Dear Reader,

There are a lot of news stories surrounding Bernanke’s press conference yesterday. In my opinion, he didn’t say much that we don’t already know. Rather than attempt to discern his economic outlook from vague statements, I want to touch on a few major slip-ups in his talk. As I’ve noted in the past, even the most careful person can’t make it through an hourlong press conference without some mistakes.

The first quote has been reported in several major news outlets. At about 10:20 in the conference, Bernanke stated, “We don’t have a precise read on why this slower pace of growth is persisting.” I see two problems here. First, this statement should scare everyone from a Ph.D. economist to an average guy on the street without a clue about the Federal Reserve: Bernanke has just admitted his cluelessness.

Second, if Bernanke can’t explain the growth slowdown, then what does that mean for his unemployment and inflation projections accompanying the press conference? The charts point to falling inflation and unemployment. Isn’t it a bit hard to forecast unemployment when one doesn’t even understand growth in the present?

Further in the press conference, one journalist asks about the trajectory of future rates – whether they will rise suddenly or gradually. Bernanke say that he can’t say for sure as the situation is constantly changing. Well, if Bernanke doesn’t know, how can he possibly forecast lower inflation? To get lower inflation, he must necessarily raise rates – hence, that’s a bit of a contradiction.

The next quote is my favorite, and comes at about 25:15 in: “It’s only been two years since we’ve had the worst financial crisis certainly since the Great Depression, possibly the history of the United States.” That’s a serious mess-up. How are the bailouts and the near-zero interest rates defended every time? It’s usually something like, “If extraordinary actions weren’t taken, we’d be in another Great Depression.” According to Bernanke, the recent financial crisis was possibly the worst in “the history of the United States.”

Let’s clarify that – not the second-worst financial crisis, but possibly the worst. Yes, number one.

At another relevant part of the press conference (16:45), Bernanke responds to a journalist inquiring about the effects of immediate deficit cuts. According to the journalist, some view this as a route toward job creation. Bernanke responds with, “In the very short run, fiscal tightening is at best neutral and probably somewhat negative for job creation.”

This is an honest academic opinion. It is not the position of left-wing political ideologues who act as if the sky would fall down with reduced spending. According to Bernanke, there could be a little job loss or perhaps nothing at all.

The last notable remark was at the 45:00 mark. Bernanke points out that there was a one-third chance of deflation prior to the decision for QE2. Really, that’s it? Was the further destruction of the dollar and the extraordinary rise in commodity prices worth avoiding a one-third chance of deflation? I hardly think so.

In today’s edition, the Casey Research energy team will discuss the expansion of Russia’s energy industry; then, Jeff Kopocis writes about increased world competition both in business and sports.

Russia’s Grip on Gas

By the Casey Research Energy Team

Russia loves being in control of other countries’ energy needs. The nation supplies a quarter of the natural gas consumed in Europe, owns 40% of the world’s uranium enrichment capacity, and rivals Saudi Arabia for the top spot on the list of global oil exporters.

However, that is not enough. Russia has several major initiatives under way to increase its stake in the global natural gas scene; these include new developments near Sakhalin Island that are aimed at boosting trade with Japan, and negotiations with China over $100 billion worth of pipelines to carry Siberian gas into Chinese cities.

Sakhalin Island is off Russia’s eastern coast (just north of the Japanese island of Hokkaido); some major oil and gas fields lie near the island’s northeast coast. The Sakhalin II project was the first to start producing oil in 1999. Over the next ten years the consortium of owners, led by Russia’s state gas company Gazprom, added two other oil platforms, an onshore processing facility, an oil export terminal, a set of pipelines, and a liquefied natural gas (LNG) plant. These operations produce roughly 53 million cubic meters of gas and 395,000 barrels of oil per day. The LNG plant at Sakhalin II is Russia’s first and only LNG facility to date.

The success of Sakhalin II sparked another development, known as Sakhalin I, which taps into three offshore fields. Operated by Exxon Mobil, the Sakhalin I consortium includes Russia’s OAO Rosneft, India’s ONGC Videsh, and Japanese joint venture Sodeco. The partners produce oil from the Orlan platform, which pulls roughly 250,000 barrels of oil per day from the Chayvo zone.

Now, two major Sakhalin developments on the horizon are set to transform the area from an oil-focused region to a major gas producer. First, Gazprom officials recently announced that development work at the massive Sakhalin III gas project, originally scheduled for 2014, has been pushed up because of increased demand from Asia. The accelerated schedule, targeting production by the middle of next year, will also let the project take advantage of a new pipeline from Sakhalin to Vladivostok. Natural gas reserves at Sakhalin III are estimated at 1.4 trillion cubic meters.

Second, a long-standing dispute between Exxon Mobil and Gazprom at Sakhalin I may be close to resolution, paving the way for the Sakhalin partners to develop that project’s massive gas resource. Until now the partners have only pulled oil from Chayvo, but the formation also holds some 485 billion cubic meters of natural gas reserves. Exxon Mobil holds the right to export gas from the project, even though Gazprom holds a monopoly on Russian gas exports, and Exxon originally intended to export the gas directly to China. But Gazprom wanted the gas from Sakhalin I for itself, to fill the rest of that new Sakhalin-Vladivostok pipeline. It now looks like Gazprom has prevailed in the dispute – the company expects to sign a deal with Exxon before the end of the year to purchase all of the gas produced at Sakhalin I.

While the Sakhalin developments are significant, they pale in importance compared to a proposed natural gas supply deal between Russia and China. Two years ago the countries agreed in principle to build two massive pipelines from Siberia into China; after lengthy negotiations the countries were hoping to finalize details ahead of Chinese President Hu Jintao’s state visit to Russia in mid-June.

Those hopes were dashed when the potential partners could not agree on pricing, but negotiations continue because the rewards for both sides are huge. For Russia, a major deal with China means diversification away from European markets as well as a way to capitalize on remote resources. China is simply looking to secure stable energy supplies wherever it can find them. The country’s natural gas requirements are expected to increase from less than 3 trillion cubic feet today to 9.7 trillion cubic feet in 2035.

Building the two pipelines is expected to cost some $100 billion; the 70 billion cubic meters of gas exported through those lines each year could amount to 2% of Russia’s gross domestic product. It would be one of the largest energy deals ever signed, and a difference of a few percentage points on the gas price would translate into billions of dollars. In that light, it’s not surprising that the potential partners are having trouble agreeing on prices.

Gazprom wants gas prices similar to those it receives in Europe, which are pegged to oil markets. China National Petroleum (CNP) is holding out for a discount, based on the argument that Russia has no other market for its eastern Siberian gas. CNP is especially pressed to achieve a good price because it faces government controls on natural gas sold in its domestic market. Whenever CNP buys gas at European-level prices, it has to sell that gas at a loss. Both sides downplayed the disagreement, leaving observers confident that a deal will eventually emerge.

Russia has incredible energy riches and knows it. Russia’s leaders are well aware that Asia’s energy needs are only going to increase, and they are more than happy to position their country as a primary supplier. They already have a strong foothold in the oil market and control the flow of nuclear fuel through their control of almost half of the world’s uranium enrichment facilities. Now they are clearly working to step up in the natural gas scene, and we’d bet they’ll do it.

[As the world’s energy situation fluctuates, knowing where to invest can seem a daunting challenge. Let Marin Katusa and his energy team do much of the research for you. Subscribe to Casey Energy Report risk-free to get specific recommendations, as well as access to all its archives. Details here.]

International Competition

By Jeff Kopocis, Junior Analyst

Several of us at Casey Research enjoy playing golf. Okay, maybe “enjoy” is not the correct verb. Each time we tee up we think, “This could be the day. Today’s round will be the best round I’ve ever played.” This may come as a shock to non-golfers, but it typically doesn’t work that way. Best described by author John Feinstein as “a good walk spoiled,” golf is perhaps the world’s most frustrating sport. For those readers who have never picked up a club with the intention of becoming the next great golfer, consider yourselves lucky.

When my non-golf-playing friends mention wanting to learn golf, I simply tell them that they’re too smart for the game. After all, they’ve avoided golf this long and should continue to do so with a focus on other sports. Maybe tennis, for instance. In addition to good exercise, tennis (like golf) is also a good sport for conducting business, and it seems much less wearing on one’s mental makeup. If I were ever bright enough to quit golf, I’d try tennis. But I’m a golfer through and through; and tomorrow’s round could be the best I’ve ever played.

This past Sunday, Rory McIlroy convincingly won the 111^th U.S. Open Championship at the Congressional Country Club in Bethesda, Maryland. His final total score of 16 under par was an all-time record for the four-day tournament, besting Tiger Woods’ former record of 12 under par shot in 2000. Jason Day, who placed second, finished a healthy eight shots behind McIlroy.

The U.S. Open is the second of golf’s four major tournaments. “Majors,” as they’re referred to, are the World Series or Stanley Cup for professional golf players. By virtue of his 18 major victories, Jack Nicklaus is considered by many to be the best golfer of all time.

Just two months ago, Rory played a dreadful final round at this year’s first major, the Masters Golf Tournament, where he shot a final-round 80 to lose a four-shot lead and the tournament. Many observers wondered if there would be a repeat performance in the U.S. Open when Rory entered the final round with a commanding eight-shot lead.

To answer his doubters, Rory simply went out and continued to do what he’d done all tournament. He put the ball in the correct position on the fairway, made his golf ball stop on most greens, and sank putts. It was magnificent to watch as a golfer. In comparison to him, I’m not sure I even play the same sport. But I digress.

Even though Rory’s performance on the golf course was spectacular, reading deeper into what his win means may help us as investors.

You see, Rory McIlroy is from Northern Ireland. And Jason Day, the second-place finisher, is from Australia. In fact, a glance at the final leaderboard shows that only two Americans finished in the top ten. The other six spots were occupied by men from Korea, England, Spain, Sweden, and South Africa. In short, it wasn’t an American who won the U.S. Open – our national championship and presumably a tournament where American-born players feel a bit of extra pride.

Golf has long been an international game with its origins rooted in Scotland. For the better part of the 20^th century, golf and business was dominated by Americans. In 111 U.S. Opens, Americans have won 79 times, compared to 32 victories for international players .Impressively, Americans won 65 of the 70 U.S. Opens played from 1926-1999 with an incredible stretch of 35 in a row from 1926-1964 (with a four-year break for WWII).

That same period of 1926-1999 also saw tremendous economic growth in the U.S. Thus, the U.S. was at the top of both the golf and economic worlds.

However, from 2000-2011, Americans have only won five of the twelve last U.S. Opens. Golfers from South Africa, New Zealand, Australia, Argentina, and most recently, Northern Ireland have won the other seven tournaments.

It has been said that sports can be a mirror of culture. As an investor, I see increased competition in golf and global business. And I see a U.S. that has lost its firm grip on the top spot in both fields. Not only is there increased international competition, but that competition is increasingly better than the talent here in the U.S. While this is not a judgment of good or bad, it is an observation that is worth paying attention to in order to manage one’s portfolio effectively and profitably.

In golf, a benefit of golf’s internationalization is a more competitive landscape that raises all players’ games to a higher level. In business, economies of scale can be achieved and innovative thinking can be capitalized to create advancements for everyone.

The trend of increased international competition shows no signs of slowing down over the coming decades as technological advances facilitate a more interconnected world. Furthermore, as the U.S.-dollar devaluation continues, foreigners with stronger currencies will look to buy U.S.-dollar-denominated assets – particularly hard assets. Those assets will be on sale relative to their home currencies and will enable them to rid their portfolios of poorly performing U.S. dollars.  As such, it is wise for the prudent investor to diversify portfolio holdings internationally, whether it be common equities or a second home abroad. Hard assets, such as gold and silver, and companies that mine them should also perform well.

At Casey Research, we take time to try to understand the dynamics of international competition and its potential impact on a business. In our globally connected world, it’s the surest way to fully understand one’s investments and manage one’s portfolio.

And to those golfers out there: Hit ‘em long and straight.

Additional Links and Reads

Obama Administration Taps Strategic Petroleum Reserve (Politico)

Do you remember Obama blaming speculators for higher oil prices since our supply was supposedly plentiful? In case you don’t, here are his words from April:

It is true that a lot of what’s driving oil prices up right now is not the lack of supply. There’s enough supply. There’s enough oil out there for world demand. The problem is that oil is sold on these world markets, and speculators and people make various bets, and they say, you know what, we think that maybe there’s a 20 percent chance that something might happen in the Middle East that might disrupt oil supply, so we’re going to bet that oil is going to go up real high.

Since he uttered those words, crude oil prices have fallen. Nonetheless, the Strategic Petroleum Reserve is releasing 30 million barrels of oil “due to supply disruptions in Libya and other countries and their impact on the global economic recovery,” But… but… Obama said it was the speculators and not supply. It’s a wacky world, folks.

Obama’s Stimulus Program Did Work … For Washington (Forbes)

A Forbes blogger explains how the stimulus has worked for Washington D.C., which enjoys low unemployment and rising housing prices. However, I disagree with the writer on one point. He notes, “[T]he area has turned into a poster-child [sic] for Keynesian economics and liberal sensibility.” In my opinion, it’s one of the biggest failures. Go to any ghetto of Washington D.C. and see whether government spending has helped out there. D.C. is a story of an extremely large gap between the rich and poor – the exact same thing the left blames on capitalism. If Keynesian economics really worked, shouldn’t everyone be better off in D.C., not just the contractors and government employees?

Obama vs. ATMs: Why Technology Doesn't Destroy Jobs (Wall Street Journal)

Russ Roberts discusses the fallacy of Obama’s “ATM comment.” Essentially, Obama blamed unemployment on technology. In case you haven’t encountered the quote, here it is:

"There are some structural issues with our economy where a lot of businesses have learned to become much more efficient with a lot fewer workers," he said. "You see it when you go to a bank and you use an ATM, you don't go to a bank teller, or you go to the airport and you're using a kiosk instead of checking in at the gate."

That’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey's Daily Dispatch Editor