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I was a software developer for 25 years at a (now large) software company. Now I'm just trying to make sense of what's going on in the economy.
  • Energy Business Boom Or Bust?

    Summary: Falling prices and excessive production, plus a weak global economy lead me to wonder if we're heading for another energy bust like we had in the 1980's.

    As an employee of an oil company and owner of Houston real estate in the 1980's, I was an unwilling participant in the energy boom/bust cycle. That got me started on the wrong side of the real estate market. Now I'm an investor in the energy business and still very tied to Texas real estate.

    I also have kids that are working in the energy business who themselves own Houston real estate. All of this causes me to keep a very wary eye on the energy business. A few days ago I worked through the boom/bust cycle again in my mind, then scratched out this diagram. I just wanted a visual chart to help me navigate our position in the cycle.

    (click to enlarge)Commodity Boom/Bust Cycles

    Here's my general understanding of the boom bust cycle. The numbers correspond to the graphic.

    The production of natural resources (e.g. oil and gas, minerals, metals) is capital intensive and requires companies to borrow to finance exploration and production.

    1. When commodity prices go up, banks are more likely to make loans for these enterprises. Many companies are ready to exploit the easy money at the peak of the boom cycle. As these companies invest in exploration the companies that provide E&P services boom. As new production comes online the supply of the commodity is driven up, but prices may continue to rise due to speculation and hoarding. However high prices eventually reduce demand.

    2. When the supply significantly outstrips demand the bust cycle begins. Prices begin to fall, causing E&P companies to see revenues decline. Because their debtors still demand payment, E&P companies must produce more to generate the same revenues with lower unit prices. These companies will continue to grow production at prices well below replacement costs because stopping production is too expensive. Initially this leads to more jobs and benefits the service companies. More production means higher supply, further driving down prices. Eventually some E&P companies can't make their debt payments and go into default.

    3. Some facilities are now producing at an operating loss and have to be shut down. Defaults on E&P loans cause banks to raise interest rates. This further raises production costs and drives even more E&P companies into bankruptcy. Bankrupt companies stop production and lay off workers while they attempt to sell their properties at a loss. Laid off workers further depress the economy and reduce demand.

    4. Eventually low prices allow demand to grow again. Short term monetary and fiscal stimulus may jump-start this process. Now the bust is coming to an end and the next boom cycle can start. At first, prior excess capacity is absorbed so demand can grow for some period of time before prices begin to rise.

    The commodity cycle is one reason companies in this industry are referred to as "cyclical" companies. Somehow most people involved in these industries forget about the cycle and/or ignore it and/or attempt to exploit it. Ultimately it is a business that causes a lot of people to become fabulously wealthy and spectacularly broke.

    Conclusion: It appears to me that we are somewhere between 2 and 3 on my chart. Thus the next shoe to drop is probably budget cuts in the energy business, leading to weakness in the overall energy economy. Since the US economy is much more dependent on the energy business to fuel growth, a slowdown could affect much more than the traditional oil-patch states. It may be time to use caution when investing in stocks and real estate linked to the energy business.

    Oct 27 6:27 PM | Link | 1 Comment
  • FASB And Its Effect On The World Economy

    Originally posted in August 2011 here:

    The Financial Crisis of 2007-2009 started and ended largely as a result of the actions of a small group of men known as the FASB (Financial Accounting Standards Board). This is WAY under-reported by the media, but I learned about it from Bill Isaac on Fox News Channel during the financial crisis.

    To be brief, in 2007 the FASB introduced accounting rule FAS 157 aka the "Mark to Market" accounting rule. That required financial institutions to raise more and more capital to meet reserve and margin requirements as their illiquid asset values plummeted. In other words, they had to sell more and more assets as the value of those assets declined. This created a self-perpetuating and accelerating financial vortex for some very large institutions from which they could only be saved by the Federal Government.

    Under great political pressure, Congress passed the "Emergency Economic Stabilization Act of 2008", which authorized the SEC to review the FASB rules. By March 16, 2009 FASB finally relented on the worst provisions of the rule and the market instantly turned positive. This rule has also been attributed with increasing bank profits in the recovery (and thus executive bonuses) by exaggerating the increase in asset values after they were artificially depressed by the collapse.

    I'm not really complaining about FAS 157 (as modified) since it brought the financial world back to reality from its euphoric bubble. But as with any good regulatory body, they abused their power. Thank God they finally came down off their pedestals before financial Armageddon, which was within days of becoming reality in 2009. "Vogons" exist in the FASB...

    I suppose the point of bringing this up now is this: the financial meltdown and its meteoric resurrection was a bunch of bureaucratic nonsense. But the political reaction to it, and the resulting massive public debt are very real. Unwinding that will be painful if even possible.

    Nov 22 5:06 PM | Link | Comment!
  • Bernanke: Still Easy After All These Years

    I don't blog much on this subject, but I couldn't resist today.

    SO the Fed chairman decided to keep the pedal to the metal and continue pumping money into the pockets of sellers of "bond substitutes" today. Yes, they may actually be buying treasuries and MBS, but the net effect is the money that would have been absorbed by these markets has to find another home. Some of that money finds its way into "lower quality" debt but the smart money is going to find a home that has more inflation protection.

    Recently I posted a note about an "art bubble" forming because very wealthy people like JayZ are paying obscene (what about JayZ isn't obscene after all) amounts of money for some pretty trashy art and very expensive collectible cars. My comment:

    This is just another example of where all the QE money is going. Can't buy bonds, stocks are risky; let's buy collectibles! It's not inflation till it hits the other 99%.

    To which I got these replies:

    The QE money is sitting in bank reserves, not chasing goods, services ... not art.

    QE money is not going to buy art. What the hell are you smoking?

    If he is smoking anything, I'm sure that he needs several moments to figure out that he should light the end furthest from his face.

    It is true that JayZ probably didn't decide to go buy Bugatti's and Jean-Michel Basquiat art work because bond rates weren't high enough, but there are other bidders out there who are using art and other limited-supply investments to shelter their assets from inflation.

    The inflation is limited to the "bond-substitute" market for now because these people don't shop at Wal-Mart and don't eat at McDonald's, and they probably don't need any more food even if they did. So they continue to buy stocks, junk bonds, and yes even collectibles and that is how all that QE money leaks into the economy.

    What I have to wonder today is why the Fed chairman didn't "taper" their bond purchases. It was widely expected and would have been accepted without much fanfare, but instead the Fed chose to "laissez le bons temps rouler" (let the good times roll) another quarter. Something tells me a gran mal headache is waiting around the corner.

    Does anybody still think I'm smoking something?

    Sep 18 6:00 PM | Link | 1 Comment
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