL), China Petroleum (NYSE: SNP) and China Life Insurance (NYSE: LFC). It is extraordinary that telecom, energy and financial services industry shares should drop so sharply when none has any direct relationship to the others.

The four concerns about China’s financial health persist. The first is that inflation still lurks even though China’s economy has slowed. The sharp increase in food prices has many economists worried that real wages cannot keep up with the cost of living. And China counts on its middle class to consume a large portion of the output of the nation’s impressive manufacturing sector. Inflation will cause discretionary income to fall.

Property values, particularly in the largest cities, are high by historic measures and compared to similar real estate around the world. Any sharp slowdown in China’s GDP will undercut the ability developers to expand and rent these properties. Individual home owners could be left with large numbers of underwater mortgages. Analysts fear a rapid drop in property values similar to those in Japan three decades ago. Japan’s real estate fiasco helped ruin its GDP expansion, and the recovery from that took several years. By some standards, Japan’s economy has never recovered completely from the blow.

The chance of a trade war with the U.S. has increased sharply in the past several weeks. What was unimaginable has become possible. The U.S. Senate has agreed to a bill that would result in sanctions against China because of its currency problems. The Treasury Department recently delayed its biannual analysis of nations that have used their currencies to put the U.S. at a disadvantage with regard to trade balances. The Obama administration hopes quiet negotiations will resolve the yuan valuation issue. The belief that will work continues to dwindle.

And, the most significant concern about a sharp stall of China’s growth is Europe. Austerity and high unemployment have turned the EU economy back toward recession. If the sovereign debt crisis worsens, the recession could be deep and long. The EU economy is still the largest by GDP, about $2 trillion more than the U.S. A drop in demand for China’s exports could put manufacturing in the People’s Republic into a tailspin.

Stocks markets, some experts say, trade based on investor perceptions of what economies and earnings will be six months to a year into the future. China is in great trouble if there is truth to that.

Douglas A. McIntyre

Agrium, Inc. (NYSE: AGU) named Bull of the Day at Zacks.
Agnico-Eagle Mines Ltd. (NYSE: AEM) Raised to Outperform at Credit Suisse.
American Express Company (NYSE: AXP) Cut to Hold at Jefferies.
AMR Corporation (NYSE: AMR) Raised to Outperform at Rodman & Renshaw.
BHP Billiton (NYSE: BHP) Raised to Outperform at Credit Suisse.
Capital One Financial Corp. (NYSE: COF) Cut to Hold at Jefferies.
Chipotle Mexican Grill Inc. (NYSE: CMG) Started as Outperform with $370 target at Credit Suisse.
China Petroleum & Chemical Corp. (NYSE: SNP) Started as Neutral at Credit Suisse.
CNOOC Ltd. (NYSE: CEO) Started as Outperform at Credit Suisse.
The Jones Group Inc. (NYSE: JNY) Value stock of the day at Zacks.
LM Ericsson Telephone Co. (NASDAQ: ERIC) Raised to Buy at Citigroup.
PetroChina Co. Ltd. (NYSE: PTR) Started as Neutral at Credit Suisse.
Riverbed Technology, Inc. (NASDAQ: RVBD) Cut to Equal-Weight at Barclays.
SodaStream International Ltd. (NASDAQ: SODA) Raised to Buy at Deutsche Bank.
Sonoco Products Co. (NYSE: SON) Cut to Hold at Argus.
Stillwater Mining Company (NYSE: SWC) Removed from Focus List ar Credit Suisse.
W.R. Berkley Corp. (NYSE: WRB) named Bear of the Day at Zacks.

Your email address

subscribe

terms and conditions

 JON C. OGG

TransCanada stands to lose the most if the project is denied. The entire Keystone pipeline system is nearly fully contracted for a total of 900,000 barrels/day for an average term of 18 years. That is a big loss if the pipeline isn’t built. The largest producer in the oil sands is Syncrude, a joint venture that includes Imperial Oil Resources (wholly owned by Exxon Mobil Corp. (NYSE: XOM)), Suncor Energy Inc. (NYSE: SU), and China Petroleum & Chemical Corp. (NYSE: SNP) — Sinopec — among others. Other producers include ConocoPhillips Corp. (NYSE: COP), Chevron Corp. (NYSE: CVX), Murphy Oil Corp. (NYSE: MUR), Total SA (NYSE: TOT), Royal Dutch Shell plc (NYSE: RDS-A), BP plc. (NYSE: BP), and Devon Energy Corp. (NYSE: DVN).

These companies won’t lose everything because the bitumen from the oil sands will go somewhere, somehow. Unless, of course, the Canadian government decides to shut down every project in Alberta, and that simply will not happen. One of the big problems facing the producers now is that they’re crude is landlocked and sells at a substantial discount to WTI. For the week ending September 23rd, Heavy Hardesty grade crude sold for $78.28/barrel, while WTI sold for $80.29 and Brent sold for $109.17. Getting crude from Alberta to a coast, any coast, is critical for producers.

If the Keystone XL pipeline is killed, an expansion to an existing pipeline system to the US/Canadian west coast could take up some of the slack. Kinder Morgan Energy Partners LP (NYSE: KMP) is investigating an expansion to its Trans Mountain system and Enbridge Inc. (NYSE: ENB) has already begun the permitting process for a similar pipeline to the west.

Another interesting development are proposals from both of Canada’s major railroads to construct a pipeline-by-rail from Alberta to west coast. And while nothing officially like a pipeline-by-rail has been proposed for the run to the US Gulf Coast, rail traffic has already increased substantially from North Dakota south to Cushing and, eventually producers hope, to the Gulf.

In July weekly US rail carloads of petroleum and petroleum products hit a four-year high, and the August total of about 7,400 carloads is even higher. A rail tanker holds about 1,500 barrels, so every day about 1.6 million barrels of petroleum is moving around on the US rail network. Add to that another half a million barrels a day from the oil sands and that puts about another 2,500 tanker cars on the rails every day.

There were 750 reported rail accidents involving hazardous materials in 2010. The odds of a significant oil spill rise if we add more oil transport by rail.

The same is true if the Canadian crude is moved by truck. Truck transportation by surface road is even more expensive and prone to accidents. There were nearly 12,000 road accidents involving hazardous materials in 2010. Besides being much more expensive, more tanker trucks carrying up to 300 barrels of oil each raises again the odds on an environmentally significant spill.

So while pipeline spills are a concern, rail and truck accidents are far more common. The Keystone XL pipeline should be held to a very high safety standard, but it is probably the safest way to move the most Canadian crude.

The argument that Canada should stop development and extraction in the oil sands may make more environmental sense, but until a large-scale alternative transportation fuel is available at a reasonable price, oil sands development will very likely continue. And moving that oil by pipeline is really the only sensible option.

Paul Ausick

China, in particular, stirs a lot of interest because its technically recoverable shale gas deposits are estimated to be about 1,275 trillion cubic feet (Tcf). That’s about 50% more than the estimated 862 Tcf of technically recoverable shale gas in the US. And US companies like Baker Hughes Inc. (NYSE: BHI), Halliburton Co. (NYSE: HAL), Schlumberger Ltd. (NYSE: SLB), and National Oilwell Varco, Inc. (NYSE: NOV) with both deep pockets and experience in shale gas exploration and production could get a crack at developing China’s vast shale gas deposits. US producers like Chesapeake Energy Corp. (NYSE: CHK) and Devon Energy Corp. (NYSE: DVN) are less likely partners, but such a deal is not impossible.

To date, no development of China’s shale gas resources has begun. The government is mulling plans both to offer subsidies to domestic E&P companies and to permit foreign company participation in extracting the gas. China’s approach to allowing its domestic companies to develop shale gas is something of a balance between granting licenses only to big players like Sinopec, formally China Petroleum & Chemical Corp. (NYSE: SNP), Cnooc Ltd. (NYSE: CEO), and China National Petroleum Co.’s Petrochina Ltd. (NYSE: PTR) and permitting smaller players to get into the hunt.

The government wants to avoid the development of hundreds of independent companies, as happened with the coal mining industry. The unlicensed coal mines were extraordinarily lethal to miners and riddled with corruption. The central government has fought hard to bring the miners under control in the last two years or so.

The Chinese have no experience or technology to develop their shale gas resources. Royal Dutch Shell plc (NYSE: RDS-A) has already been signed on by one of the two small Chinese companies to win a lease and the company has also formed a partnership with Petrochina.  Chevron Corp. (NYSE: CVX) and BP plc (NYSE: BP) are in discussions with Sinopec to form a partnership as well. Cnooc paid Chesapeake more than $2 billion for rights to participate in developing some Eagle Ford shale leases.

As China’s government continues to explore its options regarding shale gas development, one thing does seem clear. The government is leaning towards a less restrictive approach than it has taken with other hydrocarbon development. The country is also likely to adopt some sort of subsidy policy that would encourage shale gas development. That would be enough to really get foreign companies lined up to go to work.

Paul Ausick

The US Energy Information Administration estimates the China sits on top of about 1,275 trillion cubic feet of shale gas, which is about 50% more than the agency’s estimate for US deposits. The Chinese companies are looking for partners to develop the shale gas resources, and the expertise is in the foreign major integrated oil companies, the oil field services companies, and the drillers.

Royal Dutch Shell plc (NYSE: RDS-A) has signed a deal with a small Chinese gas company to explore, making it the first of the major integrated companies to get a toehold in exploration for shale gas in China. PetroChina has also formed a partnership with Shell and both Chevron Corp. (NYSE: CVX) and BP plc (NYSE: BP) are reportedly talking with Sinopec to create exploration joint ventures, and Norway’s Statoil ASA (NYSE: STO) is also seeking shale-gas assets in China.

The start of a boom in exploration for shale gas inevitably begins with the majors because that is their basic business. But it’s difficult to imagine that these companies will get any sort of participatory deal in the production of the gas. More likely is a fee-based deal where the companies are paid their expenses plus a defined amount for every cubic foot produced.

More likely to see bigger profits are the services companies like Halliburton Co. (NYSE: HAL) and Schlumberger Ltd. (NYSE: SLB) and the drillers like Baker Hughes Inc. (NYSE: BHI) and National Oilwell Varco, Inc. (NYSE: NOV) with extensive onshore experience. It is unlikely that US producers like Devon Energy Corp. (NYSE: DEV) or Chesapeake Energy Corp. (NYSE: CHK) will derive much benefit from the Chinese push into shale gas development, but if one of the producers does some creative thinking it’s possible.

The good news is likely to last a relatively short time however. Sinopec’s chairman has said that he expects unconventional gas like shale gas and coal-bed methane to drive growth for the company in the future. And getting Sinopec and the others to the point where they are self-sufficient could take up to four years.

And the Chinese certainly intend only to rent the technology they need now and to demand a transfer of technology from its partners so that the partners can be cut loose eventually. This pattern has been played out in solar PV development, wind turbine development, and virtually every sort of information technology development in China.

It’s still very early days in the Chinese shale gas industry. But the broad outline is well-established and well-rehearsed. There’s no reason to expect shale gas development to follow a different script.

Paul Ausick

This is the largest deal in the oil sands since last year’s acquisition by China Petroleum & Chemical Corp. (NYSE: SNP), or Sinopec, of the oil sands assets of ConocoPhillips Corp. (NYSE: COP) for $4.65 billion. Cnooc expects the deal to close by the end of this year, assuming regulatory approvals and an acceptance by two-thirds of Opti’s creditors. So far about 55% of noteholders have approved the deal.

And why not? Opti’s shares are trading for $0.12 on the Toronto exchange and its market cap is about $32.4 million. Cnooc is paying $34 million to shareholders, a premium of just 5.5%. Considering that Opti’s shares have lost 93% of their value in the past 12 months and that the company had filed for bankruptcy just a week ago, the company’s shareholders are probably glad to get anything at all.

Cnooc already owns a nearly 17% stake in oil sands developer MEG Energy Ltd. which it bought more than six years ago. When completed, this project could produce up to 500,000 barrels/day of crude.

Sinopec owns the 9% stake in the Syncrude project that it bought from Conoco, as well as a 50% stake in the stalled Northern Lights project that it shares with Total SA. Another big Chinese oil company, PetroChina Co. Ltd. (NYSE: PTR), owns a 60% stake in two properties held by Athabasca Oil Sands Corp.

China’s large oil companies have invested heavily in projects based in Africa, South America, and North America, including two deals between Cnooc and Chesapeake Energy Corp. (NYSE: CHK) which give Cnooc a stake in two large shale gas projects in the US.

There are sure to be more such deals as the global supply of oil slides and the costs of developing difficult and expensive projects such as those in the Canadian oil sands get even more expensive. China’s investments in these projects represent both a hedge against falling supply and a hedge against a weak dollar.

Paul Ausick

If it’s any consolation, China is raising its prices for gasoline as well. Chinese drivers will begin tomorrow paying about $3.70/gallon. China’s government forces the price hikes on its refiners, but then at the end of the quarter China National Petroleum Corp. and China Petroleum and Chemical Corp. (NYSE: SNP), the country’s two largest refiners, get paid back directly by the government.

Two of the largest refiners in the US, Valero Energy Corp. (NYSE: VLO) and Tesoro Corp. (NYSE: TSO), have seen share prices dip today after the EIA’s weekly report. Valero shares are down nearly -2.5%, to $29.77, following a new high today of $31.12. The stock’s 52-week range is $15.49-$31.12. Tesoro also hit a new high today of $28.74, before giving back its gains. The stock is currently down about -3.5%, at $27.24, within its 52-week range of $10.40-$28.74. Smaller competitor Western Refining Inc. (NYSE: WNR) also posted a new 52-week high this morning of $19.50. The stock is now trading down about -2.5%, at $18.60, within its 52-week range of $4.01-$19.50.

Cotton jumped $0.07/pound today, triggering a halt in trading because the white fluffy stuff had hit its daily limit. Demand for cotton is expected to be high again this year, while in the US acres planted in cotton did not increase by the expected 20% over 2010 plantings. US acres devoted to cotton are forecast to rise about 15%, from nearly 11 million acres in 2010 to about 12.6 million acres in 2011. Competition for land from other high-priced grains and oilseeds are partly responsible for the less-than-expected plantings.

Copper continues its spectacular rise, up more than another $0.10/lb today, to $4.37. Regardless of warnings by many observers that non-commercial Chinese buyers are stockpiling copper to use as collateral for loans, traders just can’t seem to get enough of copper futures. China is expected to crack down on the non-commercial stockpiling of copper, but hasn’t done so yet. Even if the Chinese government does take a firm stand, however, there are plenty of indications that copper supply will be short of demand by at least 400,000 metric tons in 2011. Some analysts are predicting an average price for copper of $4.45/pound in 2011. This is nosebleed territory.

Gold is trading above $1,456/ounce this afternoon, primarily because expected interest rate hikes at the European Central Bank and the Bank of England could tamp down equities. Silver is trading above $39/ounce, after peaking earlier in the day at around $39.65.

Among the stocks and funds involved with copper, Freeport-McMoran Copper & Gold Inc. (NYSE: FCX) is essentially flat, at $56.60, within its 52-week range of $28.36-$61.35. The iPath DJ-UBS Copper Total Return Sub-Index ETN (NYSE: JJC) is up more than 3%, at $57.95, within a 52-week range of $36.60-$61.69. The Global X Copper Miners ETF (NYSE: COPX) is also up about 1%, at $20.80, after setting a new 52-week high this morning of $20.98.

The SPDR Gold Shares ETF (NYSE: GLD) is up slightly, to $142.12, after posting a new 52-week high today of $142.62. The Market Vectors gold Miners ETF (NYSE: GDX) is down slightly, at $62.61, with a 52-week range of $45.70-$64.62, The Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) is up slightly, at $41.79, in a 52-week range of $24.25-$44.86.

Silver ETF iShares Silver Trust (NYSE: SLV) set a new 52-week high today of $38.82, but is trading slightly down from that at $38.42 at around 2 pm ET. The Global X Silver Miners ETF (NYSE: SIL) also set a new 52-week high of $30.69, but has given some of that back, trading now at $30.02.

Paul Ausick

Total will pay about $1.74 billion to Suncor to gain an additional 19.2% stake in Suncor’s Fort Hills project and a 49% stake in Suncor’s Voyageur upgrader project. The deal bumps Total’s interest in the Fort Hills project to 39.2%. Suncor owns 40.8% of the project and is the operator. Teck Resources Ltd. (NYSE: TCK) owns the remaining 20% and is not involved in this deal.

In exchange for the stake in the Voyageur project, Total passes a 36.75% stake in its Joslyn project to Suncor, retaining 38.25% for itself. Total will be the operator at Joslyn. Occidental Petroleum Corp. (NYSE: OXY) owns 15% of the project and Japan’s Inpex owns the remaining 10%, and neither is involved in the announced deal.

Total will also cancel work on an upgrader it had planned as part of the Joslyn project. Instead the Voyageur upgrader will process the bitumen from both Fort Hills and Joslyn at a rate of 200,000 barrels/day once the upgrader is completed, now scheduled for 2016. Suncor expects to more than double its output by 2020, to more than 1 million barrels of oil equivalent per day.

Total’s history in the oil sands is a bit rocky. The company tried in 2009 to acquire UTS Energy, a partner with Suncor and Teck in the Fort Hills project, for about $830 million. Finally in July 2010, the French company coughed up about $1.5 billion for UTS to get its initial 20% stake in the Fort Hills project. Now Total owns nearly 40% of a deposit estimated to equal 3.4 billion barrels of oil equivalent. Total also owns 50% stakes in two other oil sands projects, Surmont (a 50/50 joint venture with ConocoPhillips Corp. (NYSE: COP)), and Northern Lights, another 50/50 joint venture with China Petroleum & Chemical Co., or Sinopec, (NYSE: SNP).

Oil sands development has gotten hammered by environmental groups for its destruction of the environment, its greenhouse gas emissions, and its nearly unquenchable thirst for water. However a report issued by Royal Society of Canada scientists downplays the impacts of oil sands mining but does note that the development accounts for 5% of Canada’s greenhouse gas emission and that as the industry grows so will emissions. The report also states that there is a need to review the adequacy of the financial reserves meant to pay for environmental disasters and to repair damage when projects shut down.

Total committed itself to oil sands development as a way to build its proved reserves at a reasonably affordable price. Even the massive costs of developing an oil sands project pales compared with developing ultra-deepwater reserves.

Paul Ausick

Late last week the government upped the required reserve ratio for the country’s banks by 50 basis points, putting the rate paid required at the largest banks at 19% of deposits. And as far as interest rate hikes go, MarketWatch cited a Citigroup note stating that an interest rate hike of 0.25% was already priced in to equities.

The Chinese government is reluctant to boost interest rates because that would almost surely cause money flows into the country to rise, adding more fuel to the inflation fire that is building. It seems that inflation fears are being trumped by the government’s desire to keep the country’s economy growing.

Perhaps the most rapidly rising Chinese stock belongs to Baidu, Inc. (NASDAQ: BIDU), the Chinese search engine provider. The company held about 73% of the search market at the end of the third quarter and its stock price has soared by about 150% in the past twelve months.

Compare that growth with China Mobile Limited (NYSE: CHL), the country’s largest mobile phone company, which has risen by about 10% in the past year. Or China Petroleum & Chemical Co., known as Sinopec, (NYSE: SNP) which has grown by less than 10%.

Sinopec is more than twice the size of Baidu, as measured by market cap, and China Mobile is larger than Sinopec. But Baidu is viewed as the dominant player in its market, even though search engine revenue for all companies in China is likely to be less than $2 billion in 2010. Google Inc. (NASDAQ: GOOG) had about 25% of China’s search engine market in the third quarter, but its wrangling with the government has given Baidu a big shot in the arm.

Though the markets took comfort from the Chinese government’s inaction over the weekend, all is not really well in the country’s equity markets. The government has declared that its top priority for 2011 is to stabilize prices without stunting economic growth. But the country’s loose monetary policy has pumped billions of yuan into the economy and helped inflate bubbles, particularly in real estate.

The government has decided to tighten monetary policy going forward, but has offered no specifics. The lending target for 2011 has been set at 7 trillion yuan, down from 7.5 trillion yuan in 2010 and 9.6 trillion yuan in 2009. That could help a little.

But the government appears to be searching for a precision tool that does not include interest rate hikes or currency revaluation as a means to rein in inflation and maintain economic growth. If it finds one, then Baidu and China Mobile are likely to benefit. Sinopec and other Chinese oil companies are not, because the government will almost certainly have to do something to tamp down rising gasoline prices for Chinese consumers.

Today’s good news in China’s equity markets is likely to be temporary. Once the government decides how it plans to deal with inflation, equity markets are not likely to applaud the outcome.

Paul Ausick