Families showering together may offend some sensibilities.   However, the April, 2009 issue of National Geographic Magazine has a photo (legs only, sorry) of a family doing just that.  Not only do they shower together, they do it standing in flat plastic containers to catch the soapy run off.  The run off is then used to water the garden.  This is one of many measures promoted by the state of South Australia to conserve water in the drought stricken area.  Water is so precious every last drop is reused as often as possible.
Often called Blue Gold, water is the ultimate commodity.   Why?  Simple, without it, for ourselves and our crops, we die.  Life cannot exist without water.  Yet, we often take clean water for granted.  We waste it and dump toxins in it.  In an increasingly crowded world that has to change.
Watts Water (WTS) a $780 million cap company has been around since 1874 and supplies water control systems in North America, Europe and China.  The company has been in China since 1994 but saw Chinese revenue decrease in 2008 due to currency, tax, wage and transportation issues.
The company website is www.wattsind.com The site provides access to SEC filings, annual reports from 2001, dividend and stock data, press releases, webcasts and other company information.
WTS manufactures valves and related products which insure water quality, conservation and control.  Recent focus has been on valves which prevent water back-flow.  Back-flow controls prevent dirty water from contaminating clean supplies.
Smartmoney magazine discusses how Watts Water may benefit from the US $789 billion stimulus plan.  See the article here.  Competitors include Flowserve Corp (FLS) and  some private firms.
Watts had negative publicity last month as it cut jobs but increased executive compensation (see article here).  Also, there are some litigation issues which have dragged on for several years (see the 2008 annual report).
Watts has a PE of 13.7, price/sales ratio of  .53 and a well covered 2.1% dividend.   There have been 22 years of consecutive dividend payments.  Recent market rallies show WTS participating strongly.
China is suffering from major water quality problems while President Obama’s stimulus programs will benefit water infrastructure products in the US.  In a world increasingly needing clean water WTS seems to have a bright future.
This seems to be a solid, long established company.  Recent problems in China, litigation and perhaps ill timed layoffs and executive compensation issues may warrant some caution, however.
Disclosure: Long WTS

Derivatives: Gambling at Public Expense

If, unknown to you,  certain parties had bets totaling millions of dollars on the chance your $200 thousand house will burn down in the coming year, would you be upset?  I suspect so.  Some of those parties may need money,  may send an arsonist over, maybe not even tell you in time to get your family out.  Well… Welcome to the world of derivatives.  Only, forget the $200,000 house, start thinking in the billions and trillions.

Now, sit down, these figures may shock you:  The face (notional) value of derivatives held by US commercial banks is over $200 trillion dollars and the total derivative market over $700 trillion. Don’t believe me?  Click here for the US government’s recently released fourth quarter OCC Report.  Read the first two bullets.  Remember, this is just derivatives held by US commercial banks, the total derivative market is, as mentioned above, over $700 trillion (see here).
How much is $700 trillion dollars?  Temple University math professor John Allen Paulos says: “A million dollars a day for 2,000 years is only three-quarters of a trillion dollars”   Well, think about it a minute or so, then go figure $700 trillion.
Okay, critics of this article’s viewpoint will be quick to point out this is not new news and derivatives can be unwound, it is a zero sum game.  Derivatives are useful for farmers, miners and many others, hedging future market commodity risks.  They increase liquidity and facilitate transactions.  Credit Default Swaps (CDSs) can be used to measure perceived risk of an asset.  The purpose of this article is not to demonize all derivatives, rather it is to point out the danger in the speculative components, especially when the public dime (bit of an understatement that) is involved.
The question is: What are commercial banks doing with over $200 trillion of derivatives?  This amount is over three times larger than world GNP , more than all the world’s combined stock and bond markets.
You may wonder; what the hoot is going on here?  Credit Default Swap (CDSs)  didn’t even exist 14 years ago. Now they are a $62  trillion dollar market.  Interest swaps started slowly in the 1980’s, the five banks above alone hold $162 trillion worth.  Why is this rapidly growing market so huge?  Is it necessary? A recent  Newsweek article mentioned the derivative market may be in the quadrillions soon.
I can see only one explanation: large scale speculation.  Another, perhaps more accurate term, would be gambling.
The OCC report tells us which banks are deeply involved in derivatives,  it is five large commercial banks.  They are JP Morgan Chase (JPM), Citigroup (C), Bank of America (BAC), HSBC Bank USA, and Goldman Sachs (GS).  Some 82% of the holdings are interest rate swaps.  Swaps are risky with winners and losers.  Goldman Sachs is the most deeply involved.
Goldman recently reported much higher than expected first quarter earnings.  How much of the earnings is due to AIG (taxpayer) CDS payments to Goldman?  I don’t know.  Don’t ask Goldman’s CFO David Viniar, even he is “mystified”.  Mr Viniar says the trades “netted to zero”.  Perhaps the reason the payments netted to zero is because taxpayers, via AIG, made good for AIG to Goldman’s benefit.  Now they want to repay TARP - a nice public relations  move.  If Mr Viniar is “mystified” by his own firms trading how much more so are taxpayers.  Why does this remind me of  Enron’s CFO statements of awhile back?
Glass-Steagal was repealed in 1999, allowing banks and others, equipped with sophisticated computer systems, to plunge into derivative trading.    A worldwide, unlimited casino opened up.  Hedge funds, banks, insurance companies all taking advantage.
Derivative trading is a huge, unregulated market, run around the world by the self-appointed elite.  They use OPM (other people/countries money) skimming off profits.  Forget lotteries, forget sports betting, forget Vegas.  This stuff is the ultimate!  Look at the sums involved.  A powerful elixir those in power cannot resist playing with.  Gambling at this level for personal accounts may be acceptable - what else can you do with sums that large?  Holding the world economy as hostage and involving taxpayers as backups for losses, however, is criminal.
This high-stakes gambling, like all gambling, has winners and losers.  Consider Bear Sterns, AIG and Lehman Brothers as the losers.  In a deleveraging world, we may be getting more and more losers.  It doesn’t take much of a shift in a $700 trillion market to wipe out world class companies in days, look at AIG.  Look at what may have happened to Citigroup without taxpayer money.
The large commercial banks are heavily into interest rate swaps, with a combined notional value of over $150 billion according to the OCC report.  If these systemically important institutions start losing on their interest rate bets, which the OCC Report said happened in the fourth quarter,  will we the taxpayers be on the hook to  bail them out again?  Remember the interest rate swap market is much bigger than the CDS market brought down AIG.
Forbes magazine, in their March 16, 2009 issue, has an article on how Lawrence Summers (currently heading the White House’s National Economic Council) entered into interest rate swaps at Harvard University which “burdened Harvard with a multibillion-dollar bet on interest rates that went against it”.  The Forbes article goes on to say that bad derivative bets may have adversely affected universities and hospitals around the nation.
So, how dangerous are derivatives?  Warren Buffett called Credit Default Swaps “financial weapons of mass destruction”.  AIG proved him right. AIGFP  insured CDS derivatives, lost their bets, didn’t have the money to make good, even all of AIG couldn’t make good.  So the American taxpayer was told they must make good, to the tune of hundreds of billions of dollars.  American taxpayers are the losers, financial institutions world wide are the winners.  Now, after AIG, tell me how you can possibly think derivatives are not dangerous.  And, doesn’t it strike you as strange: few are talking, even now, about reining in the derivative markets?  Perhaps defenders of derivatives can explain to us who “don’t understand” what possible good comes from this bloated market.
Systemically important institutions have no business being major players in this market.  Certainly, taxpayers have not agreed to participate, much less bail out the losers.  This is why US taxpayers are organizing “tea parties”.
The US government has printed, borrowed or promised some $14 trillion so far.  And guess what: It hasn’t worked!The London protesters suddenly don’t look so foolish, they at least aren’t bankrupting companies and countries.  AIG, FANNIE, FREDDIE, JP Morgan, Bank of America, Citigroup will soon want even more taxpayer money.  Will we have the courage to say no to this insanity?
Disclosures: none

Southwestern Energy’s Fayetteville Shale Focus

Arkansas, a oil and gas producing state?  Yes!  Southwestern Energy Company (SWN), an $11billion dollar (market cap) exploration and production company, is here.   Focusing on natural gas extraction from the Fayetteville Shale in the north central part of the state, the company has been a major player since 2004 when production started.
In addition to the Fayetteville play, the company has conventional wells and acreage in other parts of Arkansas, Texas and Oklahoma.  Southwestern also has midstream gathering and marketing subsidiaries.
Southwestern has an attractive, well organized and informative website at www.swn.com  At the site investors can find, among other things, news, annual reports, SEC filings plus they can request information.  There is a two page summary fact sheet which provides the highlights of Southwestern’s revenues and reserves.
Chesapeake Oil (CHK) and BP plc (BP) also are active in the Fayetteville.  BP plc acquired an interest in Chesapeake’s Fayetteville assets for $1.9 billion in late 2008 .  Chesapeake sold the stake to bolster its cash position.
Fayetteville Shale is black, organic rich, rock of Mississippian age (approximately 325 million years ago) and lies at a depth of 1,500 to 6,500 feet in north central Arkansas.  Typically a well is drilled vertically to just above the shale layer, then drilled horizontally for some 3,000 or more feet.  The horizontal boreholes intercept pre-existing vertical fractures.  Then, with the help up hydraulic fracturing, gas flows up the vertical fractures into the horizontal borehole from which it can be collected.  If you are interested you can view here, a short (10-15 minute) video of the process put out by Northern Oil & Gas.
Southwestern’s stock price, currently around 31, is below the July, 2008 high of 52, but well above the low of 19 in October of 2008.  The stock is up since October despite declining gas prices over the same period.
Since some 91% of the stock is held by institutional and mutual funds, thus redemption requests may negatively impact price.
Southwestern’s total proved reserves have increased from 1,026 bcfe (bcf equivalent) year end 2006 to 2,185 bcfe December 31, 2008.  Most of the increase has come from the Fayetteville shale, which now accounts for 1,545 bcfe or 71% of proven reserves.   Southwestern’s natural gas production from the Fayetteville has increased from 53.5 bcef a day in 2007 to an anticipated 229-232 bcef a day in 2009.  Reserve replacement was 386% in 2006, 474% in 2007 and 523% in 2008.  Southwestern seems to be finding lots of gas.
As of 12/31/2008 total cash was $196.28 million ($.571/share) and total debt was $734.5 million.  With the help of hedging, the company, unlike some of its peers, was profitable in the fourth quarter of 2008.  Levered Free Cash Flow (amount of cash available to stock holders after interest payments on debt), however, was  -$831.98 million.
Despite low gas prices Southwestern is still planning a capital program of $1.9 billion for 2009 with the major focus on the Fayetteville shale.  They plan to drill up to 650 wells.  Since, unconventional shale gas in recent years has been found to have lower F&D costs than conventional gas, hence the proliferation of horizontal drilling.
Howard M. Korell, Chairman and CEO sold some $3.2 million in stock the week of March 19-25, 2009.  Mr. Korell sold this stock some 3 weeks after the upbeat teleconference of February 27, 2009.  Mr. Korell intends to retire in the first quarter of 2010.  There are no reported insider buys so far this year.
Natural gas prices continue near record lows, currently the price is below $3.70/Mcf (Mcf is 1000 cubic feet).  Since late February, the price of oil has rebounded some 50%  while the price of gas continues to decline.
Industrial use, residential heating and electricity generation are the major markets for natural gas.  Recession has reduced industrial demand,  the onset of warm weather is dropping heating demand and recession has also somewhat lowered utilities demand.  At the same time, thanks to companies like Southwestern, supplies are increasing, a “perfect storm” driving down gas prices.
We will probably continue to see low gas prices for the next several months.  On the other hand, with the increasing scarcity of oil, I expect natural gas demand to eventually grow as it replaces oil as an energy source.  T. Boone Pickens envisions natural gas replacing or augmenting oil for powering vehicles, a great idea, but this is still in its early developmental stage.
Another wild card is soon to come online LNG production worldwide.  LNG imports, their cost basis and potential impact on US prices probably can only be estimated at this point.
Although Southwestern is rapidly growing reserves and is a low cost producer at around $3/Mcf (scroll down here to see chart), low gas prices will drag on income.  Already some of the higher cost producing companies are shutting down rigs as natural gas prices drop below production cost.  This will eventually tighten supply.  Long term this is bullish for Southwestern.  Dollar devaluation of course (if it occurs) will only make natural gas reserves more valuable.
Demand trends and Southwestern’s levered free cash flow, for now, are bearish.  I would keep on eye on natural gas prices and Southwestern’s debt costs.  A gas price upturn , say above $4.40 mcf, may indicate an entry point into this stock.  Long term investors who don’t want to time the market could consider any significant price dip as an entry point.
Disclosure: None

Derivatives: Gambling with Taxpayer Money

f parties, unknown to you,  had multimillion dollar bets that your $200 thousand house will burn down in the coming year, would you be upset?  I suspect so.  Some of those parties may need money,  may send an arsonist over, maybe not even tell you in time to get your family out.  Well… Welcome to the world of derivatives.  Only, forget the $200,000 house, start thinking in the billions and trillions.
Now, sit down, these figures may shock you:  The face (notional) value of derivatives held by US commercial banks is over $200 trillion dollars and the total derivative market over $700 trillion. Don’t believe me?  Click here for the US government’s 4th quarter OCC Report, released last Friday.  Read the first two bullets.  Remember, this is just derivatives held by US commercial banks, the total market is, as mentioned above, over $700 trillion (see here).
How much is $700 trillion dollars?  Temple University math professor John Allen Paulos says: “A million dollars a day for 2,000 years is only three-quarters of a trillion dollars”   Well, think about it a minute or so, then go figure $700 trillion.
Okay, these figures are scary and many derivatives are useful and can be unwound.  Derivatives are also useful hedges for farmers, miners and others to smooth out market fluctuations.  They increase liquidity and facilitate transactions.  Credit Default Swaps (CDSs) can measure perceived risk.  The purpose of this article is not to demonize all derivatives.  My question is: why do commercial banks doing with over $200 trillion of them?  This amount is almost four times larger than the total GNP of the entire world, more than all the combined stock and bond values of the world.  Their is only one explanation and that is large scale leveraged speculation.  Another, maybe more accurate term, would be gambling.
Which banks hold much of these derivatives?  The OCC report tells us.  It is five large commercial banks.  They are JP Morgan Chase (JPM), Citibank (C), Bank of America (BAC), HSBC Bank USA, and Goldman Sachs (GS).  Some 82%  of the holdings are interest rate swaps.  Swaps are risky with winners and losers.  Goldman Sachs is most deeply involved.
Now, like me, you may wonder what the hoot is going on here?  Credit Default Swap (CDSs)  didn’t even exist 14 years ago. Now they are a $62  trillion dollar market.  Interest swaps started slowly in the 1980’s, the five banks above alone hold $162 trillion worth.  Why is this rapidly growing market so huge?  A recent  Newsweek article even mentioned the market will be in the Quadrillions soon.
Glass-Steagal was repealed in 1999, allowing banks and others, equipped with sophisticated computer systems, to plunge into derivative trading.    A worldwide, unlimited casino opened up.  Hedge funds, banks, insurance companies took advantage.
Systemically important institutions have no business being major players in this market.  Certainly, taxpayers have not agreed to participate, much less bail out the losers.
The claim is made that derivatives are just paper entities in which assets and liabilities zero out.  Well, yes, there is truth to that.  But, this high-stakes gambling, like all gambling, has winners and losers.  Consider Bear Sterns, AIG and Lehman Brothers, all losers.  In a deleveraging world, we are getting more and more losers.  It doesn’t take much of a shift in a $600 trillion market to wipe out huge companies in days, look at AIG.  Look at what would have happened to Citigroup without taxpayer money.
So, how dangerous are derivatives?  Warren Buffett called Credit Default Swaps “financial weapons of mass destruction”.  AIG proved him right.
Forbes magazine, in their March 16, 2009 issue, has an article on how Lawrence Summers (currently heading the White House’s National Economic Council) entered into interest rate swaps at Harvard University which “burdened Harvard with a multibillion-dollar bet on interest rates that went against it”.  The Forbes article goes on to say that bad  derivative bets may have adversely affected univerisites and hospitals around the nation.
AIGFP  insured CDS derivatives, lost their bets, didn’t have the money to make good, even all of AIG couldn’t make good.  So now the American taxpayer was told they must make good, to the tune of hundreds of billions of dollars.  American taxpayers are the losers, financial institutions world wide are the winners.  Now, after AIG, tell me how you can possibly think derivatives are not dangerous.  And, doesn’t it strike you as strange: few are talking, even now, about reining in the derivative markets?
The megabanks are heavily into interest rate swaps, with a combined notional value of over $150 billion according to the OCC report.  If these systemically important institutions start losing on their interest rate derivatives, which the OCC Report said they did in the 4th quarter,  will we the taxpayers be on the hook to  bail them out again?  Remember the interest rate swap market is much bigger than the CDS market which got AIGFP into trouble.
Derivative trading seems to be a huge, unregulated market, run by the self-appointed elite all over the world amongst themselves.  They use OPM (other people’s money) skimming off profits.  Forget lotteries, forget sports betting, forget Vegas.  This stuff is the ultimate!  A powerful elixir those in power cannot resist playing with.  Doing this for there personal accounts is one thing but  Holding the world economy as hostange and involving taxpayers as backups for losses, however, is criminal.
One wonders how much of the pre TARP scare mongering last fall was true.   Now, the bailouts are bankrupting our nation and there is no end in sight.   We need to start listening to people like Richard Shelby and Ron Paul, not Paulson, Geithner and their cronies at the big banks and Goldman Sachs.  It is time to make those responsible take their losses.
The US government has printed, borrowed or promised some $14 trillion so far.  And guess what: It hasn’t worked! The London protestors suddenly don’t look so foolish, they at least aren’t bankrupting us.  AIG, FANNIE, FREDDIE, JP Morgan, Bank of America, Citigroup, Goldman Sachs want even more of our money, there is no end in sight.   This is insanity!
Disclosures: none