Fund Manager
Craig Porter
Over the past few years we have noticed an interesting trend developing in the natural resource sector which will limit future capital spending by corporations. It also is further proof of our thesis that it is getting very difficult and time consuming to bring on new production. Governments around the world are changing the terms of contracts they have agreed to with resource companies. Not surprisingly, the higher commodity prices rise, the greater interference we are starting to see. Governments looking for a greater piece of the pie are increasing taxes and royalties as well as nationalizing assets. The Former Soviet Republics and Russia have become masters at this, expropriating both energy and mining properties after the original companies have spent the capital necessary to get the assets into production. Contracts are being cancelled on minor technicalities, such as paper work not being filed on time, and the new partner of choice is often a state-owned company. So, although the world is craving more commodities, many nations seem to be fostering an environment that will limit growth in their natural resource industries, and ultimately will dampen overall tax revenues.
Our country is also not immune to these influences. Until recently we had been extolling the virtues of Canada as a safe haven for investment in the energy sector. However, recent government initiatives have put a damper on the sector and have contributed to the anemic performance of the TSX energy sector this year. Last fall the federal government eliminated the tax exempt status of royalty trusts, driving investors away from the sector. Then this September the Alberta government announced the results of a study paper that they commissioned to look at whether or not the province was getting a fair share of oil revenues. The report concluded that significantly higher royalties should be charged on oil and gas production to the tune of about $2 billion per year. The response to these proposals was fairly quick and pronounced. The energy sector sold off as investors feared lower returns, and producers, both domestic and international, lined up to state that they would be slashing their capital budgets in Alberta and taking their dollars elsewhere. As an example, Canadian Natural Resources stated that they would cut over $7 billion in oil sands spending over the next 15 years which would eliminate 3,900 direct jobs and 16,000 indirectly. The government has stated that they will listen to all affected parties in this matter before making a final decision. Ultimately, although we believe that royalties will go up, we feel that it will be a figure acceptable to all involved.
The price of oil hit an all time high above $83 per barrel during the quarter. Although there appears to be plenty of oil in the markets, prices were driven higher by factors such as lack of refining capacity, political risk, speculative investing and continued strong demand from Asia. The price of natural gas remained flat throughout the quarter. Gas remains inexpensive compared to oil for a number of reasons. Warm weather in the last two winters has led to higher than normal inventory levels. As well, significant amounts of liquefied natural gas were shipped into North America this summer to meet air conditioning demand. Although we were in a positive energy environment the TSX oil index was off 3.6% during the quarter. In addition to the political factors already discussed, rising cost structures and a strong Canadian dollar have impacted the profitability of most producers. The winners in the sector for the quarter were either the large producers with exposure to the oil sands, or those companies that have a significant portion of their assets offshore.
The price of gold had a dramatic rise in the third quarter, moving $83 to a 27 year high of US $742 per ounce. Although many of the drivers of gold were in place,including falling interest rates and political instability, the key driver was a rapidly falling US dollar. As 85% of gold is purchased outside the U.S. a falling dollar makes gold cheaper for people in other countries. The third quarter is also typically a seasonally strong period for gold as jewelers stock up on gold for the key holiday seasons around year end. The TSX Global Gold Index rose 14% during the quarter, less than we would have expected for the move in the commodity. Many producers are having difficulties in keeping their production costs down leading to diminished earnings. As well very few companies are finding enough new gold to replace that which they are mining out this year. This has led to continued consolidation in the sector as the cash rich seniors look for smaller companies that have sizeable deposits that can be brought on at low costs.
The base metal sector was up slightly, about 2.3%, during the quarter. This number, however, hides the realty that the sector plummeted 25% from peak to trough before fully recovering to close the quarter on a positive note. In August, fears of an economic slowdown in the U.S. brought on by the housing sub-prime crisis caused the markets to correct sharply. Investors were worried that a slowing U.S. housing market would have dramatic implications for base metal demand. Upon further introspection, however, we note that on a global basis demand for metals remains robust, and the problems of new supplies have not been corrected. Large global producers such as RTZ and BHP continue to state that any metals they produce are being consumed in Asia, in particular the bulk commodities iron and coal. So, outside of a coordinated global recession, we feel that the metal sector will provide some of the best returns in the near future.
Craig Porter - Q3 2007 Commentary
Date Published
Fund Manager
Over the past few years we have noticed an interesting trend developing in the natural resource sector which will limit future capital spending by corporations. It also is further proof of our thesis that it is getting very difficult and time consuming to bring on new production. Governments around the world are changing the terms of contracts they have agreed to with resource companies. Not surprisingly, the higher commodity prices rise, the greater interference we are starting to see. Governments looking for a greater piece of the pie are increasing taxes and royalties as well as nationalizing assets. The Former Soviet Republics and Russia have become masters at this, expropriating both energy and mining properties after the original companies have spent the capital necessary to get the assets into production. Contracts are being cancelled on minor technicalities, such as paper work not being filed on time, and the new partner of choice is often a state-owned company. So, although the world is craving more commodities, many nations seem to be fostering an environment that will limit growth in their natural resource industries, and ultimately will dampen overall tax revenues.
Our country is also not immune to these influences. Until recently we had been extolling the virtues of Canada as a safe haven for investment in the energy sector. However, recent government initiatives have put a damper on the sector and have contributed to the anemic performance of the TSX energy sector this year. Last fall the federal government eliminated the tax exempt status of royalty trusts, driving investors away from the sector. Then this September the Alberta government announced the results of a study paper that they commissioned to look at whether or not the province was getting a fair share of oil revenues. The report concluded that significantly higher royalties should be charged on oil and gas production to the tune of about $2 billion per year. The response to these proposals was fairly quick and pronounced. The energy sector sold off as investors feared lower returns, and producers, both domestic and international, lined up to state that they would be slashing their capital budgets in Alberta and taking their dollars elsewhere. As an example, Canadian Natural Resources stated that they would cut over $7 billion in oil sands spending over the next 15 years which would eliminate 3,900 direct jobs and 16,000 indirectly. The government has stated that they will listen to all affected parties in this matter before making a final decision. Ultimately, although we believe that royalties will go up, we feel that it will be a figure acceptable to all involved.
The price of oil hit an all time high above $83 per barrel during the quarter. Although there appears to be plenty of oil in the markets, prices were driven higher by factors such as lack of refining capacity, political risk, speculative investing and continued strong demand from Asia. The price of natural gas remained flat throughout the quarter. Gas remains inexpensive compared to oil for a number of reasons. Warm weather in the last two winters has led to higher than normal inventory levels. As well, significant amounts of liquefied natural gas were shipped into North America this summer to meet air conditioning demand. Although we were in a positive energy environment the TSX oil index was off 3.6% during the quarter. In addition to the political factors already discussed, rising cost structures and a strong Canadian dollar have impacted the profitability of most producers. The winners in the sector for the quarter were either the large producers with exposure to the oil sands, or those companies that have a significant portion of their assets offshore.
The price of gold had a dramatic rise in the third quarter, moving $83 to a 27 year high of US $742 per ounce. Although many of the drivers of gold were in place,including falling interest rates and political instability, the key driver was a rapidly falling US dollar. As 85% of gold is purchased outside the U.S. a falling dollar makes gold cheaper for people in other countries. The third quarter is also typically a seasonally strong period for gold as jewelers stock up on gold for the key holiday seasons around year end. The TSX Global Gold Index rose 14% during the quarter, less than we would have expected for the move in the commodity. Many producers are having difficulties in keeping their production costs down leading to diminished earnings. As well very few companies are finding enough new gold to replace that which they are mining out this year. This has led to continued consolidation in the sector as the cash rich seniors look for smaller companies that have sizeable deposits that can be brought on at low costs.
The base metal sector was up slightly, about 2.3%, during the quarter. This number, however, hides the realty that the sector plummeted 25% from peak to trough before fully recovering to close the quarter on a positive note. In August, fears of an economic slowdown in the U.S. brought on by the housing sub-prime crisis caused the markets to correct sharply. Investors were worried that a slowing U.S. housing market would have dramatic implications for base metal demand. Upon further introspection, however, we note that on a global basis demand for metals remains robust, and the problems of new supplies have not been corrected. Large global producers such as RTZ and BHP continue to state that any metals they produce are being consumed in Asia, in particular the bulk commodities iron and coal. So, outside of a coordinated global recession, we feel that the metal sector will provide some of the best returns in the near future.