Tuesday, May 20, 2008


The stock market is an emotional auction sale. The lower the airline stocks go, the better the buy they become. Even the weakest majors, LCC and UAUA have substantial cash on hand. After years of seeing the big carries, such as Pan Am, Eastern, TWA, CAL, DAL and NWA file bankruptcy, it is now the little carriers that are going under.

For the month of May, CAL is flying the second or third highest May load factor ever. This incredible feat is after adding an average of more than $160 per ticket for higher fuel costs. The company is producing positive cash flow and is even likely to show a taxable profit this year. The current price is a very rare opportunity.

I have written extensively about the huge fuel investments that will pay off in the coming months. The refinery that opens in India in July is designed specifically to refine the sour gunk that comes out of Iran and Saudi Arabia. The 9 billion dollar investment the Saudis made over the past, I think 6 years, is producing 300,000 new barrels this month and will be producing another 200,000 by year end and another 600,000 in 2009. Consumption has fallen to the point that refiners are refusing all thick gunk unless huge discounts are offered. Saudi Arabia has reduced its price on thick gunk several times in the past two months. Iran sits with 30 million barrels in ships off the coast and probably much more in land based storage. With Iran refusing to sell thick gunk at the market price, the market price of the sweet crude you see posted every day has gone up. The refiners do not start up a thick gunk refinery just to handle a barrel or two. US refinery utilization is running in the low 80's as a result of the refusal to crank up for a few barrels of gunk. It may be true that the US refineries are not willing to buy Iran gunk for any price.

The price is ready to break. Brent oil futures went into contango last week and US futures are flat for months to come. Any oil producer who is not selling forward several years worth of production at today's prices is playing a fools game. The current price gives the producers extreme profits. Profits that are temporary but still extreme. The congress is ready to investigate speculators but it is the speculators who will be left holding the obligation to buy oil at these prices for years to come.

No matter what happens to the price of fuel, several large airlines will survive and prosper. CAL and DAL are two that will do well. AMR will make a dramatic recovery as soon as its unions come to terms. The willingness of regulators to go along with consolidation is going to dramatically increase the "network value" of these carriers. As I have reported, the value of a network grows exponentially by the number of nodes. An airport connected to hundreds of other airports is the same as any other kind of network; the addition of one more airport increases the value of all the other locations.

The talking heads cannot figure out why the railroads are exploding upward in price. The railroads are further along in the restructuring that began in 1978. The price has been bid up to irrational levels relative to airline stocks. I would not dream of shorting railroads but Dow Theory tells us that the economy booms soon after both theindustrial average and the transportation average breaks out. The transports are on new all time record highs. Big rails that are enjoying peak earnings are selling at 17 times those earnings. They are selling at maybe 35 times normalized earnings.

Commodity futures contracts are at never before levels. Trillions of dollars have been bet on higher oil prices even though current prices are unsustainable. My only concern is when not if. When the commodities bubble pops, there will be a flood of money looking for a new home.

The list of international negotiations that are in progress is also at an unprecedented level. Just a few days ago, when Bush came back from Saudi Arabia with his tail tucked between his legs, the media was all over the fact that the Saudis had only agreed to increase production by 300,000 barrels per day. The media did not bother to report that this was another 300,000 barrels per day undercutting the price of oil sitting in Iran. Iran normally sells about 4.5 million barrels per day but they import about 2.5 million barrels per day of petroleum products. The 300,000 barrels extra production from the Saudis represents 3/20 or 15% of Iran's export volume. OUCH!

What else did the media fail to report? That Bush walked away from Saudi Arabia with yet another civil nuclear trade agreement. It is now true that most of the Middle Eastern nations have signed off on civil nuclear power development treaties.

Why did Bush not hold the treaty high and brag on the extra 300,000 barrel hit to Iran? Bush needs the American people to cooperate in putting maximum pressure on Iran. The way to do that is to create the impression that the price of oil is going to go up to $150 or even $200 per barrel this year. Many an American must be shocked before taking action. Who can guess how many bicycles, scooters and small cars will be bought because there seems to be no end in sight.

Iran is the odd man out in more ways than one and yet all kinds of concessions are being made to "bring them to the table". The Sunnis of Lebanon have been "thrown under the bus" in order to give a bone to Iran. The Gaza strip has been given over to Hamas. The US is well served by a legitimate government in Lebanon of any stripe, as long as it agrees to not support terrorist. Iran is holding tightly to its "right to the peaceful use of nuclear power" while progress is being made. Iran has submitted a package of proposals to the 5+1 nations and the 5+1 nations will be sitting down to discuss a resolution soon.

With Spain and Italy teetering on the edge of recession and central bankers from all over standing on the brakes, the demand for oil is going to subside. Even so, the US is enjoying a boom in trade. A boom in trade means that international air traffic will hold up well. While international traffic is off 1% from its record pace, this is in the face of price increases of 40% or more. International demand is very inelastic. Prices could double from here and most of the business travel would continue.

When Yogi Bear sat down on the freshly painted white park bench, he tried to fix his painted rear by sitting down on a freshly painted brown park bench. The point is that two wrongs do not make a right. I should have told you to wait until now to invest in airlines. The profits from here will be enormous. My recommendations have been wrong but even a stopped clock eventually gets the time right.

The peak in oil prices is likely to be over by memorial day. We are almost there. I mentioned a day or two ago that short term indicators are over bought. Without seeing the numbers, I can assure you significant repairs to these indicator were made by the action today.

Let me give you another time frame. A long remembered major historical event of 2008 will be the civil nuclear power treaty between Russia and the USA. This treaty is already in the hands of congress. The congress has 90 days to vote no or the treaty becomes law. There are something like 83 days left. Russia very much wants this treaty to go through. Russia is the second largest producer of oil on the planet. After dragging their feet for years, Russia signed off on the economic sanctions against Iran a couple of days after the treaty was negotiated. The Russians may have quietly increased production more than the Saudis in order to insure that there will be no market for thick Iranian goo!

When I was 15, a friend and I attended a high school football game. As we walked over to the opponents side of the field, we were met by a motorcycle gang. The two biggest guys were suddenly in our face. They each whipped out switch blade knives and asked us if we were the ones who had thrown tomatoes at them. I can honestly say that I did not wet my pants, but I would have eaten dirt if these guys had only asked. I can still remember the feeling of pending death. Iran has the USA and Russia in their face. The rest of the gang is ready to bankrupt the country if an agreement cannot be reached. Iran has actually moved to the negotiating table. The US will not be an attendee but the parties will finally be talking head to head.

Bush has about 90 days to help his party hold the presidency. The Bush loss to Clinton has not been redeemed. Bush has given Russia 90 days to get a deal done. Russia stands ready to sell trillions of dollars worth of uranium. Even Egypt and Turkey have no less than 7 nuclear reactors on the drawing boards. This is not your neighborhood poker game. The stakes are extremely high. The map was laid out years ago.

A few days ago, Osama bin Laden delivered an audio address. He rebuked the Arabian states for agreeing to allow the existence of the Zionist State. In other words, Osama bin Laden is familiar with the fact that the Syrians and the Israelis have negotiated a treaty. The addition of Lebanon and Syria secures most of Israels border as Egypt and Jordan are already on board. Iraqi government troops just strolled into Sadr City. The Iranian supported militias are standing down. There will still be sporadic suicide bombing for years to come but the war on terror has been "won". Crime will always be with us but those who kill innocents do not deserve to be called warriors.