OIL Slickonomics – Part 9

David R. Kotok
Chairman and Chief Investment Officer
OIL Slickonomics – Part 9
July 4, 2010


Americans were troubled by a different British threat two hundred and thirty-four years ago when Jefferson’s famous declaration launched our grand experiment in democracy. Now, as then, we Americans find ourselves immersed in debate and facing uncertainty.

Then we fought a revolutionary war and rejected dominance from afar. Now we have already lost a global energy war. We have not restrained our oil hunger. We are presently dependent on foreigners for about ¾ of our oil needs. The BP spill, its aftermath, and the Obama drilling moratorium now threaten to raise that percentage to a new all-time high level of 85% dependency.
In Jefferson’s time, the authentic tea party affirmed that “taxation without representation” was anathema. America’s early decades codified some of our “inalienable rights” like free press, property ownership, and the right to a jury trial with a presumption of innocence. Now our free press shows us daily photos of the oil flow, video of empty Pensacola beaches, the angst of a Louisiana Parrish president, and the business failure of the a Gulf shrimper.

Property was ill-defined at our origins because Jefferson could not achieve a united thirteen colonies any other way. It took a century and a civil war to remove human beings from the definition of owned assets. Our evolving system replaced dueling pistols with lawyers and debtors’ prisons with bankruptcy.

Now lawyers duel in the GOM with hundreds and hundreds of actions. Bankruptcy risk is rising, according to market-based pricing of BP and its partners. An unprecedented $20 billion fund will bypass courts. This settlement between BP and the US government breaks new ground in America. In time, we shall see if the unintended consequences end up outweighing the value.

Many analysts, including ourselves, believe $20 billion is too low and will prove to be insufficient to settle all legitimate claims. This fund was created out of a political decision-making process. It was not derived directly through our multi-century evolved process of adjudicating disputes. To be paid from the fund a claimant has to give up some rights. He must settle early and when the ultimate damage claim is unknown as to final size.

During the last two centuries our American government centralized. Its powers grew. After Jefferson, financial obligations evolved through three huge pre-World War II, multi-decade cycles of inflation and deflation, boom and bust. Crisis after crisis led to official attempts to prevent their repetition. This effort has always been unsuccessful for Americans as our political system ebbs and flows between restrictive financial conservatism and liberalistic fiscal and monetary ingenuity.

As the financial reform bill wends its way through Congress, the issue of BP’s global derivative exposure begins to surface in markets. This is a global market measured in the trillions. We will soon learn more about BP and Credit Synthetic Obligations (CSO). One detailed analysis from Moody’s identifies 117 of them that may be impaired by BP credit downgrades. Remember, BP was once an “AAA” credit. It is now “BBB” according to Fitch.

Friday’s employment report was unpleasant reading. It affirmed our forecast of a very slow job recovery ahead in the US. On July 4, 2010, the narrow, and headline-generating, computation shows that one of every ten Americans is looking for a job and unable to find one. One of six is either underemployed or unemployed (we are using the U-6 or broad definition of unemployment). Think about it: 17% of our willing and working-age citizens have income levels below their previous experience.

In addition, our nation has watched trillions in housing wealth disappear. Our homes, the most pervasively owned asset in America, have been the bastion of savings for our stabilizing middle class. It is a damaged sector. Its owners bear scars; its foreclosed former owners suffer.

The national statistics need one more month to be disaggregated in sufficient depth to estimate job losses from the BP spill and from the Obama moratorium. Business condition reports compiled by the Atlanta and Dallas Fed regional banks will begin to discuss the economic pain in tourism, fisheries, and oil service industries. We expect this to make for continued unpleasant reading. If the Obama moratorium holds in its present form, we expect a million more job losses over the next few years to “pile on” the job losses to date. This is in addition to those originating in the loss of fisheries and tourism. Obama may be destined to run for re-election in 2012 with a broadly computed (U-6) unemployment rate of 18-20%. This November the Congress too will be faced with these numbers, which is why some incumbents have decided to retire.

In Sarasota, some locals seem relieved by NOAA’s latest probabilities of oil-slick landfall. NOAA says the likelihood of the oil damage reaching the Florida Keys and Miami is greater than the chance of it hitting the Tampa-Naples stretch of Florida’s west coast. Why? NOAA says the shape of the continental shelf alters the direction of the currents. We note, however, that the NOAA study looked only at models of the directional flows of GOM currents. It did not consider hurricane activity.

On July 4, one-third of America’s GOM is closed to fishing. NOAA’s jurisdiction stops at the federal boundary. Thus, Mexico, Cuba, or international treaty enforcement determines fishing prohibitions in the non-US Gulf.

The Sarasota fishmonger on Lemon St. now gets his shrimp from Sanibel. “Louisiana is dead for years,” he said. “It will not come back in my lifetime.”

At Walt’s Seafood, at 4144 South Tamiami Trail, the manager told me his oysters now come from the Texas side of the GOM. I asked him about hurricane-induced changes and underwater dispersant plumes. He offered me a blank stare. “I leave that up to the government to tell me what I can do,” he said.

Walt’s had some July 4 special offerings to accompany a cold, crisp Sauvignon Blanc from Marlborough, New Zealand. I thought about seafood, personal safety, trust in government, and the GOM. I pondered the damage BP and its partners inflicted. Moreover, I considered that this is now a five-state regional tragedy thanks to politics, which are making it worse.

But what to eat? Is it safe? In the end, some flown in from New England Ipswich steamed clams and a Maine Lobster proved to be succulent.

The belly is sated. The wine was flavorful. However, celebratory joy seems muted on this Fourth of July.

David R. Kotok, Chairman & Chief Investment Officer, Cumberland Advisors, www.cumber.com

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