For 41 years Libyan strongman Moammar Qaddafi was a thorn in the side of the West. In fact President Reagan, on Apr. 15, 1986, sent the US Sixth Fleet on a massive and successful attack that wiped out much of the North African country’s military power and nearly claimed the dictator’s life.
No friend of Western democracies, Qaddafi waged war deep into the heart of Africa, fomenting violence in neighboring Chad, Mali and Niger. He sponsored terrorist training camps and flaunted warm relations with other notoriously anti-Western, anti-capitalist and anti-democratic leaders. Now to stay in power, he’s apparently employed an army of mercenaries to carry out air and ground attacks on Libyan civilians.
It’s hard to imagine anyone would mourn Qaddafi’s passing, other than family members and cronies who’ve profited so richly under his rule. Ironically, just as the rebellion to overthrow him has neared success this week, global markets have sold off, apparently on the “uncertainty” of who or what will follow his regime.
The reason, of course, is Libyan oil and gas supplies. Midway through the last decade Qaddafi appeared to have a change of heart regarding foreign investment in the country’s energy business, perhaps because development without them was proving problematic. As a result a flood of new capital entered the country, and the industry revived.
Today Italy and Spain depend on Libya for an estimated 22 and 13 percent of their crude oil supplies, respectively. Italy also depends heavily on the country for natural gas (13 percent of 2010 supplies), with a good portion transported via Eni’s (NYSE: E) Greenstream pipeline under the Mediterranean Sea to Sicily. Italian companies have an estimated $5.5 billion in total infrastructure investment in Libya, which they would stand to lose in complete unraveling.
It shouldn’t surprise anyone that markets always price in the worst-case for global events. And with Qaddafi vowing to fight to his “last drop of blood”–and presumably everyone else’s–it’s easy to conjure up nightmare scenarios. Loyalist militias today apparently fired on unarmed protesters leaving mosques in the capital Tripoli today, causing an unknown number of deaths.
A permanent loss of gas and oil supplies from Libya could be made up from Russian energy supplies. That would, however, increase the latter’s influence immeasurably, particularly in Europe. It would also tighten global supplies considerably by essentially removing 2 percent of output at the same time developing world demand is inexorably ratcheting up and demand in the US has been recovering.
That raises the specter of much higher oil prices, particularly as summer driving season arrives in the Northern Hemisphere. Many worry this will spark global inflation. Others are concerned it will halt the economic recovery just as it’s gaining momentum, as consumers are forced to curtail spending in other areas to keep their cars running.
My colleague Elliott Gue has written extensively on these issues. And I urge Utility & Income readers to check out The Energy Letter, Elliott’s free weekly commentary, for more. My concern, however, is how Libya can and will affect income investors. Here’s how I see it.
First, whoever wins Libya’s civil war, getting the energy flowing again will be a top priority. The country simply depends too much on energy production–95 percent of total merchandise exports at a recent count. It also depends heavily on European markets, where 90 percent of that output goes. Those ties are further reinforced by such projects as the Greenstream pipeline.
Not being able to do business in Libya would strike a blow at the already weakened economy of Italy. On the other hand, the two countries have had tight ties since the Punic Wars a couple millennia ago. The Italians endured the Qaddafi era; they should be able to weather whatever comes next.
Italian oil giant Eni has been cited frequently since the violence began as a “loser” from the conflict, as it currently draws 14 percent of global output from Libya. The company has cut its production in the country to half normal levels and has at least temporarily shut Greenstream. Yet, it’s already clear it could actually wind up a winner, as it rationalizes a transaction to buy 3 billion cubic meters of already “prepaid” gas from Russian giant Gazprom OAO (Other OTC: OGZPY.PK) and benefits from higher oil and gas prices elsewhere.
The stock took a hit in the first few days of the conflict but has since bounced back, as investors have taken note of these prospects. It would also be a major mistake to count out the company’s prospects in North Africa. Just days after regime change in neighboring Tunisia, for example, Eni announced a major investment program in that country. It’s not hard to envision it will do much better in Libya under a new government.
In contrast to Eni, most dividend-paying energy-producer stocks rallied in the wake of the Libyan news. That’s always nice. But history shows that buying oil stocks in the wake of such geopolitical events doesn’t always yield the best results for long-term investors. Traders can go in and make big money. But those who buy for income wind up paying more and therefore get less in current yield. And when the tensions cool prices invariably back off.
The bullish news is these events show once again that the balance of market power is in the hands of energy producers, perhaps more than ever. Simply, it affirms that supplies are tight relative to demand that continues to go higher. That’s a formula for higher energy prices long term–and fatter profits for producers.
On the other hand, every bull market in natural resources has plenty of ups and downs along the way. The massive price spike we saw in mid-2008 for oil and gas was the last straw for a weakening economy and financial system–not inflationary but intensely contractionary, at least in the US. The time to buy energy stocks was not in mid-2008, when prices were soaring, but later that year, when they were trading at a fraction of peak levels.
If you own energy stocks now I don’t see any reason to sell, other than to re-balance your portfolio. But if you’re a buyer, remember that patience is essential for income-investing success. Utility Forecaster, Canadian Edge, Personal Finance and MLP Profits readers will want to continue adhering to the buy targets set.
What income investments would be hurt by an energy price spike that could result from a worst-case complete sidelining of Libya? For one, any companies operating in industries for which fuel costs are a major influence on profits.
Back in the 1970s many electric utility companies used crude oil to generate a hefty share of their electricity, including several operating in tough regulatory environments. Today, however, oil has been almost entirely replaced by natural gas, which is a purely North American market and completely immune from pressures in Libya.
The only exception is Hawaiian Electric Industries (NYSE: HE), which is rapidly moving away from oil toward use of renewables and conservation with regulators’ support. The company is allowed to recover its fuel costs directly from customers, limiting financial exposure. As long as that’s the case, there’s little direct risk, though investors should use caution with the stock.
The possibility of a fuel price spike is also a risk to transports, particularly airlines. The latter, however, are generally not suitable for income investors anyway, owing to volatile earnings and cash flow.
What about interest rates? Could a fuel price spike send them careening higher, wreaking havoc among income investments? That’s a possibility at least some advisors were talking about at the Orlando MoneyShow earlier this month, and I’ll no doubt hear the same concerns at other speaking engagements this spring, including my publisher’s own show in Las Vegas Apr. 1-2, the second annual KCI Wealth Summit.
My comments are these. First, dividend paying stocks from MLPs to utilities have been decoupled from interest rates since early 2008. Instead, they’ve followed prospects for the economy, rising when the news has been good and falling when it’s soured. There’s nothing to suggest they’ve started following interest rates again.
Second, rising interest rates proved contractionary in 2003, 2004, 2005, 2006, 2007, and again in 2008, rather than inflationary. Consumers paid more, so they spent less and the faster growing pushing rates higher cooled. That’s likely to remain the case for one reason: There’s absolutely no wage-push inflation in the US, and without a return to ’70s-style inflation is simply impossible.
Higher interest rates and oil prices will take money out of people’s pockets, so they won’t be able to spend it elsewhere. Rather than fomenting higher prices across the board, they’ll slow things down. Inflation is likely to rage in the developing world as commodity prices rise. But until unemployment drops a lot more and wages start rising, it can’t happen here.
My approach remains to stick with individual companies that are growing as businesses and therefore lifting dividends over time. I don’t want to pay more than prices that are justified by the growth of these businesses and dividends.
This approach requires those who follow it to stick with positions over time, even as the markets move up and down. That means the value of holdings rises and falls throughout the various cycles. But we can steady the value of our overall portfolios by holding a mix of investments that perform well under varying conditions.
If an income investor is worried about a meltdown–either resulting from a Libyan implosion or something else–they need to hold positions in dividend-paying stocks that would do well under those conditions. That could be Canadian or Australian stocks, which are priced in currencies that rise in value when natural resource prices do. If we’re worried about another 2008, hold some low-duration, high-quality bonds–nothing will protect your wealth better.
Above all, hold stocks of high-quality companies, preferably those that are growing dividends as well. That’s the key to building wealth in any environment, no matter what happens in Libya, Russia, China or anywhere else.
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