[A quick note before today’s DR begins. Our e-mail address has changed! All replies, questions, objections, threats, plaudits, and observations can now be sent to email@example.com . If you used the old address last week, chances are your letter didn’t get to us. Please send any correspondence to the new address. Thanks!]
–Welcome to acronym city (AC). Today’s Daily Reckoning (DR) is all about initial public offerings (IPOs), mergers and acquisitions (M&As), and what they tell you about the market. We’ll also look at why energy is becoming a flash point in Europe and how natural gas is taking centre stage. First, though, we’d like to announce a changing of the guard in the leadership of the resources market.
–Please, if you see them on the street today, thank iron ore and coal for all the hard work they’ve done over the last 10 years making Australia more prosperous. They’ve employed tens of thousands of Australians and made shareholders of BHP Billiton and Rio Tinto very happy, not to mention Gina Rinehart, Andrew Forrest, Clive Palmer, and Nathan Tinkler. A job well done, steel-making ingredients!
–But weep not for the base metals, iron ore, and thermal coal. As Ecclesiastes tells us, there is a time for everything, including a time to mourn and a time to dance. If we mourn the passing of metals leadership in the commodity complex, we dance with joy for the emergence of energy.
–Hold on just a minute! Is it too soon to announce the death of metals? Are we presuming too much when we say that Chinese metals consumption is peaking? Is it too bold to say that Australia’s resource bull market is on the edge of its first major change in almost 10 years?
–Well, we’ll find out this week what half-year earnings are for Rio Tinto and BHP Billiton. But earnings are backward looking. The most important story in the commodity markets last week was the proposed merger between two Swiss-based companies, Glencore and Xstrata.
–The all-stock merger between one of the world’s largest miners and one of the world’s largest commodity traders would create an $89 billion company. That’s still smaller than BHP Billiton, in terms of market cap. But the combined company would suddenly become the world’s largest thermal coal exporter, the world’s largest zinc producer, and the world’s third-largest copper miner, according to Reuters.
—Investors need to watch mergers like this for a sign that organic growth in a business has peaked. Desperate CEOs can try and increase earnings by acquisition or by creating new “economies of scale”. There probably ARE certain efficiencies to be gained by big companies getting even bigger. But another way to view a big merger is that CEOs have resorted to theatrics because there is no other easy way to squeeze more profit out of the business.
–Mergers between mega-equals can also be as much about grandiosity as they are about increasing marginal profits. There is something irresistible about creating super corporations, like two galaxies drawn together by their own immense gravity. Human beings are fascinated by mega-sized things. The Pyramids, the Titanic, the AOL-Time Warner merger.
–But bigness itself is probably a liability in the global economy/ecosystem (unless you’re an Apex Predator like the State, or own a State-granted monopoly on a business…like Telstra). Making things bigger doesn’t always make them better, especially in business. Often, it just makes them more complicated, hard to run, and impossible to understand.
–Glencore’s deal with Xstrata may not even go through. Both companies need the approval of regulators in Japan, South Korea, Canada, Australia, and Brazil. And you can be sure commodity consumers are not going to be happy about the consolidation of pricing power in a super producer. But either way, the mere idea of the merger looks to us like a consolidation at the top end of the food chain in the commodity complex. Change is afoot.
–The biggest change, by our reckoning, is that China’s most metals-intensive phase of economic development is behind us, not ahead of us. That changes Australia’s relationship with China from one based on the iron ore of the Pilbara to one based on uranium and natural gas.
–For example, the China Guangdong Nuclear Power Corporation (CGNPC) is about to make a $2.2 billion dollar bid for Perth-based Extract Resources. Extract is developing the fourth-largest uranium-only deposit in the world in Namibia. The State-owned Chinese company is close to sealing the deal on Extract because it announced on Friday that it had secured 89.5% of Kalahari Minerals. Kalahari owns 43% of Extract, making it just a hop, skip, and a jump to 50% control.
–There are two important points here. First, China’s State-owned companies are busy going out into the world to secure real resources for the 21st century. This is a better investment for them than buying Greek or American bonds. Second, Africa is home to some of the most promising uranium projects in the world. It’s also become a hot-bed for off-shore oil and gas development (both off the west coast in Angola and the east coast in Kenya and Tanzania).
—Diggers and Drillers editor Alex Cowie has two African-based uranium plays. Uranium has rallied hard since late last year, proving that the best resource investors are contrarians who buy what everyone else hates. Kris Sayce first tipped us off to the East African off-shore gas industry with one of his recent recommendations in Australian Small-Cap Investigator.
–Of course there are going to be some readers who hate the idea of investing in new oil and gas ventures. But the reality is that energy is a scarce and strategically valuable resource. That makes it a compelling investment theme.
–For example, a blast has hit a vital gas pipeline connecting Egypt, Israel, and Jordan. As if the Middle East wasn’t combustible enough right now, this points out how unstable the region has become. That’s not a good thing when it’s still the home of the world’s largest proven oil reserves. This instability is accelerating the search for oil and gas from other places.
–And don’t forget Russia. There’s plenty of gas there. But Vladimir Putin is not always willing to sell it. State-owned gas giant Gazprom admitted it cut Russia’s gas supply to Europe by 10% over the weekend. It was an especially bad time because Europe is literally freezing right now (climate change).
–Was Russia exercising energy leverage over Europe? Russia’s main naval access to the Mediterranean is through ports in Syria. Over the weekend, the United Nations tried to slap tougher sanctions on Syria. Russia and China slapped those sanctions down. And then Russia turned off the gas to Europe.
–Europe gets 25% of its gas from Russia. Russia has the largest proven reserves of conventional natural gas in the world. Its pipelines to Europe are more like life lines. It’s no wonder the EU has pressured the US Congress to exempt a gas pipeline from the Caspian Sea from being shut down by sanctions on Iran.
–Yes. It’s getting pretty interesting in the world’s energy markets. We sense that we’re on the verge of a big transition from one era to another. Not everyone is happy with that. For example, this Washington Post article reports what we’ve been saying since last summer: shale gas is a disruptive technology that changes the game in global energy markets.
–You might wonder why lower petrol prices, lower power bills, and cheaper energy for industry is a problem. Well, it’s a problem because no other energy source competes with that. Cheap gas makes coal-fired electric power expensive. It also renders renewables like solar and wind non-competitive.
–The non-competitiveness of solar and wind with cheap gas greatly displeases the carbon-tax pushers of the world. They would like to put all hydro-carbons out of business in order to gain more power and control over energy (and over you). To be fair, they believe they are doing this for your own good, in order to save the planet. More on saving the planet through higher prices tomorrow.
for The Daily Reckoning Australia