The Rude Awakening
Wall Street, New York
Thursday, May 18, 2006 ------------------------- - What's mine is mine and what's yours is...mine – the
joys of taxes,
- A big thanks to some politicians for the next raging
bull in commodities,
- Broken down in Bolivia, lots of red arrows in the
markets chart and plenty more...
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I-Been-Hosed
By Eric J. Fry "Out here in the real world," observed the Rude Awakening
column of November 8, 2005, "we refer to the fruits of our
labor as 'earnings.' But up on Capitol Hill, politicians
recognize these same fruits as 'taxable gains.' We believe
we deserve our earnings, by virtue of the fact that we
worked hard to produce them. But the politicians believe
that they deserve our earnings, by virtue of the fact that
they have already spent them. "So whenever somebody earns a whole bunch of money, all at
once, politicians like Hillary Clinton, the Senator from
New York, begin to imagine that they deserve an even larger
share of our earnings than usual." ...And so do politicians like Hugo Chavez, Evo Morales and
Alfredo Palacio...the respective presidents of Venezuela,
Bolivia and Ecuador. In the name of "equity" and "fairness" the aforementioned
politicians – along with a number of other politicians
around the globe – are conducting a kind of economic
terrorism against the oil and resource companies that
operate within their borders. This emerging wave of econo-
terrorism is not a good thing. At best, it threatens the
near-term earnings growth of many resource companies. At
worst, it threatens the very survival of many resource
companies, which means that worldwide exploration efforts
could slow to a crawl at the very moment they should be
increasing. The terrorists' preferred tactics include: tearing up
existing contracts, imposing massive "windfall" taxes or
simply expropriating property and production facilities.
This budding global effort to tax resource companies into
oblivion – or to simply steal their projects – could be
very good news for the price of the resources themselves.
Oil and mineral exploration is already challenging and
costly, without the added threat of crippling, after-the-
fact taxation. Perhaps the latest efforts by global politicians to reap
where they do not sow will amount to nothing more than a
temporary populist fad, but if the movement gains momentum,
$100 crude oil may arrive sooner, rather than later.
Already, the horror stories are proliferating...from
Venezuela to Bolivia to Russia to...Mongolia. On Monday, the shares of Ivanhoe Mines (a.k.a. I-been-
hosed) tumbled about 30% on reports that the Mongolian
government will impose a whopping 68% "windfall tax" on
mining companies. Ivanhoe has invested about $370 million
in a copper/gold project within the country, but has not
yet begun production. Earlier this month, the shares of Apex Silver (SIL), which
operates a large silver project in Bolivia, plummeted 25 %
when President Evo Morales nationalized Bolivia's oil
industry. Because Morales has set his sights on all mineral
production within the country, Apex Silver shares continue
to drift lower. Morales took his cue from Venezuelan President, Hugo
Chavez, who one month earlier, forced foreign oil companies
to cede majority ownership of their projects to the
Venezuelan national oil company and to accept higher
taxes...or to abandon their projects and leave. Chavez's tactics may be different in degree from that of
Senators Clinton and Levin, but it is hardly different in
kind. "We need a windfall profits tax," Michigan Senator, Carl
Levin, recently whined, "because these profits have been
absolutely obscene...If the president would call the oil
companies into the Oval Office and tell them he's going to
support a windfall profits tax ...I'll bet that the price
of gasoline would come down within a matter of days." That's a bet your editor would take. In fact, the exact
opposite effect would probably result. The more that
politicians seek to tax, the less that oil companies will
attempt to explore...and that mining companies will attempt
to mine. After President Jimmy Carter imposed a windfall tax on oil
companies in 1980, domestic oil production tumbled. "From
1980 to 1988," the Christian Science Monitor reports, "the
windfall tax brought in $80 billion in gross revenues - far
less than the $393 billion projected - before it was
abolished, according to an analysis released last month by
the Congressional Research Service. It also lowered US
domestic production, the analysis found, by somewhere
between 1.2 percent and 4.8 percent during that period." Reagan repealed the flawed policy eight years later. It may not matter to today's populist politicians that
their actions will impede future efforts to develop the
world's natural resources. But it may matter very much to
resource investors. The nearby charts present a glimpse of
what may lie in store: Commodity prices up; resource stocks
down. 
Curiously, ever since early April, when Hugo Chavez began
"revising" contracts with foreign oil companies, the
performance of resource stocks has been lagging behind the
performance of natural resources themselves. 
The following chart presents this divergence in very high
relief. The share price of Apex Silver, which operates
primarily in Boliva, has been tumbling while the price of
silver has been climbing.
These price charts may be anticipating the hostile new
world that resource companies now inhabit – a world in
which aggressive and unpredictable taxation greets every
exploration success. In such a world, "successful" mineral
exploration may no longer mean profitable exploration. If,
therefore, exploration efforts slacken – even a little –
commodity prices could continue rising...a lot. So let's thank Hugo Chavez – and Senator Clinton – in
advance for the next phase of the bull market in
commodities. [Joel's Note: As Eric recently pointed out, markets don't
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-------------------------
Obscene Profits"
By Eric J. Fry
It might surprise Senator Hillary Clinton – as well as many
Rude Awakening readers – to discover that oil company
profits are much less "obscene" than those of the nation's
largest finance companies. As the chart below illustrates, the combined cumulative
earnings of Citigroup and Bank of America from 1995 through
the third quarter of this year totaled an astounding $223
billion, a sum which happens to be $14 billion HIGHER than
the combined cumulative earnings of ExxonMobil and Chevron
over the same timeframe. In each and every one of those ten
years, the two big finance companies earned more money than
the two big oil companies. Never once did Exxon and Chevron
manage to produce an "obscene" profit that exceeded that of
Citibank and Bank of America...NEVER ONCE. 
Is the comparison fair? You bet. The combined enterprise
value of the two oil companies is nearly identical to the
combined enterprise value of the two banking behemoths. So
why tax the oil companies' "windfall" profits and not those
of the finance companies? Only Senator Clinton knows for sure. If Ms. Clinton had
truly wished to recoup "windfall" profits, she could have
started the process with Citigroup, which just happens to
enjoy a large, comfy presence in her home state of New
York. One could argue that Citigroup has enjoyed a decade-
long windfall, thanks to the very low interest rates – and
steep yield curve – provided by Alan Greenspan's Federal
Reserve. To be clear, we don't think either sector produces obscene
profits worthy of supplemental taxation. But if forced to
choose between the two, finance-company profits seem much
more obscene than those of the oil companies.
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