Some of my favorite economic indicators are delicious.
The Economist has its Big Mac Index, which shows price distortions in places like China or Norway based on the cost of the same beef, bun, and special sauce.
For Peru, my destination this week on a multi-industry research junket, I'm thinking about avocados. I take great pleasure in taking advantage of cheap tropical produce in South America. Like in Chile, where the locals slather guacamole, or palta, on hot dogs and hamburgers.
Peru, for its part, is advancing its avocado exports deeper into the U.S. market, and both sides of that tasty trade will benefit. The Department of Agriculture ruled on January 4 that Peruvian avocado farmers will be able to ship as much as 19,000 metric tons of Hass avocados to the States every year. Prices for the fruit in American aisles could drop by 6%, adding layers to domestic dips while padding the incomes of thousands of farmers in the shadow of the Andes.
Of course, raw numbers can be appetizing too — especially when you get a whiff of Peru's 9.8% increase in gross domestic product in 2008 and expected region-leading growth in 2010! 2009's GDP numbers only moderated to around 6% year-on-year, because Lima financiers steered clear of the derivatives crisis while it brewed.
Peru's Pole Position for Global Growth
Peru's position on the Pacific Rim has for centuries made it a key port for Asian fishermen and traders who want access to Latin American markets. These days, hungry China's resource appetite on one side is nearly balanced by bullish Brazil on the other...
A giant new highway bridging the Pacific coast and the country's eastern border with Brazil will make Peru a transit market worth salivating over. That road alone may add a full percentage point to Peru's GDP, according to a recent report in the Christian Science Monitor.
The truth is that Peru's location is incredible in terms of both international and internal economics. Peru has a system of microclimates that can jar a person's system with precipitous drops in temperature and altitude, while benefiting businesses that want a variety of natural resources within easy reach.
In a few days, I'll be meeting with local and international entrepreneurs, as well as government officials who have helped usher Peru through periods of serious political tribulations to today's rising prosperity. All these people are part of a puzzle that investors need to see fully in order to maximize the profit potential that Peru presents.
So where can you invest in Peru?
Let's start with the whole menu: a U.S.-traded Peru ETF!
Play Peru Easily with this Exchange-Traded Fund
The iShares MSCI All Peru Capped Index Fund ETF (NYSE: EPU) captures a cross-section of the industries and companies that already have deep roots in one of Latin America's sleeper emerging market sensations of 2009-2010.
EPU beat its Chilean counterpart (NYSE: ECH) by about 13% in 2009, and that's music to Peruvians' ears. You see, Peru and Chile are locked in a border dispute and Peru recently arrested one of its own air force officers who was suspected of spying for Chile.
The two countries even clash over pisco — a sweet grape liquor popular straight down the Andes — the origin of which is a topic of hot debate.
As far as ETFs go, the flavor you savor may have more to do with the kind of stocks you prefer than which flag you'd like to see on a liquor bottle.
EPU, the Peruvian ETF, is far more heavily weighted toward mining companies like Buanaventura Mining Co. and Southern Copper (NYSE: PCU). Chile, though it's the top copper producer in the world, has its national metal industry controlled primarily by the government, which pushes resource wealth into pension funds and national savings.
International investors in Peru can do more with their money than they can in Chile to tap the commodity hunger of mega-builders like China, India, and Dubai.
So we see that you can take advantage of publicly-traded miners in Peru. But EPU also gives you access to the financial institutions that are helping to link Peru's growth from government-led investment campaigns like ProInversiones (which I will detail during my trip), to the small-to-medium-sized businesses that line Lima's streets.
Credicorp (NYSE: BAP), EPU's top banking component and itself an ADR stock, rose by 57% over the past year. With that total, it walloped the Financial Select Sector SPDR (NYSE: XLF) while showing that emerging market financial institutions are not too hot to touch.
Peru's national finances are on the up-and-up, too.
The country just completed the trifecta of "investment-grade" ratings upgrades from Moody's, Fitch, and S&P. Investors are buzzing that Peru is a country with resource wealth on par with many African countries, but with only a fraction of the governance and corruption problems of the continent just across the South Atlantic.
When it comes down to value, Peru also beats Chile on its ETF's price-to-earnings ratio. EPU is a full 5 points lower than ECH, which trades at more than 22 times earnings.
If you want more for your money, Peru is the place.
I've got a full docket of meetings and site visits that will bring me up to speed on everything from mining projects to large-scale renewable energy efforts across Peru. China comes into play there, too; the Chinese clean energy market is expanding rapidly, and entrepreneurs in the Middle Kingdom are looking for inroads in developing economies like Peru.
And I'm looking forward to delivering the latest information that will lead you to superior returns while most investors continue to snooze on this amazingly dynamic emerging economy.
Saludos,
Sam Hopkins
International Editor
Assume oil is priced on the NYMEX for $80/Bbl.
Subtract a regional price adjustment of $10/Bbl for sweet crude, and $15/Bbl for sour crude (which contains some percentage of sulphur and thus is more costly to refine). For this example, well use the sweet crude adjustment. This draconian $10 - $15/Bbl is because the Bakken oil fields are not very close to refining capacity and needs to be trucked long distances.
Subtract what an operator has to pay in royalty to whoever owns the mineral rights, which must be leased by the producer. The producer pays the mineral owner a cash bonus (as high as several thousand dollars per mineral acre) and a royalty of usually 20% of the products of any wells drilled which includes oil and natural gas. Therefore, royalty from an $80 Bbl is $16, which the producer never sees.
Then subtract (North Dakota in this case) severance tax of 6%, or $4.80/Bbl.
Then subtract lifting cost, which is the cost of raising the oil to surface, typically by a pumping unit or a Unidraulics equipment arrangement which relies on pumping water down hole through a venturi, bringing oil and water back to surface, then cycling downhole all over again. This cost is energy-intensive, requires electricity or natural gas as fuel and moves a horse-head pumpjack at the wellhead or the Unidraulics piping and tanks. The average cost to do this, allocated on a per-barrel basis, is $12.25. This number has to then be adjusted for royalty, because the royalty owner does not have to pay production cost. Therefore, the math for this is: $12.25/.80 Net Revenue Interest (the production fraction left for the producer after subtracting .20 for a 20% royalty) = $15.30/Bbl.
The total erosion of the per-barrel oil price by taking all the above into account is $46.10/Bbl.
The numbers set out above are used to calculate the economic limit of a well, when added to the finding cost of Bakken oil (see below). The cost of drilling in the Bakken is high, because the Bakken is not a porous, permeable sandstone. Instead, it is a shale and has low permeability and porosity. Consequently, rather than drilling a conventional vertical well bore, it is necessary to drill a vertical hole, then kick the well bore out in the horizontal plane, while keeping the drill bit and drilling string within the oil-saturated shale formation. Modern technology has made this possible over the past 20 years. It is the only way to offset low formation permeability by exposing thousands of feet of prospective formation to the open well bore.
Since the lateral extensions of these wells have to exceed generally 2500 in order to open up enough reservoir, the cost of drilling and completing such Bakken wells is nominally $2.5 million per well, which includes the cost of huge hydraulic fracturing of the Bakken formation in order to open up the low permeability Bakken rocks to help the flow of oil out and into the well bore. By contrast, a conventional oil well, such as in Louisiana, Texas and Oklahoma, dont require horizontal lateral configuration and thus are much cheaper to drill to the same equivalent depth. In conventional exploitation, the oil (and associated natural gas) flow to the well. With Bakken, you have to bring the well(s) to the oil!
An example of this difference is taken into account when calculating the finding cost of Bakken oil, which is simply the cost of drilling a Bakken well divided by the number of Bbls estimated to be recovered from the well, adjusted for the royalty barrels. In this example, well be generous and give a Bakken well an ultimate recovery of 400,000 Bbls. When that is adjusted for 20% royalty and divided into the well cost, then the finding cost amounts to $7.80/Bbl, not adjusted for the time value of money.
Taking all of the above into account, it is demonstrated that the economic limit (defined as the sum of the finding cost added to the lifting cost) of a Bakken well is $53.90. In terms of what a Gulf Coast U.S. producer is used to, this economic limit is a scary number. It means that when oil prices fall below $64 on the NYMEX, then Bakken oil producers begin to make red ink.
In summary, the Bakken rig count will be high when oil is in excess of $80/Bbl, and rigs will be stacked when oil is much below that number. World oil prices have far more often been less than $70/Bbl than any price higher.
One last example of the economic sensitivity of Bakken and Canadian tar sands oil: When oil prices collapsed during the latter part of 2008, more than one million barrels/day of Canadian oil was taken out of the world market. The rig count in the Bakken also fell. Only recently has the rig count in the Dakotas and Montana begun to recover, as Bakken oil production rises above a red ink income statement with current prices at nominally $80/Bbl on the NYMEX.
By contrast to all the above, a Texas producer of conventional oil experiences a lifting cost of nominally $6.25/Bbl for the higher oil/ratio wells adjusted for a 20% royalty, pays a Texas severance tax of 6.3%, and pays a royalty owner the same nominal 20% royalty. The cost of drilling and completing a conventional well to a Bakken equivalent depth is $700,000, which for this example lets penalize the comparison by saying that such well will produce an ultimate recovery of only 250,000 Bbls. Consequently, the economic limit of a Texas oil well using these examples on a per-barrel basis is: $3.50 finding cost + $6.25 lifting cost + $16 royalty + $5.04 Texas state severance tax.
Thus, the economic limit is ~$31/Bbl for Texas/Oklahoma/Louisiana conventional oil. Since there is no regional adjustment off of the NYMEX oil price, the Gulf Coast producer thus makes a greater net operating income because the economic limit of his production is only 57% of the economic limit of a Bakken producer.
Its all in the numbers. John Dickinson, 651 Bering Drive, Unit 202, Houston, Texas 77057 (713)334-7733
Screw Peru. If the United States doesn't support it's own agriculture, someday the U.S.A. could be blackmailed or even shut down.
Look what has happened to our other industry. Rusting steel mills and major vehicle manufacturing depleted.
Apparently none of you lived through the WW-II years. If it weren't for our own agriculture and manufacturing capabilities you would be a $orry lot and be bowing down to the $wastica or Rising $un.
I'm a financial and social conservative but not $tupid.
Yeah I know, if you don't invest then $omebody will.
Our nation is being weakened enough as it i$. Besides that I like California avacados.