Own BHP or Rio? Time to Worry

107

And away we go for another week.

I apologise in advance. You and I have no choice but to return to a familiar theme. We’ve been grappling with this for a year now.

It’s the IMO 2020 rule, coming into place on 1 January, 2020. Earlier this year, I said this could be the biggest trade of 2019.

This relates to new environmental restrictions around the type of fuel that global shippers can burn (in case you just joined Profit Watch). 

I know, I know. It’s much more fun to talk about a Facebook crypto coin or the arrival of the self-driving car.

But the global economy is not so detached from the old way of business, as it can seem sometimes.

Ships, miners and farmers still burn a lot of diesel each day.

In January 2020, this new shipping fuel will need to be a low-sulphur, cleaner version of the dirty ‘bunkers’ used now.     

And if you own shares in BHP Group [ASX:BHP] and Rio Tinto [ASX:RIO], for example, you’d better pay attention…

(Hardly anyone is excluded here, because they’re in any default super fund for sure.)

The Australian has finally picked up on the story[1].

They cite an analyst at a research firm called Wood Mackenzie who’s warning that diesel costs for the miners (any miner, not just the big two) could rise 6-7%.

That’s part of the operational cost for their mines.

Then you can add on top of that the extra transportation cost — possibly as high as 30% — of shipping all that iron ore and coal and copper by ship to China.

Rising costs eat into earnings. That’s not what you want as a shareholder.

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This stress on the price is because of the current dynamics within the oil market right now.

Now, I’m not saying ‘Sell the big miners now.’ But this is a very important story to follow.

You see…that potential rise in the cost of diesel of 6-7% may prove to be far too low.

It could be a lot worse. The oil market is very delicately poised right now.

We have Iran under US government sanctions. Venezuela’s production is in severe decline.

The market has so far adjusted to these factors.

Libya in North Africa is another major producer.

Last week came the news that a Libyan general is marching on the capital and possibly could reignite a full-blown civil war[2]

Fellow producers Algeria and Nigeria aren’t exactly a beacon of stability, either.

Then we have the disconnect happening in America…

Two forecasts, two opposite conclusions

One of the factors that has kept the price of oil down is US shale. It’s been a wonderful gift for the world in keeping energy prices down.

The people who have funded this largesse — shareholders in US shale firms — aren’t feeling quite so giddy.

The shale industry has consumed billions in capital and is yet to show a sustained profit.

Reuters just analysed the top drillers[3]. In 2018, they spent US$6 billion more in cash than they brought in.

Most investors who put money in these firms years ago, and held, have a loss to show for it.  

You got cheaper petrol!

But it’s the projection of production growth in the US that concerns us now. The International Energy Agency thinks the US is going to keep pumping out huge amounts of oil.

Energy economist Philip Verleger is expecting a loss of one to two million barrels of oil per day by the end of December 2020. 

His forecasting record is the best I’ve seen in this space.

The pressure on oil is to the upside, as long as the global economy doesn’t tank around us.

But there are no slam dunks in investing.

We do have — as always — the Trump card in play…

A possible export ban?

President Trump makes no secret of the fact that he wants oil prices lower. He tweets about it regularly. This plays to his working-class base.

You might think his threats are empty. They’re not.

For example, he could release oil from the US strategic reserve or attempt to block US exports to keep the domestic price of US fuel products down.

This would toast the rest of the world.

US exports of oil were banned until Barack Obama removed the restriction.

It may be that Trump puts it back again.

That’s speculation on my part.

Regardless, watch oil. It’s shaping up to be the key market of 2019.

Best wishes,

Callum Newman,
Editor, Profit Watch


[1] ‘Shipping Industry Fuel Reforms to Hit Local Miners.’ The Australian, April 8, 2019.

[2] ‘Libyan General Claims to Have Seized…’, ABC News, April 8, 2019.

[3] ‘Cash Flow Still Weak…’, Reuters, April 3, 2019.  

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