The Fleet Street Letter’s Brian Durrant picks out two big stories for the year ahead. Both could have a major bearing on your wealth in 2013.
In 2012, we spent much of our time reasserting the status of the Fleet Street Letter as a contrarian publication.
We recommended stocks that are deeply unpopular among British investors: shipping groups, insurance, retailers – these are the stocks that have been left behind during the monetary experiments of the last year. But these are the stocks with the most potential to deliver great returns in 2013.
But the Fleet Street Letter is not just about making contrarian recommendations. It’s bigger than that. We see ourselves as following in a decades-long tradition of delivering ‘great contrarian’ stories to the loyal FSL readership. Our forebears bought gold in 1999 and oil in 2001. And we think we could be onto another great contrarian story in natural gas.
In fact that is one of two big stories that could have a huge impact on your investments in 2013. And I’d like to talk about both today.
We’ll start with the push for gas. This will undoubtedly be a huge story over the next year. Then we talk about the bursting of the British austerity myth – and the grave consequences that could have for the British economy.
But first to ‘Saudi America’…
Can Britain engineer an energy renaissance?
Over the last few years the US has engineered an energy renaissance. Right now America imports 20% of its total energy consumption, much of it from the Middle East. But over the next year, America will continue to take major steps towards becoming self-sufficient in energy.
In short, a country that has long been the Saudi Arabia of agriculture, producing for example 40% of the world’s maize, it is soon set to become the world’s dominant oil producer too. In fact, the International Energy Agency estimates that US oil production will exceed Saudi Arabian output levels in five years’ time for a period that is expected to last until the mid-2020s. Meanwhile North America is set to be a net oil exporter in 18 years from now.
These projections, which would have seemed outlandish five years ago, are a result of rocketing US output in oil and shale gas – sped by advances in fracking technology. And North America’s energy renaissance has serious implications for asset prices. Already the flood of new oil from shale and Canadian sources has pushed the West Texas Intermediate benchmark oil price ($92.52/ barrel) to a discount of a fifth compared to Brent crude ($112/barrel), the international benchmark.
Compared to the rest of the world, North American energy is cheaper, which makes heavy energy users like chemical plants and aluminium smelters ultra-competitive. And this price disparity will last until new pipelines are constructed so that US sourced energy can reach world markets. At the same time the US’s trade balance is improving. US imports of oil in the 12 months to August were at their lowest since 1998.
This renaissance will also feed into the US economy. By 2020 the shale gas boom is expected to create 3.6 million jobs in the US, both directly and indirectly through lower energy costs. Carbon emissions are also falling, as gas is substantially cleaner than coal.
Contrast that with Europe, where the focus on pushing up the use of renewable energy has led to a sharp increase in power costs. While the German industrial group Siemens faces rising energy prices, Dow Chemical – a large US manufacturer – called the availability of shale based hydrocarbon supplies in the US a “game changer”.
But can fracking come to the rescue of the UK? Well, once in a while the UK has a bit of luck. It happened in the North Sea with oil explorations from the 1970s onwards. And it could happen again, provided we can find the right calibre of politicians and civil servants to drive the process and make it happen.
Because until recently Britain has been missing a trick. The UK is sitting on a huge amount of untapped energy in the form of shale gas trapped deep in sedimentary rock. This is happening at a time when personable disposable incomes are being eroded by higher domestic energy costs. Two years ago experts reckoned that shale gas supplies were 5.3 trillion cubic feet (tcf). But earlier this year the British Geological Survey significantly increased the estimate to as much as 200 tcf. Exploration companies themselves have claimed to have identified 300 tcf so far. Meanwhile offshore resources, which are harder to extract, could be as much as five to ten times higher. Whatever the numbers turn out to be, Britain has the potential to be one of the world’s top gas producers.
Blackpool could be the new Aberdeen
A report by the Institute of Directors uses conservative assumptions, reckoning that the UK would be 50% as successful as the Americans in extracting shale gas. Yet it projects that 35,000 jobs would be directly created and that there would be enough onshore supply to meet 10% of our gas demand for the next century and carbon emissions would be cut by 8%.
In the early days ‘green’ campaigners were supportive of shale gas extraction. However support has waned following two minor earthquakes near Blackpool caused by shale drilling. But the realisation that cheap gas could undermine the subsidies given to alternative carbon-friendly energy sources will have been influential too. It is a fact of life that most reliable energy sources have serious drawbacks from time to time: coal mining disasters, oil spills and the Fukushima nuclear accident. Shale gas is no different in this respect.
The government’s endorsement of shale gas extraction led to the approval of up to 30 gas fired power stations recently. The Department of Energy has not been in a hurry. But with many of the country’s power plants being shut down in the next few years, there has to be real urgency now.
The other serious obstacle is regulation. Unlike the US, Europe has a heavy regulatory structure which continues to undermine the competitiveness of European industry, and a bureaucratic structure geared towards energy subsidy. While in the UK, energy policy has been infested by the green lobby and its lawyers. Mindful that the lights might go out in 2015, there are hints of a change of heart. The Chancellor’s commitment to shale gas exploration in the Autumn Statement is mildly encouraging. Our portfolio, with several deeply undervalued gas producers, is well placed to take advantage of the possible gas bonanza. So let’s move on to the next big story for 2013…
The end of the British austerity myth
However there is no cause for complacency. We are now half way through the parliamentary term of the coalition government. George Osborne’s primary responsibility was to clean up the mess he inherited from the public spending binge under Gordon Brown. There has been a lot of talk about austerity but has it really happened? As far as the public finances are concerned, austerity should be the antithesis of living beyond your means. This means a period of austerity should be characterised by living within your means and therefore debt can be cut in the process.
The chancellor has talked tough to appease the bond markets and credit rating agencies; the BBC, trade unions and the opposition have consistently portrayed a dour image that the UK is in the grips of austerity; and the public have been taken in.
ITV asked ComRes to poll the general public ahead of the recent Autumn Statement. This was the question:
“Which of these statements do you believe to be the most accurate?”:
A) The coalition is planning to cut the national debt by £600bbn between 2010 and 2015;
B) It is planning neither to reduce nor increase it;
C) The coalition is planning to increase the national debt by £600bn.
Only 6% responded to the correct answer: C. 49% thought the coalition was planning to slash national debt; 14% said it would keep it the same; and 31% didn’t know.
This is result of sloppy reporting which says that if you are planning to borrow less each year this will cut the national debt. The truth is despite the planned ‘austerity’ measures the coalition was still planning to increase the national debt by £600bn. Every year the government is in deficit means that national debt will be higher.
It is against this backdrop of misunderstanding that the chancellor pulled two more stunts to indicate the state of public finances are better than they really are. The growth forecasts are produced by the independent Office for Budget Responsibility. The growth forecasts are produced by the independent Office for Budget Responsibility. It said that output would fall by 0.1% in 2012, grow by 1.2% this year; and then that growth would accelerate to 2.0%, 2.3%, 2.7% and 2.8% in subsequent years.
This sounds too good to be true. The practice of over estimating growth in the future has already resulted in the March forecast for 2016 GDP being lowered by 3.6%. The UK economy is more likely to struggle as it has done for the last few years, which makes the chancellor’s fiscal forecasts for the future more or less redundant.
Not only has the budget arithmetic involved wishful thinking but it has also incorporated creative accounting wheezes. The headline deficit falls from £121.4bn in 2011/12 to £80.5bn in 2012/13. One-off items distort the figures: the government has taken over the Royal Mail pension fund; it has reclassified Bradford & Bingley and Northern Rock in the public accounts and has grabbed quantitative easing profits from the Bank of England. Now if you also disregard the one-off sale of the 4G spectrum, last year’s deficit would be higher than 2011’s.
As lower-than-forecast growth means that the chancellor will not hit his debt/GDP target for 2015/16, Mr Osborne chose not to raise taxes or cut spending to meet it. In the eyes of the rating agencies this is clearly a sign that the government’s determination to tackle the level of debt is slipping. It’s only a matter of time until a credit downgrade.
It is difficult to be optimistic about the gilt market, which offers such paltry yields; it amounts to a return free risk. More attractive yields are available on blue chip equities with strong balance sheets. There are plenty in our portfolio. At the same time markets will not move in a straight line and we will certainly be ready to exploit buying opportunities in under-rated and unloved stocks. And if you are looking for a full and comprehensive study of just how grim the British debt crisis could get, then you should pick up the MoneyWeek report. That is an absolute must read for British investors in 2013.
You can read the report here.
• The article was first published in The Fleet Street Letter on 15 December 2012. The Fleet Street Letter is a regulated product issued by Fleet Street Publications Ltd.