Can Argentina Triple Energy Production With Reform? YPF Up 2%

Argentina lawmakers voted in energy legislation that could help the country boost its oil and gas production over the next two decades.

It took months of negotiations between the government, provincial governors and other interests to agree on distributing revenue from the country’s oil and gas deposits. The legislation now requires the signature of President Cristina Fernandez de Kirchner.

Argentina’s debt default drama and infighting on central bank controls has obfuscated some well-known facts:  Argentina is No. 3, worldwide, in shale-gas reserves, and No. 4 in shale oil, according to the U.S. Energy Information Administration. Yet Argentina’s refining capacity is limited and it imports energy products, according to the EIA. The bill would allow Argentina to boost crude oil production to 1.8 million barrels per day by 2035 from about 550,000, and natural gas output could more than triple, according to an Accenture report quoted by Bloomberg.

Shares of oil-and-gas producer YPF (YPF) rose 2.5% Thursday. The Global X MSCI Argentina ETF (ARGT) was up 2%. Oil majors Total (TOT) and Chevron (CVX) have invested in Argentina, and  ExxonMobil (XOM) has talked with YPF about energy exploration opportunities in Argentina.

Companies are lukewarm to the legislation, says Nicholas Watson at Teneo Intelligence, given Argentina’s economic malaise, currency controls and soaring inflation  – 40% by some estimates. According to Bloomberg, the new parameters:

• allow companies that invest $250 million over three years to sell 20 percent of production in international markets without paying export taxes.
• allow 35-year concessions to shale and offshore fields.
• cap royalties at 12 percent plus 3 percent in provincial net income taxes.
• create a federal auction system, replacing one that varies by province.

Watson writes:

“The most positive take-away from the reform is greater regulatory consistency. While provinces set their own royalties and terms for concessions, the new system establishes a country-wide 12% cap on royalties (rising to up to 18% on concession extensions), and introduces a national auction system. In addition, the reform eliminates the carried interest regime by which provincial oil and gas companies have held minority stakes in concessions without having to make up-front investments. And for companies, the new law extends license timeframes, lowers the bar at which point exemptions on export taxes take effect from $1 billion to $250 million, and loosens currency controls by permitting companies to retain hard currency earned from 20% of their exports.

Buenos Aires provincial governor Daniel Scioli’s chief economic advisor last week said that it would take four years to bring inflation down to single digits …  devaluation expectations will cause companies to delay investments. Barring a deal with holdout creditors early next year and/or pragmatic moves to correct economic distortions, confidence is likely to remain muted until after Fernandez leaves office in December 2015.

While this author’s most recent Barron’s column, “Too Early to Fall for Argentina,” was skeptical on Argentina equities for individual investors because publicly-traded options are illiquid, we noted that hedge funds have been betting on YPF. Colleague Andrew Bary said in December 2013 that undervalued YPF shares could triple; the U.S.-traded shares are down 1% year to date.

For more on Argentina’s economy and the effect of its July debt default, and suggested articles, see the post, “Argentina Reading List: Economy Slumps After Debt Default.”

Schwab: Time Is Now For Emerging Markets Investing

For investors willing to take on moderate to high risk, emerging markets are at “a turning point that may mark the beginning of a sustained upturn,” says Jeffrey Kleintop, Schwab’s chief global investment strategist.

In a just-released white paper that’s bullish on emerging market investing, Kleintop says slower global growth is reflected in attractive, low valuation — a key reason for emerging market upside. He thinks emerging markets stocks can benefit from global economic improvement, be a buffer against weaker global growth, and offer diversification.

“Emerging markets economies would gain from global trade growth, which appears poised for improvement despite the risks presented by the slowdown in Europe and geopolitical spillovers. The attractive valuations for EM stocks have started to be recognized by the markets. Even some of the most economically miserable EM countries have seen solid stock market performance in 2014.”

Indeed, the iShares MSCI South Africa ETF (EZA) is up 4% over the past year, and the Global X FTSE Argentina 20 ETF (ARGT) is down 3% over 12 months, while the iShares MSCI Emerging Markets ETF (EEM) is down more than 1% in the same span and the iShares MSCI Brazil Capped ETF (EWZ) is down 16% in that period. India’s stocks have been the stellar performers this year, with the election of Prime Minister Narendra Modi, who has been quick to institute reforms. The iShares MSCI India Small Cap ETF (SMIN) is up 69% over the past 12 months, and the Wisdom Tree India Earnings Fund (EPI) is up 36%.

A key to Kleintop’s positive argument now is low valuation. He writes:

“A key support is that low valuations on EM stocks means that they are trading at a significant discount to U.S. stocks and those of other global developed markets. EM stocks rarely have been more inexpensive on a relative basis and are well below their average historical prices on an absolute basis. Investors already have priced in a more pessimistic outlook for EM stocks, making them better positioned to sustain strong performance than stocks of developed international markets such as Europe.”

Recognizing historical disappointments and the risk in emerging markets, he offers a little history:

EM investors in the 1990s were used to significant up-and-down swings. Financial crises were regular occurrences in EM countries in Asia and Latin America. These included the Mexican “peso crisis” in 1994, the Asian “contagion” of 1997-98, and the Argentine debt default of 2001. … From 2002 to 2007, the “BRIC” era (named for a 2001 paper on the economies of Brazil, Russia, India, and China) saw EM stocks experience a period of spectacular performance resulting from a few key drivers: emerging market economic growth was rapid … and EM stock valuations rose while developed market price-to-earnings (PE) ratios fell …

After that golden era, we all know the score: emerging markets slowed; many became dependent upon developed economy weakness, and the Federal Reserve’s quantitative easing encouraged money to flow into emerging markets and create unsustainable trade and budget deficits. Currency devaluations resulted in losses on foreign-currency-denominated investments.

National Bank Of Greece, Down 50% in 2014, Still Has Fans

Shares of the biggest bank in Greece are down 5% today, bringing the decimated stock’s year-to-date decline to 50%.

Investors are still stewing over Europe’s latest bank stress test after EU bank authorities said there is still work to be done. The latest bank stress test failed Greek banks based on their balance sheets in late 2013, but Greek banks restructured in 2014 and, with financing, have a stronger footing.  J.P. Morgan offers another reason why Greek bank stocks are selling off: “as hedge funds square up positions in a rising volatility environment, Greek assets are punished severely.”

National Bank of Greece (NBG), down 5.6%. The GlobalX FTSE Greek 20 ETF (GREK) is down 1.5%. Banks account for 58% of Greek market, JPM estimates.

Meanwhile, bond yields have been on the rise, with fear that the fragile recovery from sovereign default could take a turn for the worse. But J.P.  Morgan writes that:

The brush with Euro exit is more or less complete and Greece is showing solid signs of positive GDP growth for the first time since 2007. With nominal GDP down 25% from the peak and unemployment still 28%, there is much healing still to do and growth to come. The positive AQR [asset quality review] announcement over the weekend was met with a negative stock market reaction. We are surprised and disappointed by the negative reaction … The stock market is clearly worried by the bond markets, where 5-year yields move from sub-4% in September as high as 7.5%. We think there are two key concerns.
First, the presidential elections (super-majority needed in parliament) could trigger early elections. Polls put [the leftist party] Syriza in the lead. Second, the negotiations over leaving the Troika process are difficult [the bailout by the European Commission, the International Monetary Fund and the European Central Bank]. Domestic politics demand more freedom from the Troika, but the debt looks big enough to make official creditors want additional oversight. We think much of the volatility stems from the ownership base of the new bonds and the stocks – as hedge funds square up positions in a rising volatility environment, Greek assets are punished severely.

J.P. Morgan Analyst David Aserkoff sticks with its two Greek picks: National Bank of Greece and the Greek utility Public Power (PPC.Greece).

“We expect the catalyst for the banks to be the successful resolution of the AQR [asset quality review] process in October … We swap out Piraeus Bank (BPIRY and TPEIR.Greece) for Alpha Bank (ALBKY and ALPHA.Greece). We think Alpha has a better balance sheet with very similar upside.”

With one day left in October, and the definite threat of goblins emerging for U.S. shareholders. See “Bank of Greece Sinks on EU Stress Test” on Barron’s Emerging Markets Daily blog.

Venezuela Debt Default Unlikely, But Bolivar Devaluation In 2015?

Venezuela’s commitment to make debt payments should hold even if oil prices slip a little lower for a little longer.

So says Eurasia Group’s Risa Grais-Targow, who writes that even with oil prices of $75 to $80 per barrel for a sustained period, Venezuela can service debt. But if there was a precipitous drop in oil prices below $70, funds would be harder to come by, and that could raise greater risks for President Nicolas Maduro. She writes:

“For now, the military remains fully vested in [the] regime’s survival and if anything, Maduro is better positioned within the PSUV [The United Socialist Party of Venezuela] now than he was when he assumed office. If, however, there is some sort of social explosion … factions of the military would likely be unwilling to defend Maduro’s presidency, leading to a potentially messy political transition. Though not our base case, a sustained and precipitous drop in oil prices (below $70) would likely accelerate such a risk, and materially threaten the government’s ability to meet its debt obligations.”

Earlier this week, Venezuela’s state-run oil company made a $3 billion debt payment, and took to Twitter to publicize its action.

Eurasia Group thinks oil prices will rebound “somewhat” later this year or early next year. Following a research trip to Caracas, Grais-Targow writes:

“… The government remains committed to servicing its external debt in 2015 and is not even considering the possibility of default … While Venezuela’s oil basket fell to $75.90 last week, the average oil price for 2014 remains $94.14 (compared to $98 per barrel in 2013 and 103 in 2012) … Assuming that the price of Venezuela’s oil basket is $75-$80 or above, the government will have the capacity to both meet its external debt obligations and minimum import demand. While the government remains unwilling to even consider meaningful economic reforms until after the 2015 legislative elections, it will likely undertake a foreign exchange adjustment in the months ahead, likely in early January 2015. Though the precise form of devaluation is unclear, a dual system, with the two Sicad rates of 12 bolivars to the dollar and 50 bolivars to the dollar seems the most likely outcome …”

A handful of Venezuela’s major companies, including banks, paper and mining companies, trade over the counter with ADRs.  Investors can get exposure to Venezuela’s bonds in the iShares Emerging Markets High Yield Bond ETF (EMHY), which is up more than 8% year to date. While the fund represents a basket of 200 bonds, Venezuela debt was the third largest concentration at about 6% of assets as of Oct. 28, according to the iShares summary of its emerging market high-yield bond fund.

The iShares Latin America 40 ETF (ILF) is up 2.7% today while the iShares MSCI Emerging Markets ETF(EEM) is up 0.8%. Data was not available for the iShares MSCI Emerging Markets Latin America ETF (EEML).

Vale 3Q Earnings Below Consensus, Stock Lower

Shares of Brazilian mining giant Vale tumbled 3% Thursday morning after the company reported earnings results that were lower than expected.

Vale (VALE) stock is down 37% this year, and has fallen nearly 30% in the past three months, along with the drop in commodity prices including iron ore. Shares of Rio Tinto (RIO) are down 1.3% today and BHP Billiton (BHP) shares are down 0.5%, while Cliffs Natural Resources (CLF) stock is up 3.8%.

Anthony B. Rizzuto, Jr., Novid Rassouli and Ryan Wentling at Cowen write:

“Third quarter 2014 adjusted Ebitda (earnings before interest, taxes, depreciation and amortization) of $3 billion came in below the consensus estimate of $3.8 billion and our $4.0 billion. Weaker-than-expected results were primarily driven by lower iron ore prices and realizations as well as higher costs per ton. We expect shares of Vale to underperform the group today. … Iron ore sales volumes of 78.1 MM mt in 3Q14 were 1.5% quarter over quarter. However, a 9.3MM mt buildup in inventories, partially driven by the interruption of the Carajas Railroad in September, negatively impacted sales volumes in the third quarter … Vale, along with the other majors, continues to increase iron ore production. Management highlighted that this comes at a time when demand from Chinese steel producers is increasing only moderately. The Chinese economy grew at 7.3% y/y in 3Q14 and is now expected to be below the government’s 7.5% target. Vale expects Chinese steel production to continue to grow, however, at a more moderate pace. We believe these factors may continue to exert downward pressure on iron ore prices …”

Cowen has a $12 price target on the shares, which were recently trading at $9.90. Brazil’s Bovespa Index is up 2% today after Brazil’s central bank raised the overnight interest rate. The iShares MSCI Brazil Capped ETF (EWZ) is up nearly 3.5% today.

Brazil Surprise: Central Bank Raises Interest Rate

Brazil’s central bank surprised markets by raising the country’s overnight borrowing rate by 25 basis points to 11.25%.

The Bovespa Index is up 1.8% this morning, and the real is weaker against the dollar. The iShares MSCI Brazil Capped ETF (EWZ) jumped in early trading, up 3.3%, while the iShares MSCI Emerging Markets ETF (EEM) is up 0.42%. Shares of Petroleo Brasileiro (PBR) the state-run energy company, are up 2% today, but have tumbled nearly 12% this week in contrast to the flat performance of the Bovespa for the week.

The decision comes just days after a runoff election returned President Dilma Rousseff to power, but with only a narrow margin. Reflecting on the divisions revealed in the ugly election campaign, Deutsche Bank economists Robert Burgess and Jose Carlos Faria explain:

“Perhaps the controversy produced by President Rousseff’s strong criticism of central bank independence during the campaign forced the BCB’s hand to regain credibility, and there could be speculation on whether the president approved of the decision or not. In any case, we believe the much faster-than-expected adjustment in interest rates is positive for market sentiment (as it strongly signals austerity), and could contribute to a reduction in the total size of the tightening cycle. Market participants will now turn their attention to the COPOM minutes to be released next Thursday.”

The decision was split: 5 members voted for the 25 basis point hike while 3 members voted against it. Deutsche thinks the committee was justified, given the higher inflation outlook, in adjusting monetary conditions “to ensure, at a lower cost, a more benign inflation scenario for 2015 and 2016.” But, given already high rates, and a weak economy, not a single person surveyed in Brazil by Agência Estado expected a rate hike, and none of the economists surveyed by Reuters expected Brazil to hike rates. Deutsche was in agreement:

We thought the central bank “would at least wait for the government to send a clear signal on its plans for fiscal tightening. In the end, this looks like the “credibility hike” that the market would have expected should the opposition have won the presidential election on Sunday.”

Emerging Markets Winners, Losers As Energy & Commodity Prices Fall

With the international price of crude hovering near $86 per barrel, governments have to rethink their fuel-price subsidies as India has. And prices for commodities, from iron ore to soybeans, have collapsed in recent months as well. Nomura offers a handful of currency trades in emerging markets based on who wins and who loses as commodity prices decline.

Emerging Market Must Reads: Russia EU Recon Flights, Mexico’s Resilience

Some headlines in the emerging markets world for Wednesday:

Emerging markets finished the day mixed after the Federal Reserve said it would end its asset-purchase program, and keep interest rates low for a considerable time as it monitors inflation and the job market. The iShares MSCI Emerging Markets ETF (EEM) erased gains, and ended the day fractionally higher.

Mexico: Resilient in the face of the Fed’s pronouncement, the iShares Mexico Capped ETF (EWW) was flat on the day, while countries more affected by higher interest rates moved lower, including Turkey: the iShares MSCI Turkey ETF (TUR) was down 0.5%. Meanwhile, Mexicans are getting increasingly agitated as authorities continue to look for 43 male students who disappeared after they were arrested by police and reportedly turned over to a drug gang. See “In Mexico, A New Lead On Missing Students,” The New York Times.

Russia: Four groups of Russian planes conducted reconnaissance missions in Europe, an unprecedented number, according to the North American Treaty Organization. The Wall Street Journal reports that the flights could have endangered civilian flights, given the size of the maneuvers. The flights were on Tuesday and Wednesday, and planes from eight nations reacted to the perceived threat, rare in the post-Cold War era. See “NATO Tracks Large-Scale Russia Air Activity In Europe,” WSJ. The Market Vectors Russia ETF (RSX) fell nearly a point Wednesday.

Venezuela: Allaying fears about debt default, Venezuela’s state-run oil company PDVSA paid a $3 billion bond payment due, with the Finance Minister Rodolfo Marco Torres confirming the action in a Tweet, followed by an Economic & Social Development Bank of Venezuela Tweet that “the Bolivarian government continues to honor its commitments. PDVSA has paid its 2014 bonds for $3 billion. Efficiency!” Here’s the Tweet from the bank posted to Finance Minister Rodolfo Marco Torres‘ feed:

RT @RMarcoTorres El Gob Bolivariano continúa cumpliendo sus compromisos: Pdvsa realiza pago de Petrobonos 2014 por 3000 MM $ ¡Eficiencia! — Bandes (@BandesVe) October 29, 2014

More from The Financial Times in “Venezuelan Oil Co Makes Bond Payment.” And in case you missed it: With oil prices in a slump, meaning lower input costs, maybe the refining business isn’t so bad. Debt-strapped Venezuela isn’t selling its U.S. refiner Citgo after all. See “Venezuela Cancels Plan To Sell U.S. Refiner Citgo,” WSJ.

India: In U.S. trading Wednesday afternoon, India-focused exchange-traded funds moved lower, and that was especially true for smallcaps: the iShares MSCI India Small Cap ETF (SMIN) was down 2%.

Interest Rates: Russia, Fed & Turkey

The Central Bank of Russia meets on Friday and market observers looking for a one-point interest rate hike may have it wrong, says Benoit Anne, strategist at Societe Generale.

Anne explains the two kinds of interest rate hikes, and Russia’s options, thusly:

“The standard inflation-targeting rate hike is when a central bank is concerned about inflation deviating away from the official target or when the central bank wants to proactively manage inflation expectations. The more dramatic financial-stability rate hike is an aggressive emergency policy action to stabilise local and foreign-exchange markets in the face of severe financial stability risks.”  What Russia is likely to choose  ”is where the local curve – and a number of market participants – get it wrong.”

The local rate curve implies a hike of 100 basis points on Friday, meaning a financial-stability rate hike.  (See “Should Russia Raise Rates To Boost Ruble?” on the Barron’s Emerging Markets Daily blog.) But, Anne writes:

Yury Tulinov, head of research at Societe Generale’s  Moscow-based Rosbank, has explained to me is that the CBR remains fundamentally committed to its inflation targeting framework. … Yury is actually calling for only a 50 basis point rate hike, an inflation-targeting hike, or well below current market pricing. If this scenario does materialise, investors will believe (wrongly) that the CBR has chickened out, which will result in an even weaker RUB. Don’t expect the RUB to bounce any time soon. It gets interesting on the local rates side, however. Right now, the trajectory of local rates is simply one way. The 1y x-ccy is currently trading at 10.00%, another 20bp higher on the day. But if the central bank raises its policy rate by 50bp, we may actually see some temporary retracement. Maybe not that major a retracement, but given the fact that the 1yrates have risen by 100bp over the past week, this will constitute a notable break in the current momentum. … Any short-term setback on Friday should be used to re-establish payer positions, in my view.

Anne predicted the Federal Reserve Open Market Committee would be risk-supportive. What happens with U.S. rates has a big impact on emerging markets like Turkey with a big current account deficit and, thus, prospects for rising borrowing costs.

“Societe General’s Phoenix Kalen recommended “a Turkey 2y x-ccy rates receiver, based on our view that the current environment is highly supportive of Turkey’s fundamentals. In particular, the lower oil price will nicely promote a much lower current account deficit as well as downward pressures on domestic prices. Under this global deflation fear environment, Turkey’s local rates are well positioned to continue performing. And let’s never forget, as I have said many times before, that the [Central Reserve Bank of Turkey] DNA is fundamentally dovish. That means that the CBRT will cut its policy rate at the very first opportunity.”

The Market Vectors Russia ETF (RSX)  fell 0.9% Wednesday. Among trading vehicles, the Direxion Daily Russia Bear 3X Shares (RUSS) rose 2.44%, while the Direxion Daily Russia Bull 3X Shares (RUSL) fell 2.4%. The  iShares MSCI Turkey ETF (TUR) fell 0.5%.

Emerging Markets Lower After U.S. Fed Pronouncement

The Fed said it will end its asset purchase program, but also said it will keep interest rates low for a “considerable time,” putting it on track to raise rates next year.

It was a hawkish pronouncement from the U.S. Federal reserve meeting today, but the overnight rate remains at zero, where it has been since 2008. The initial reaction: a 0.6% decline in the Standard & Poor’s 500 Index. In emerging markets, the iShares MSCI Emerging Markets ETF (EEM) lost some of the day’s gains: it was up 0.8% at 2 p.m., but is now down 0.2%.

Brazil’s Bovespa Index is sank further, from a 1.6% decline at 2 p.m. to a decline of nearly 2%. The iShares MSCI Brazil Capped ETF (EWZ) is down 1%. Shares are also lower in countries with large current account deficits that would be hurt by higher borrowing costs. The iShares MSCI Turkey ETF (TUR) is down 1%. The iShares MSCI South Africa ETF (EZA) is down 0.6%. Shares in Argentina and Greece are also lower.

Higher interest rates are expected to fuel the flow of money from riskier emerging market investments to those with safer yields. While emerging market central bankers have warned the Fed not to move too quickly, there are many other risks for emerging markets. Here’s what John Williams, the president of the San Francisco Fed, said earlier this month:

“It is not just what the Fed is doing, it is that fact that different central banks are moving in different directions for appropriate reasons … quite honestly, unconventional policy is going on in Japan and the European Central Bank, so to me it is really the cross currents that … drive the uncertainty and some of that risk out there in global markets.”

See: “Risk For Emerging Markets Is Not Just the Fed: Williams,” MarketWatch.