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Dolly, Iran, China, Food Prices, Airline Cuts

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Dolly, Iran, China, Food Prices, Airline Cuts

It was not a big day in the oil patch. Tropical storm Dolly crossed the Yucatan Peninsula and is headed for the Mexican coast but the intensity is falling. Winds have declined to 45 mph and it should make landfall on Tuesday night. A few rigs evacuated workers as a precaution but generally this is turning into a non event. Ironically the hurricane forecasters are confused as to why it has not strengthened after moving over warmer water in the Gulf. Some analysts say it is because Dolly is moving so fast westward at 17 mph that it has not had time to develop.

Oil prices rose in the afternoon as electronic futures for August expired at the close. The regular futures contract expires at the close of trading on Tuesday. Prices rose to just over $131 at the close but declined to $130.50 shortly thereafter. The Iran meeting produced a list of public officials going on a verbal attack about Iran's failure to communicate. If words were bombs the war started on Monday. All carried the same message that Iran has two weeks to come up with a clear and positive decision or the next round of stronger sanctions will be sought. Strangely there was very little press from Iran itself. It was almost as if they were afraid to say anything they may have to retract a week from now. They may actually have seen the future and it was not pretty and be considering how to exit this confrontation gracefully.

The International Energy Agency warned on Monday that oil production from non-OPEC countries is set to peak within the next two years, leaving the world increasingly dependent on OPEC supplies. Fatih Birol, head of the IEA, said falling production in the North Sea and Mexico would leave Shell and BP sidelined at the expense of the national oil companies of OPEC. That means there is nowhere left for Shell and BP to drill that is not controlled by OPEC. Production in the North Sea has fallen by about 7.2% per year since 2002. Production in Mexico has been falling at a rapidly increasing rate for the last two years and could hit 13% in 2008. Birol said it was imperative that governments acted urgently to reduce their dependence on oil. Birol is in the middle of an analysis of all the major oil fields around the globe and the results of that study will be released in November. Birol has already warned that the results will be shocking. Because of his insistence that governments "urgently" reduce dependence on oil I think it is safe to say we are not going to be pleasantly surprised in November.

China said that coal stockpiles fell over 8% over the last two weeks and are dangerously low. This is potentially worsening the current electricity shortage. Nearly 80% of China's electricity is generated by coal-fired plants. Current China demand is 14,000 megawatts over current production capacity and that is expected to increase to 18,000 megawatts during the summer heat. Brownouts are a daily occurrence as we near the Olympics in August. 2.5% of the nations plants were shutdown on Monday due to lack of coal. According to officials there is still enough coal for 10-days of consumption but supplies are not being replenished as fast as they are being used. China has ordered supplies to plants around the Beijing region to be tripled next week to increase stockpiles ahead of the games. This will come at the expense of outlying areas where electricity could be out for weeks. China has issued a "red alert" and will be cutting off electricity to energy-intensive factories and factories that pollute ahead of the games. Unofficially every non-critical business around Beijing will be given a forced holiday for a week before and during the games to cut down on pollution, traffic and energy usage. During the games vehicles have been banned from the roads on alternate days based on the even/odd number on their license plates. 

Sara Lee said higher food and energy costs would be passed on to consumers with a 20% or greater increase later this year. Kraft Foods, Kellogg's, ConAgra and Tyson are also raising prices. Food prices jumped +5.3% in June alone and according to those manufacturers there are further large price hikes in the pipeline. Kraft said it would raise prices by 12-13% this year and cheese categories could rise by 25%. In June meat prices hit a 22-year high because of record costs for corn and soybean feed crops for livestock. Consumers are expected to reduce their meat consumption by 5 lbs per person next year for the biggest drop since 1982. 

Midwest Air announced it would cut flights to 11 cities and ground a third of its fleet because of rising fuel costs. The flights will cease on Sept-8th. Midwest grounded 12 less efficient MD-80s because of a 36% increase in fuel costs. This is just another in a long string of service cuts by U.S. airlines. Say goodbye to cheap flights because capacity is dropping fast.

Jim Brown

OptionInvestor.com

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