Energy Finance

In order to coordinate its ratings system with its colleagues at CLSA, the Calyon Securities (USA) Equity Research department is changing its oil and gas exploration ratings system. The new ratings system recommendation methodology will change from an absolute system to a relative system based on the local market (S&P 500).

Key to new Calyon Securities (USA) ratings system:
BUY = Expected to outperform the local market by >10%
Outperform (O-PF) = Expected to outperform the local market by 0-10%
Underperform (U-PF) = Expected to underperform the local market by 0-10%
SELL = Expected to underperform the local market by >10%. Performance is defined as 12-month total return

Housing starts fell 4.5% to a 791,000 pace in October, with starts at the lowest pace since just after WWII, say Standard & Poor’s analysts David Wyss and Beth Ann Bovino.

Manufacturing indicators were equally bleak. Industrial production rebounded 1.3% in October, after plunging a revised 3.7% in September (previously negative 2.8%), the worst monthly decline since 1946.

Economic releases this week include:
• The stock market also reached new lows, with the S&P falling to 752 on Friday (midday), down 51.9% since Oct. 9, 2007, and the largest bear market since the ’30s.
• The Empire State index fell to a new record low of -25.43 in November, while the Philly Fed index edged down to -39.3 in November, its lowest since Oct. 1990.
• Consumer prices dropped 1% in October, the largest one-month drop in the history of the series (1947). Core consumer prices were down 0.1%, compared with the 0.2% gain expected, giving the Federal Reserve some room to lower interest rates.
• The producer price index (PPI) plunged a record 2.8% in October, more than the 1.7% drop expected. Declines in both indices were concentrated in energy prices. The core PPI, excluding food and fuel, was up a firm 0.4%, stronger than the 0.1% expected.
• Federal Open Market Committee’s October 28-29 minutes reported that the Fed cut its GDP growth forecast for 2009 to between -0.2% to 1.1% (previously 2.0% to 2.8%). FOMC extended its December policy meeting to two days, Dec. 15 through Dec. 16, to allow for additional time for discussion.
• The Conference Board’s U.S. leading indicators dropped 0.8% in October, from a revised 0.1% gain in September (0.3% before). Six of the ten components were negative.
• While Fannie Mae and Freddie Mac reported Thursday that they will temporarily suspend foreclosures on occupied homes, house Democrats insisted on a plan from the auto sector.
• The Treasury Department reported a record $237.2 billion deficit for October, up from $56.8 billion a year earlier, as outlays surged because of the various rescue measures.
• Initial claims for unemployment insurance benefits rose by 27,000 to 542,000 in the week ending Nov. 15, the highest since July 1992. The number of people receiving benefits surged 109,000 to 4.012 million in the week ending Nov. 8,, the highest since December 1982, pushing the insured unemployment rate up 0.1% to 2.9%. The four-week average of initial claims climbed to 506,500, the highest since January 1983.
• Oil prices fell below $50 per barrel on Friday from $58 per barrel a week ago, down 66% from $148 per barrel in early July on gloomy demand outlook.

Goldman Sachs has lowered its U.S. growth forecast, noting fiscal policy stagnation, record increases in unemployment and a sharp decline in profits. It now expects U.S. GDP to fall 5%percent in the current quarter, with unemployment rate reaching 9% in the fourth quarter of 2009.

It also forecast the 10-year yield to fall to 2.75% by the end of the first quarter of 2009, as compared to previously estimated 3.5%.

“The combination of weaker real activity and slower inflation means that profits of U.S. companies will fall even more sharply than we had previously expected,” Goldman reports.

Goldman now sees economic profits falling 25% in 2009 on an annual average basis, the biggest drop since 1938. It had earlier expected a fall of 20%.

Not good news: Worries about the prospects for employment helped drive Wall Street’s decline Wednesday as stocks continue to fall.

The Fed projected that the nation’s average unemployment rate would rise to 6.3% to 6.5% this year and 7.1% to 7.6% next year. The level in October was 6.5%, and last year the rate averaged 4.6%.

According to economic theory, about 5% unemployment is perfect. That percentage indicates a healthy workforce with about 5% of the workforce in transistion from one job to another, women on maternity leave or caring for children, and labor movement from one industry to another as technology changes and companies merge or divest business units.

But 7% is bad. It denotes expectations of a downward spiral, as manufacturing sectors layoff people, who then buy less luxury goods and services, whose privders then layoff people, and so on and so on.

Advice for us worker bees?
Practice these two phrases: “Welcome to Wal-Mart” and “You want fries with that?”

Total gas consumption is expected to increase by 1.1% in 2008 and fall by 0.2% in 2009, according to the Energy Information Agency’s report released yesterday.

Consumption in 2008 is projected to be higher in every sector except for electric power, led by 4.1% and 3.2% percent growth in the residential and commercial sectors, respectively. While very slight growth is expected in the residential and commercial sectors in 2009, the contracting economy is expected to cause a 2.2% decline in industrial sector consumption next year. The weakness in global economic growth could limit U.S. exports of gas-intensive products and further reduce gas consumption by industrial consumers.

Meanwhile, total U.S. marketed natural gas production is expected to increase by 6% in 2008 and by 2% in 2009. Production activity from unconventional fields in the States of Texas, Wyoming, and Oklahoma is expected to increase supply from the Lower 48 (non-GOM) by almost 10% this year. While continued onshore production growth is expected in 2009, lower average prices and poor economic conditions are expected to limit the expansion of supplies to 1.9%

For 2008, federal GOM production is now expected to decline by 14.8% as repairs to supply infrastructure continue, while 2009 growth of 2.7% reflects the expectation of further recovery and less shut-in production during the 2009 hurricane season.

On October 31, 2008, working natural gas in storage was 3,405 Bcf. Current inventories are now 78 Bcf above the 5-year average (2003–2007) and 130 Bcf below the level during the corresponding week last year.

The Henry Hub spot price averaged $6.94 per Mcf in October, $0.94 per Mcf below the average spot price in September. The slowing economy, continued growth in domestic gas production, and the significant decline in oil prices have led to a dramatic shift in expectations for gas prices over the forecast.

On an annual basis, the Henry Hub spot price, which averaged $7.17 per Mcf in 2007, is expected to average $9.25 per Mcf in 2008 and $6.82 per Mcf in 2009, $1.35 per Mcf lower than the forecast 2009 price in last month’s EIA Outlook.

Last week witnessed the largest single-week decline in the Baker Hughes gas-directed rig count since 1993. Following a decline of 41 rigs, the count stands at 1,498, says Stephen Richardson, analyst at Morgan Stanley & Co. Inc.

“The count has remained stubbornly high for the past month despite the decline in the 12-month strip and tighter credit conditions. While lease expiry, producer hedging, and meeting fourth quarter production targets among the public E&Ps may all conspire to keep the rig count sticky in the weeks ahead, a falling count remains the key forward indicator of a production slowdown.

“Our expectations remain for a circa 500-rig reduction by mid-2009, which implies a circa 12-rig weekly reduction over the coming eight months. A flat production growth outlook for ‘09 is likely to result, in our view. Supportive of this view, Chesapeak now expects 125 to 128 operated rigs by yearend, down from 135 to 140 previously, and expects to maintain this activity level through 2009.”

Credit Suisse Group AG of Switzerland plans to cut more jobs at the securities unit and may sell part of its asset management division, according to a report by Bloomberg’s Elena Logutenkova and Elisa Martinuzzi.

Staff reductions, which may occur before yearend, would follow the 500 layoffs announced two weeks ago, although the extent of the additional cuts is unknown. In September, the division employed 21,300.

The bank’s fund unit is “seeking to revive profit after pretax losses of 359 million francs ($302 million) over the first nine months of the year,” they report. “A joint venture or sale of the global investors unit, which includes fixed-income, equity and money market funds with 255 billion francs of assets under management, is being considered.”

Credit Suisse planned 2,065 layoffs so far at the investment bank, which racked up some 6.4 billion francs in pretax losses through September, but they are certainly not alone. Bloomberg data reveals that, worldwide, banks and brokerages have reported more than 150,000 job cuts and $711 billion of markdowns and credit losses since the global financial crisis began last year.

Morgan Stanley plans to shed 10% of its institutional securities staff and 9% of the firm’s asset-management group as client demand falls. Also, UBS AG, plans to cut 2,000 jobs, trimming the number of investment-banking employees to 17,000 by yearend.

Steel billet prices tumbled heavily in the third quarter, according to Barclays Capital Research. Mediterranean and Far East contracts both plunged by more than 70% from June to mid-October.

November has brought some stability to prices, with both contracts rising firmly back above $300 per tonne, although “this pales compared to the $1,200 per tonne level reached in June this year.”

“Demand dynamics in the steel market weakened considerably in the thrid quarter, associated primarily with a seasonal slowdown in activity in the demand centres of the Middle East and China, and then compounded by the broad financial market dislocations seen in September and October. The announcement of China’s vast fiscal package may offer some hope though moving into the second half of 2009,” say analysts Amrita Sen and Nicholas Snowdon.

Easing supply-side constraints have taken away the floor from prices, with iron ore, coal, freight and scrap prices falling to multi-year lows. However, the speed of price declines has inspired a plethora of production cuts, which, following a period of destocking, should help stem further price depreciations and indeed support price rises once demand growth returns.

The nation’s unemployment hit a 14-year high of 6.5% in October as another 240,000 jobs were lost. It’s (almost) official that we are in a recession.

The U.S. Labor Department report shows the job market “deteriorating at an alarmingly rapid pace.” Unemployment rose from 6.1% in September, tying the rate in March 1994. The last peak at 6.3% was in June 2003. A year ago, the unemployment rate stood at 4.8 percent.

Employers slashed 127,000 positions in August. Another 284,000 jobs were lost in September. More than half of the job loss occurred in the past three months. Job losses seem to be a result of housing, credit and financial market upsets.

According to reports, factories cut 90,000 jobs, the most since July 2003. Construction companies got rid of 49,000 jobs with heavy losses in home building. Retailers cut payrolls by 38,000. Professional and business services reduced employment by 45,000. Financial activities cut 24,000 jobs, with heavy losses in mortgage banking and at securities firms. Leisure and hospitality axed 16,000 positions.

Some analysts expect unemployment to climb to 8% or higher next year. In the 1980-1982 recession, the unemployment rate rose as high as 10.8 percent before falling.

If the economy contracts further in the first quarter of next year, then that more than fulfills a classic definition of a recession–two straight quarters of contracting economic activity.

“The top-50 European banks face an exceptionally difficult environment due to the confluence of reduced asset valuations, contracted market liquidity, varying levels of capital strains, and extremely fragile investor and client confidence,” says Jeff Sexton, New York-based analyst for Standard & Poor’s Ratings Services, referring to a report published on Nov.5, 2008, on RatingsDirect titled Extraordinary Times, Extraordinary Responses–External Support For Major European Bank Ratings In The Face Of Acute Market Difficulties.

“We expect the European banking system to continue to restructure and recapitalize. It will likely emerge with better capital and lower risk profiles, which would be positive for future creditworthiness. Before we get to this point, however, we expect to see continuing rating pressure as banks work through the dislocations. The median rating for the top-50 Western European banks has slipped to ‘A+’ from ‘AA-’ in the last month.

“Banks also face the prospect of rising domestic credit problems as European economies weaken. Government support toward the banking sector underpins the ratings on systemically important banks, but does not, in our view, fix the sector’s deteriorating fundamentals.”

“We are increasingly pessimistic about the depth and duration of the economic downturn, and we now expect it to be deeper than we did three months ago,” said Standard & Poor’s credit analyst Michelle Brennan. “Our view of the future business fundamentals for banks has therefore weakened over the quarter. Our ratings reflect these fundamentals so we believe that European bank ratings will remain under strong pressure over the coming quarters as profitability deteriorates and loans losses increase, even more so if funding remains scarce and expensive and even after the recently announced government-sponsored bank rescue plans,” she adds.

The severity of the current environment is evident in the numerous support packages launched by European governments, something not seen in decades. These measures are extraordinary as government actions, consistent with those that are made by supportive countries in times of extreme stress, are undertaken when no market-based solution is feasible. S&P expects these measures to provide stability to bank ratings that otherwise were potentially vulnerable to deteriorating market confidence and an associated credit cliff.

“We believe these government measures are likely to help improve confidence in the banking sector, alleviating a key risk for banks’ liquidity, but they will not solve all the sector’s problems,” says Brennan. “We can still envisage rating pressure based on weaker business prospects and financial profiles, even where systemic support has strengthened.”

Despite the expected prominence of government-guaranteed bank debt over the next three years, S&P will focus on what the underlying business models are going to look like as a result of the changes that the sector is undergoing, and what these business models will mean for creditworthiness.