10 Events That Will Reshape The Post-2014 World - New Year's Review 2015

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Includes: AAL, BEAT, BKNG, C, CBS, EOG, EPD, GM, GOOG, GT, LMT, MMP, NG, UPL, UUPT, XCO
by: Marc Liu

Summary

Ten important events that will reshape the post 2014 world involving: oil, water, population, medicine, robots and currencies. Where to invest today and why.

Oil prices crashing, droughts growing, new hostilities erupting and the ever-expanding world population. What's coming next, and how will it affect your investment decisions.

US markets hit new highs, the ruble crashes, yields are at all-time lows and oil is plunging - is it safe to invest and where?

1 - Fracking in America

Fracking has virtually doubled the total US energy reserves for oil and natural gas.

The US is verging on energy independence.

While we are much stronger energy-wise than we were, we are still small when compared to Saudi Arabia's massive reserves, although our production now matches theirs.

Supply and demand pressures have pushed energy prices downward, with oil dropping from $100+/barrel to below $57/barrel today. Oil could drop (perhaps early in 2015) to an oil market low around $38/barrel (as it did in 2008), before bottoming and starting a slow climb back up.

US energy needs $65 oil equivalent to break-even on a fully-costed production basis. Cheap energy will go a long way towards helping to balance the US budget and strengthen the economy. The drop in gasoline and home heating oil is supplying a shot in the arm to weak household incomes. Gasoline has dropped from over $4/gallon to around $2.50/gallon nationally as of December 2014.

Please note the chart below stops in October 2014, before the plunge in the national average pump price to $2.50.

2 - Fracking in Saudi Arabia

Huge fracking/horizontal drilling investments plus alternative energy projects all totaling $260+ billion were started in Saudi Arabia in 2012. According to the Saudi Oil Minister, these projects will virtually double Saudi energy reserves by 2015.

"The truth here is that the kingdom has more than 260 billion barrels. And I firmly believe that the potential to add another 200 billion barrels of oil are there to be found." - Al-Naimi (Saudi's Oil Minister) in an interview with 60 Minutes.

If he's right, that means Saudi Arabia will have 460 billion barrels of oil reserves when realized. China has just started a $300 billion drilling program as well, in their most productive energy province.

Saudi Arabia has used their swing production clout to crash oil prices to dislodge the US fracking industry and all alternative energy initiatives. Oil below $65 pressures most new energy projects, and Saudi Arabia hopes to stop or vastly reduce US fracking. Saudi Arabia holds over $2 trillion of US reserves on its balance sheet - so they are well positioned to hold their current production level. Saudi lifting costs per barrel of oil are around $2-$5 per barrel, giving them great latitude to manipulate prices.

Note the huge size of reserves below for the top #10 compared to the US, which is at #12 (and this does not include the reserves from the Saudi fracking program nor the US fracking program).

Country - Reserves (as of 2014) Barrels (MMbbl)

1

Venezuela

297,740

2

Saudi Arabia *

268,350

3

Canada

173,625

4

Iran

157,300

5

Iraq

140,300

6

Kuwait

104,000

7

UAE

97,800

8

Russia

80,000

9

Libya

48,014

10

Nigeria

37,200

11

Kazakhstan

30,002

12

United-States**

26,544

13

China

25,585

14

Qatar

25,382

15

Brazil

13,986

16

Algeria

* in 2014 - 468,000, including new fracking reserves

** in 2012 - 46,000, including new fracking reserves

"For oil-rich states that depend on oil for most of their revenue, the slide is potentially disastrous. 'Civil unrest is likely to increase in those countries due to their inability to fund subsidies that have acted to bribe the population,' offered David Kotok, chairman and chief investment officer of Cumberland Advisors. A widely used measure of the impact of oil prices on major producers' governments is the fiscal breakeven price. That's "the average price at which the budget of an oil-exporting country is balanced in a given year," according to Standard & Poor's. Estimates of fiscal breakeven prices can vary considerably based on a variety of factors, including actual budget expenditures and differences in oil production forecasts. In most cases, the oil price necessary to balance the budgets of major oil-producing countries is above $100 a barrel in 2015, according to data from Citi Research's Edward Morse. Venezuela, already facing serious fiscal woes and rampant inflation, needs oil at $151 a barrel next year to balance its budget, according to the data. Iran, which has yet to agree to curb development of nuclear weapons, and heavily subsidizes gasoline for its citizens, needs oil at $131 a barrel. And Russia, whose seizure of Crimea and continuing aggression towards Ukraine has raised tensions throughout Europe and inspired western financial sanctions, needs oil at $107 for a chance of getting its finances in order. Based on Citi's research, Libya looks as if it could be facing a serious fiscal hole, with its breakeven for 2015 at $317.

Here's a look at other notable oil producers and their fiscal breakeven points for 2014 and 2015, according to Citi Research's data.

Country

2014 fiscal breakeven oil price

2015 fiscal breakeven oil price

Libya*

317

184

Venezuela*

161

151

Yemen

160

145

Algeria*

132

131

Iran

131

131

Bahrain

125

127

Russia

105

107

Saudi Arabia*

98

103

Oman

99

103

Iraq*

111

101

UAE*

79

77

Quatar*

55

60

Kuwait*

54

54

*OPEC member

Source: MEES, IMF, Citi Research

3 - Energy demand

Today, US energy usage is at 23 barrels per capita. In most less-developed countries (China, India, South America, Asia, Africa etc.), the usage is 2-3 barrels per capita. This means that the usage in these countries will need to rise 4 times just to approach 50% of US usage. Over time, this increase in demand will push energy prices back up into the $65-$100 range, and maybe much higher.

Countries like Russia, Iran, Venezuela, Nigeria and Brazil are desperate for money and are dumping oil at any price at this time. This leaves Saudi Arabia as the swing producer (pushing energy prices down for now, but capable of pulling them back at will).

As a forecasting time line, I see a bottom in oil prices in 2015 at around $30, then recovering to around $80 by 2019.

Energy price recoveries could be faster, but currency dislocations will slow the rise (see below).

"With the benefit of hindsight, it now appears that the energy boom of the past few years might have been a bubble, not just in the US, but worldwide. Booms have a tendency to turn into bubbles when they attract too much equity and debt capital, which leads to excess capacity. When the bubbles inflate, so do the prices that attract all the capital. When the resulting excess capacity leads to falling prices, the bubble bursts as capital dries up. The key characteristic of the tulip and other bubbles is expectations that tulip prices will continue to rise even as more tulips are produced." - Edward Yardeni, December 15, 2014

That said, the realities of the growing demand for energy in the world will ultimately stabilize prices and move them back up eventually to new highs (see chart below).

4 - Compact Fusion Reactor [CFR] comes alive

The skunk works division at Lockheed Martin (NYSE:LMT) is developing a new technology called Compact Fusion - self described as "infinite" energy.

"Dubbed the compact fusion reactor , the device is conceptually safer, cleaner and more powerful than much larger, current nuclear systems that rely on fission, the process of splitting atoms to release energy. Crucially, by being 'compact,' Lockheed believes its scalable concept will also be small and practical enough for applications ranging from interplanetary spacecraft and commercial ships to city power stations. It may even revive the concept of large, nuclear-powered aircraft that virtually never require refueling-ideas of which were largely abandoned more than 50 years ago because of the dangers and complexities involved with nuclear fission reactors." - Source: Lockheed Martin materials

CF replaces dangerous nuclear fuel with a non-fissionable energy system - there is no risk of meltdown.

Nuclear plants are only 30% efficient; CF is 90+% efficient and leaves no radioactive waste. CF plants are tiny (the size of a tractor trailer box), and could power a whole power system for 100,000 families on 55 pounds of fuel. CF could save the US grid system, which is currently falling apart and requires a stated $1 trillion to rebuild. CF fuel costs are negligible compared to conventional power plants. Lockheed expects to have a working test prototype by year-end 2018, and a full commercial prototype 5 years after that.

"If we can meet our plan of doing a design-build-test generation every year, that will put us at about five years, and we've already shown we can do that in the lab." The prototype would demonstrate ignition conditions and the ability to run for upward of 10 sec. in steady state after the injectors, which will be used to ignite the plasma, are turned off. "So it wouldn't be at full power, like a working concept reactor, but basically just showing that all the physics works. An initial production version could follow five years after that." - Thomas McGuire, an aeronautical engineer who leads the Revolutionary Technology Programs unit in Lockheed's Skunk works Division.

If these prototypes proves out, this could radically reshape energy usage around the world. So, stay tuned.

This could be a big component in Lockheed Martin's future, although LMT is doing pretty well as it is.

5 - Currency dislocations and the US stock market

The US dollar traded at $.78 in 2014, near its all-time lows. Between the new energy profits, expanding technology profits and overall economic improvements, the US dollar should move towards its old highs of around $1.50 by 2017. As the dollar goes, so does the US stock market - higher over the next several years, unless it gets too over-heated.

Appaloosa Management's David Tepper said in an email to CNBC on Tuesday that 2015 is setting up to be like 1999.

Tepper wrote: "This year rhymes with 1998. Russia goes bad. Easing [is] coming from Europe. Sets up 1999 ... [oops] I mean 2015."

He said he's not calling for a top in the market for next year. "You [just] have to be aware of the possibility for some sort of overvaluation of the markets. And they are fair value now.

Worldwide money [was] made too easy for where USA fundamentals were in both late 1998 and 2014," Tepper continued, saying what happened in 1999 is "not exactly the same," but said it was "similar."

"Remember in 1999 the S&P [500] went to a 30 PE [price-to-earnings ratio]. Next year PE is now like 16, Tepper wrote.

The S&P 500 rose 19 percent in 1999, peaking in 2000 and sliding to a bottom in 2002.

The year 1999 was also associated with the tech bubble, as the Nasdaq Composite index shot up like a rocket, only to fall off a cliff in early 2000 and follow the broader market lower.

The recent Russian currency crisis has also recalled memories of a similar situation in 1998 that forced Russia to default on its debt." - Source: CBS

And why should we care what David Tepper thinks? Because David Tepper simply put has one of the best long-term track records around. As he pointed out in his July 2014 investor letter, had you invested $1 million with him in 1993 and didn't pull out, you would now have around $149 million. That works out to a compounded rate of return of 40% a year.

The US Fed action to lower interest rates (in order to allow the re-stabilization of the economy post the 2008 crash) has also helped drive the dollar higher. 2015 could see a modest change in that Fed position with slightly higher interest rates evolving. This dollar move will have profoundly negative impacts on energy and commodity prices, most of which are priced in US dollars. It will have the reverse effects on bonds as investors rush to the "safe haven" of the dollar - tempered by the Fed's modest change in policy.

However, the Chinese yuan will begin moving up as well. Buoyed by the benefits of cheap energy, the currency will begin moving to broaden its reserve status. More and more countries are beginning to accept the yuan in addition to the USD.

"November 10, 2014: China and Russia deepened their energy ties with a second blockbuster deal that lessens Russian reliance on Europe and would secure almost a fifth of the gas supplies China needs by the end of the decade... The deal is slightly smaller than the $400 billion pact reached earlier this year, shortly after Russia annexed Crimea...

... Russian oil firm OAO Gazprom (OTCPK:OGZPY) is negotiating the supply of as much as 30 billion cubic meters of gas annually from developments in West Siberia to China over 30 years, it said. At the same time, another Russian producer, OAO Rosneft, agreed to sell a 10 percent stake in a Siberian unit to state-owned China National Petroleum Corp." Source: Bloomberg

Iran, Saudi Arabia, Kuwait and others now already don't accept solely USD for trade (most accept a basket of currencies instead).

Chinese yuan convertibility will be expanded over the next several years, and could be complete by 2019. At that point, China should be in a position to challenge the USD as one of the world's major reserve currencies. The country has been adding substantial gold reserves in anticipation of this moment (boosting the percent of their currency backed by gold).

The following table shows the top six holders of gold in GDP terms. (Eurozone countries are combined into one.)

Country

Gold
(Tonnes)

Value US$ B
($1300 gold)

GDP US$ B
(2013)

Gold
Percent
of GDP

Eurozone*

10,786.3

$450.8

12,716.30

3.5%

US

8,133.5

$339.9

16,799.70

2.0%

China**

4,500.0

$188.1

9,181.38

2.0%

Russia

1,068.4

$44.7

2,118.01

2.1%

India

557.7

$23.3

1,870.65

1.2%

Japan

765.2

$32.0

4,901.53

0.7%

China

1,054.1

$44.1

9,181.38

0.5%

*including 503.2 tonnes held by ECB

**Projection

Sources: World Gold Council, IMF, Casey Research proprietary calculations

At Casey's projected 4,500 tons, the Gold as a percent of GDP shows China would be on par with the top gold holders in the world. In fact, they would hold more gold than every country except the US (assuming the US and EU have all the gold they say they have).

This move away from the USD as the world reserve currency will have profound effects on America's ability to simply print money to pay its debts in the future.

Footnote: The Russian ruble has collapsed 40% in 2014 alone, has more downside to come and then flat-lining until energy recovers and the ruble with it.

India will also be a major beneficiary of the energy price collapse, as will the rupee.

There is a possible inflation in the out years past 2019 as the US dollar's power diminishes against the yuan.

6 - Wireless medicine and Big Data transform US medical care

Dr Eric Topol (the father of wireless medicine) wrote a book in 2012 titled "The Creative Destruction of Medicine: How the Digital Revolution Will Create Better Health Care." In it, he outlined the impact on conventional medicine when wireless medicine and genomics come together to usher in preventative medical testing and care. The savings from this new technology will be so large, they could literally save Medicare and the US healthcare system. This new technology will refocus medicine from symptom-driven treatments to illness avoidance and advanced treatment.

"Doctors will still provide treatment, but they won't be doing very much diagnosing or monitoring; that will be done by patients going forward. Algorithms will facilitate those processes or take them over completely, depending on the problem. For example, you might have a condition that normally would require hospitalization. But instead,you'll be able to stay at home because your vital signs can be continuously monitored remotely. If a particular reading causes concern, a notification will immediately be sent to your doctor, who can then intervene. So it's not so much that the doctor's role is less important - it's just different." - Dr. Eric Topol

Another leading proponent of this movement is Elizabeth Holmes, the CEO of Theranos, who has just signed major deals with Walgreen's and CVS to do their blood testing. The cost of this testing is a fraction of the cost of regular blood testing, and with only several drops of blood - no needles - they can do up to 200 tests.

These tests can give the patient a profile of their personal medical condition that can then be monitored over time before seeing the doctor. So when the patient goes to the doctor, s/he will be treating the problem, not diagnosing the condition.

Here's a recent article in the New Yorker about Elizabeth Holmes and the company.

7 - Water shortages switch world focus away from Energy Rarity and to Water Rarity

Sao Paulo, US-Ogallala Aquifer, Australia, California - these are the canaries in the coal mine for global warming and water shortages.

Sao Paulo - Brazil:

"If the drought continues, residents will face more dramatic water shortages in the short term," Vicente Andreu, president of Brazil's National Water Agency and a member of Rousseff's Workers' Party, told reporters in Sao Paulo. "If it doesn't rain, we run the risk that the region will have a collapse like we've never seen before," he later told state lawmakers. The worst drought in eight decades is threatening drinking supplies in South America's biggest metropolis.

California - US:

"But when 80% of California is in an extreme drought, surface water runoff from the mountains stops flowing and reservoirs are depleted, farmers see the only way to go is down - way down...

... The drilling frenzy is escalating at a fast and furious pace in agricultural counties throughout California. Drilling permits are being issued in record numbers, raising concerns that this unregulated activity may deplete the aquifer. It has already drained water away from residents - many of them poor Hispanic farm workers - who depend on groundwater from shallow wells, some that date back 60 years and reach no farther than 50 feet to 85 feet under...

... And, yes, groundwater pumping is not regulated in California, one of the most regulated states in the nation. It is the only western state without regulated groundwater management." - Source: Aljazeera America, 8/9/2014

"So there's something of a groundwater rush going on here. Arthur's seven rigs are in constant use and his waiting list is well over a year. And because some wells here are running dry, he's having to drill twice as deep as he did just a year or two ago. This well will cost the farmer a quarter of a million dollars, and go down 1,200 feet - about the height of the Empire State Building." - Source: 60 Minutes, 11/16/2014

Ogallala Aquifer - US:

"Ninety-five percent of the United States' fresh water is underground. One crucial source is a huge underground reservoir, the 800-mile Ogallala aquifer which stretches from Texas to South Dakota and provides an estimated third of all US irrigation water.

The aquifer was formed over millions of years, but has since been cut off from its original natural sources and is being steadily depleted. In some areas its level is dropping by three to five feet (90 - 150cm) a year. Estimates for its remaining lifespan vary in different areas, ranging from 60 to 250 years.

Many farmers in the Texan High Plains, which rely particularly on the underground source, are now turning away from irrigated agriculture as they become aware of the hazards of over-pumping." - Source: BBC

While 70% of the earth is covered with water, only 3% of the water in the world today is potable. Of this, 75% is locked up in glaciers. Population explosion and bad carbon practices will shrink the amount of these reserves on a per capita basis in the years/decades ahead.

Human consumption and industrial consumption are at odds, and you can see the beginning of the water wars from here. It should be noted that fracking uses huge amounts of water in the process. Forty-five percent of the US's water usage is industrial. Water shortages are a problem for oil/industrial companies, as they compete with human consumption and agricultural use. Water price competition is already obvious, with Big Oil paying $2-3,000 per acre-inch of water, versus $250 per acre-inch for farmers in Colorado.

Big investors are actively buying up water. Boone Pickens, of oil investing fame, is the largest private owner of water in the US today.

In the chart below, you can see the spread between the amount of renewable water resources and the amount or water used. For the amount of water used, the figures are broken into 4 component areas: Internal, Agricultural, Industrial and Domestic. The disparities between the major countries and their usage are interesting.

For more information, take a look at the World Bank's 2014 Water Report.

8 - Income inequality will continue to soar

Driven by aggressive expansion of Robotics and Technology, income inequality will become even greater in the years ahead. For the last 50 years, 99% of Americans have just barely had any "real" increase in purchasing power (median household income in 1965 was $45,000 as opposed to $52,000 today) The poverty level in the US today is $23,000, not far from the household income level. Huge increases in education and health costs, coupled with nominal increases in "real" income have bankrupted the average American family.

Janet Yellen is using income growth as the qualitative measure to initiate change in Quantitative Easing policies. As such, it will be a long time before any substantial movement is shown in wages, the median household income and major QE policies. That does not mean that she won't tweak rates slightly in the near future, which she no doubt will.

Note in the chart below, how the income growth ramps up tremendously for the top 1%, but barely moves for everyone else.

The imbalance in the world is no better than the US. Per the chart below, 0.7% of the world population owns 41% of all the wealth.

9 - Robotics and Artificial Intelligence will exceed the limits of social safety

Major advancements in artificial intelligence will rapidly accelerate the replacement of people by machines. Computerization and conventional robotics have been doing this for years, but AI will move things into hyper-drive.

"I think we should be very careful about artificial intelligence. If I had to guess at what our biggest existential threat is, it's probably that. So we need to be very careful. I'm increasingly inclined to think that there should be some regulatory oversight, maybe at the national and international level, just to make sure that we don't do something very foolish." Source: Elon Musk, The Guardian

"In March 2014, he invested in Vicarious, alongside Mark Zuckerberg and actor Ashton Kutcher. The company's aim is to build a neural network capable of replicating the part of the brain that controls vision, body movement and language. It's ultimate aim is to build a "computer that thinks like a person," according to the company's co-founder Scott Phoenix says, "except it doesn't have to eat or sleep". Source: The Guardian

If one considers the apps for cell phones as a form of "personal service"robotics, then you can see how massive the robotics movement really is.

"By 2020, there will be very few people left on the planet who do not have access to a mobile phone." (Source: Microsoft, "Being Human" report)

10 - Population explosion slows

Currently, the best forecasts of world population talk about 9.5 billion people by 2050.

Today, the world's population stands at just over 7 billion.

Continuing exploding technological advancements will limit the number of profitable jobs left for people, thus pushing back against the expanding population's ability to support itself. The continued corrosion of glaciers and ice caps due to global warming will mean less water for the world as a whole. And even less on a per capita basis, due to population expansion. The growing population will also soon run up against all of the other limited natural resources of the world, including food, minerals and energy. It is more than likely that faced with the limited jobs and natural resources, people will opt to have fewer children. This is what has happened in most developed countries when families have been put under financial pressure, and I believe this will eventually happen in the rest of the world given the right circumstances.

The chart above shows the significant downward trend in the world's Total Fertility Rate (births per woman) over the last half century, falling in half (from almost 5 births per woman in 1960 to only 2.45 births per woman in 2010). The downward trend has continued for the years 2011-2014, with almost every country experiencing a drop in fertility. When the trend line crosses below the 2 births per woman line, parental replacement will have stopped, and so also will have population growth. Maybe too optimistic a thought.

Investing Ideas (based on the 10 events above):

1 - Since oil prices should stay low for quite a while, shorting the highest leveraged (weakest) E&P companies on any major bounce seems reasonable. Barron's recently mentioned Ultra Petroleum (NASDAQ:UPL) and EXCO Resources (NYSE:XCO) as having some of the highest net debt-to-capital ratios.

UPL

XCO

2 - The corollary is to buy the strongest oil companies when oil shows signs of bottoming. EOG Resources (NYSE:EOG) looks interesting - maybe by the middle to the end of next year.

EOG

3 - Given the projected strength of the dollar, gold should be weak for several years, before bottoming and then beginning a major run as the dollar falters and the yuan strengthens. Sell gold now, but buy later after a serious break below $1,000 (maybe around $800). Nova Gold (NYSEMKT:NG) is also an interesting idea that is being supported by Seth Klarman and Baupost Group - buy when gold appears to be bottoming.

GOLD

NG

4 - Long US dollar ETFs might be good for a 2-year trade. Here, PowerShares DB 3x Long US Dollar Futures ETN (NYSEARCA:UUPT) might work well.

UUPT

5 - Buy pipeline MLPs - whose stock prices might drop in sympathy with energy prices, but whose businesses will not be hurt - look at Enterprise Products Partners (NYSE:EPD) and Magellan Midstream Partners (NYSE:MMP).

EPD

MMP

6 - In the wireless medicine field, CardioNet, Inc. (NASDAQ:BEAT) is the only current pure play. It's trading up near its highs, so the game is to accumulate cautiously on pullbacks. Dr Eric Topol sits on the company's board.

7 - David Tepper's top five stocks for 2015:

"As of the end of the third quarter, Tepper's top sector in his long portfolio at his hedge fund, Appaloosa Management, is Consumer Cyclical, which composes 24.7%. Consumer Cyclical stocks tend to respond to the direction of the economy.

Tepper's largest holdings within this sector at quarter-end were: General Motors Co. (NYSE:GM), Priceline Group Inc. (PCLN), Goodyear Tire & Rubber Co. (NYSE:GT) and CBS Corp. (NYSE:CBS)." - Source: GuruFocus

1) American Airlines Group (NASDAQ:AAL) - Tepper's biggest position is AAL, at $500 million. AAL is down more than 30% over the past 3 months, and sells for just 5 times forward earnings. (Note the current recovery in price.)

2) General Motors - Tepper owns $471 million of GM. The stock looks especially attractive now, as it's selling near its 52-week low. GM has almost a 4% dividend yield, and sells for just 7 times forward earnings.

3) Citigroup (NYSE:C) - Tepper owns $405 million, and he was quoted in a Bloomberg interview as saying he thinks Citigroup is worth $70.

4) Priceline - Tepper owns $378 million worth of PCLN, which is down 6% year-to-date.

5) Google Class C shares (NASDAQ:GOOG) - Tepper owns $366 million of Google's C shares - he also owns the Class A shares.

(Source: Forbes 10/10/2014 [Charts are from Edgar On-Line, and are through 12/26/2014])

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.