19:00 USD Federal Open Market Committee Rate Decision (DEC 17) High 0.25% 0.25%
The announcement of whether the Federal Reserve has increased, decreased or maintained the key interest rate. The FOMC meets eight times per year to decide on monetary policy. After each meeting policy decisions are announced. The main task of the FOMC is to set the monetary stance by fixing the overnight borrowing rate, which essentially sets short-term lending rates in the US. Through this mechanism, the FOMC attempts to affect price levels in order to keep inflation within the target range while maintaining stable economic growth and employment. The Federal Reserve’s Cash Rate Target decision significantly influences financial markets. Changes in rates affect interest rates for consumer loans, mortgages, bonds, and the exchange rate of the U.S. Dollar. Increases in rates or even expectations of increases tend to cause the Dollar to appreciate, while rate decreases cause the currency to depreciate. Unlike most central banks, the Federal Reserve does not announce an official target inflation rate, arguing independence and flexibility is necessary to implement monetary policy effectively.

The Federal Reserve issues a statement with every rate announcement. Because the decision itself is usually highly anticipated, the wording of the FOMC statement is usually as important if not more important than the actual interest rate move made by the central bank. The FOMC statement contains the Fed’s collective outlook on the economy as well as hints about future monetary policy while the change to interest rates is nothing more than a number. The statement provides clues on plans for the future. When it comes to interest rates, the future direction of rates is usually far more important than its current rate

Treasuries Decline Before Fed’s Decision on Rate-Increase Stance

Treasuries fell before Federal Reserve policy makers wrap up a meeting amid speculation they’ll look beyond Russia’s currency crisis and discuss dropping a pledge to keep interest rates low for a “considerable time.”

U.S. debt pared losses after a report showed inflation declined in November by the most in almost six years, depressed by falling energy prices. The difference in yields between two-and 30-year securities touched the least since January 2009. The Fed is scheduled to issue its last policy statement for the year. Chair Janet Yellen plans to hold a press conference.

“It’s most likely that the Fed will refer to geopolitical or external risks, but we still expect the ‘considerable time’ to be dropped,” said Michael Leister, senior strategist at Commerzbank AG inFrankfurt. “The first rate increase could take place as early as June, and the pressure of rising yields will be more evident at the short end of the market than in longer-dated maturities.”

The benchmark 10-year yield rose two basis points, or 0.02 percentage point, to 2.08 percent as of 8:50 a.m. in New York, according to Bloomberg Trader data. The 2.25 percent note due in November 2024 fell 6/32, or $1.88 per $1,000 face amount, to 101 15/32. The yield increased by as much as five basis points.

The gap between yields on two- and 30-year securities reached as low as 2.12 percentage points.

BONDS HAVE A RATING SYSTEM

This is related to risk of the bond

US GOVERNMENT
AAA
AA
A
BBB
BB
B
BELOW B
OTHER

 

JUNK BONDS

ETF is HYG and JNK

have higher yield and high risk

Yield is called coupon

United States Government Bonds

When there are turbulent times in the market People go the the safe haven of United States Government Bonds

 

SUMMARY

if you consider that all bonds theoretically cost $100 ie their par value

if people leave Junk Bonds to seek the safety of US Treasury Government Bonds then Junk Bonds Price will go down from $100 because not so many people want to buy them to say $80

this happens in time of economic instability and uncertainty, as a result the Yield increases, ie if you only have to pay $80 to get $5 yield than $100 to get $5 yield.
Conversely when people madly want US Government Treasury Bonds the price goes up ie from $100 to $110 and then fo get a yeald of these of $2.5  for $100, is not as good a deal as from $100 getting $2.50, so yield decreases.

EXAMPLE

Europe’s highest-rated government bonds climbed, sending yields from Germany to Ireland to record lows, as tumbling oil prices dimmed the outlook for inflation and boosted demand for haven assets.

German 10-year securities rose for a seventh day, the longest run of gains since October 2013. The bunds advanced as Brent crude dropped below $60 a barrel for the first time since July 2009, weighing on emerging markets and fueling speculation the European Central Bank will begin sovereign-debt purchases known as quantitative easing. Greece’s bonds fell along with those of Spain and Italy before the first of as many as three Presidential votes starting tomorrow.

 

 

 

 

 

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Bond Terminology

Bonds have their own unique terminology, and it is important to understand these words if you are to be a successful bond investor.

Accrued Interest
Accrued interest is the interest that has been earned, but not yet been paid by the bond issuer, since the last coupon payment. Note that interest accrues equally on every day during the period. That is, it does not compound. So, halfway through the period, you will have accrued exactly one-half of the period’s interest payment. It works the same way for any other fraction of a payment period.
Banker’s Year
A banker’s year is 12 months, each of which contains 30 days. Therefore, there are 360 (not 365) days in a banker’s year. This is a convention that goes back to the days when “calculator” and “computer” were job descriptions instead of electronic devices. Using 360 days for a year made calculations easier to do. This convention is still used today in some calculations such as the Bank Discount Rate that is used for discount (money market) securities.
Basis Point
A basis point is equal to 1/100th of 1%. You may hear that a bond yield changed by 10 basis points (bps), which means that it changed by 0.10%.
Bond
A bond is a debt instrument, usually tradeable, that represents a debt owed by the issuer to the owner of the bond. Most commonly, bonds are promises to pay a fixed rate of interest for a number of years, and then to repay the principal on the maturity date. In the U.S. bonds typically pay interest every six months (semi-annually), though other payment frequencies are possible. Bonds are issued by corporations, banks, state and local governments (municipal bonds), and the federal government (Treasury Notes and Bonds).
Call Date
Some bonds have a provision in the indenture that allows for early, forced, redemption of the bond, often at a premium to its face value. Bonds that have such a feature usually have a series of such dates (typically once per year) at which they can be called. This series of dates is referred to as the call schedule.
Call Premium
The extra amount that is paid by a bond issuer if the bond is called before the maturity date. This is a sweetener that is used to make callable bonds attractive to investors, who would otherwise prefer to own non-callable bonds.
Clean Price
The “clean price” is the price of the bond excluding the accrued interest. This is also known as the quoted price.
Coupon Payment
This is the actual dollar amount that is paid by the issuer to the bondholders at each coupon date. It is calculated by multiplying the coupon rate by the face value of the bond and then dividing by the number of payments per year. For example, a 10% coupon bond with semiannual payments and a $1,000 face value would pay $50 every six months.
Coupon Payment Date
The specified dates (typically two per year) on which interest payments are made.
Coupon Rate
The stated rate of interest on the bond. This is the annual interest rate that will be paid by the issuer to the owners of the bonds. This rate is typically fixed for the life of the bond, though variable rate bonds do exist. The term is derived from the fact that, in times past, bond certificates had coupons attached. The coupons were redeemed for cash payments.
Current Yield
A measure of the income provided by the bond. The current yield is simply the annual interest payment divided by the current market price of the bond. The current yield ignores the potential for capital gains or losses and is therefore not a complete measure of the bond’s rate of return.
Dated Date
The dated date of a bond is the date on which it first begins to accrue interest. This is often the same as the issue date, but not always. If the settlement date is before the dated date, then the purchaser will pay the issuer the accrued interest for that amount of time. Of course, the purchaser will get a full coupon payment on the first coupon date, so the purchaser will get the accrued interest back at that time.
Day-count Basis
A method of counting the number of days between two dates. There are several methods, each of which makes different assumptions about how to count. 30/360 (a banker’s year) assumes that each month has 30 days and that there are 360 days in a year. Actual/360 counts the actual number of days, but assumes that there are 360 days in a year. Actual/Actual counts the actual number of days in each month, and the actual number of days in a year. In Excel bond functions, 0 signifies 30/360, 1 specifies actual/actual, 2 is actual/360, 3 is actual/365 (which ignores leap days), and 4 represents the European 30/360 methodology.
Dirty Price
The “dirty price” is the total price of the bond, including accrued interest. This is the amount that you would actually pay (or receive) if you purchase (or sell) the bond.
Face Value
The principal of a bond is the notional amount of the loan. It is also called the principal or par value of the bond, and represents the amount that will be repaid when the bond matures.
Indenture
The legal contract between a bond issuer and the bondholders. The indenture covers such things as the original term to maturity, the interest rate, interest payment dates, protective covenants, collateral pledged (if any), and so on.
Make-whole Call Provision
A provision in the bond indenture that allows the issuer to call the bond on short notice by paying the bondholders the present value of the remaining cash flows. The present value is determined by adding a pre-specified premium (usually 15 to 50 basis points) to the yield on a comparable Treasury security.
Maturity Date
The date on which the bond ceases to earn interest. On this date, the last interest payment will be made, and the face value of the bond will be repaid. This is also sometimes known as the redemption date.
Redemption Value
This is typically the same as the face value of a bond. However, for a callable bond, it is the face value plus the call premium. In other words, this is the entire amount that will be received when the bond is redeemed by the issuer.
Required Return
The required return is simply the return that an investor believes he/she needs to earn in order to make an investment in a particular security. It is based on the perceived riskiness of the security, the rate of return available on alternative investments, and the investor’s degree of risk aversion. It is likely that two investors looking at the same investment will have different required returns because of their differing risk tolerance. The required return, along with the size and timing of the expected cash flows, determines the value of the investment to the investor. Note that the required return is different from the yield (or promised rate of return), which is a function of the cost of the investment and the cash flows, and not of investor preferences.
Settlement Date
The date on which ownership of a security actually changes hands. Typically, this is several days after the trade date. In the US markets, the settlement date is usually 3 trading days after the trade date (this is known as T+3). For bonds, a purchaser begins to accrue interest on the settlement date.
Term to Maturity
The amount of time until the bond stops paying interest and the principal is repaid.
Yield to Call
Same as yield to maturity, except that we assume that the bond will be called at the next call date. Also known as yield to first call. Frequently, the yield to all call dates is calculated, and then we can find the worst-case, which is known as the yield to worst.
Yield to Maturity
The yield to maturity (YTM) of a bond is the compound average annual expected rate of return if the bond is purchased at its current market price and held to maturity. Implicit in the calculation of the YTM is the assumption that the interest payments are reinvested for the life of the bond at the same yield. The YTM is the internal rate of return (IRR) of the bond.
Yield to Worst
The lowest of all possible yields for the bond. It is calculated by determining the minimum of the yield to maturity or any of the various yields to call dates.

VelocityShares’ Daily Inverse VIX Short-Term ETN (NASDAQ:XIV) and its sister fund, the Daily Inverse VIX Medium-Term ETN (NASDAQ:ZIV), are designed to go up when the volatility of the S&P 500 goes down. XIV has a shorter time horizon (1 to 2 months) whereas ZIV has a 5 month timeframe.

To have a good understanding of how XIV works you need to know how it trades, how its value is established, what it tracks, and how VelocityShares (and the issuer- Credit Suisse) make money running it.

How does XIV trade?

  • For the most part XIV trades like a stock. It can be bought, sold, or sold short anytime the market is open, including pre-market and after-market time periods. With an average daily volume of 11 million shares its liquidity is excellent and the bid/ask spreads are a penny.
  • Unfortunately XIV does not have options available on it. However, its Exchange Traded Fund (ETF) equivalent, ProShares‘ Short VIX Short-Term Futures ETF (NYSEARCA:SVXY) does, with five weeks’ worth of Weeklys with strikes in dollar increments.
  • Like a stock, XIV’s shares can be split or reverse split-but unlike the iPath S&P 500 VIX Short-Term Futures ETN (VXX) (with 3 splits since inception) XIV has only split once, a 10:1 split that took its price from $160 down to $16. Unlike VXX, XIV is not on a hell-ride to zero.
  • XIV can be traded in most IRAs / Roth IRAs, although your broker will likely require you to electronically sign a waiver that documents the various risks with this security. Shorting of any security is not allowed in an IRA.

How is XIV’s value established?

  • Unlike stocks, owning XIV does not give you a share of a corporation. There are no sales, no quarterly reports, no profit/loss, no PE ratio, and no prospect of ever getting dividends. Forget about doing fundamental style analysis on XIV. While you’re at it forget about technical style analysis too, the price of XIV is not driven by its supply and demand-it is a small tail on the medium sized VIX futures dog, which itself is dominated by SPX options (notional value > $100 billion).
  • The value of XIV is set by the market, but it’s tied to the inverse of an index (the S&P VIX Short-Term Futurestm) that manages a hypothetical portfolio of the two nearest to expiration VIX futures contracts. Every day the index specifies a new mix of VIX futures in that portfolio. For more information on how the index itself works see this post or the XIV prospectus.
  • The index is maintained by the S&P Dow Jones Indices and the theoretical value of XIV if it were perfectly tracking the inverse of the index is published every 15 seconds as the “intraday indicative” (IV) value. Yahoo Finance publishes this quote using the ^XIV-IV ticker.
  • Wholesalers called “Authorized Participants” (APs) will at times intervene in the market if the trading value of XIV diverges too much from its IV value. If XIV is trading enough below the index they start buying large blocks of XIV-which tends to drive the price up, and if it’s trading above they will short XIV. The APs have an agreement with Credit Suisse that allows them to do these restorative maneuvers at a profit, so they are highly motivated to keep XIV’s tracking in good shape.

Understanding Contango: Natural Gas Example

http://commodityhq.com/2012/the-ten-commandments-of-commodity-investing/

http://www.zacks.com/stock/news/98520/why-i-hate-volatility-etfs-and-why-you-should-too

When it comes to commodity investing and trading, contango is a dirty word. Many investors have given contango a bad name (and rightfully so) as it has the ability to destroy value in an underlying position with the blink of an eye. Now that the ETF universe has rapidly expanded and there are a number of complex products offering exposure to the commodity world, contango has become more prevalent than ever. A number of investors have fallen prey to this phenomenon often without realizing what it was and how it impacted their holdings. Contango is simply a part of the commodity world and is not necessarily a bad thing, as it can create opportunities for profit [see also Understanding Contango: Natural Gas Example].

By definition, contango is the process whereby near month futures are cheaper than those expiring further into the future, creating an upward sloping curve for future prices over time. The reason behind this is most often attributed to storage costs; storing barrels of oil or bushels of corn isn’t cheap and the costs have to be passed down the line. Some commodities, like natural gas and crude oil, are known for exhibiting steep contango over time, while others may have very little evidence at all. In some cases, a commodity will present backwardation, which is simply the opposite of contango, when near month futures are more expensive than those expiring further into the future, creating a downward sloping curve for future prices over time [see also The Ten Commandments of Commodity Investing].

As interest in commodities as an investable asset has increased in recent years, more and more investors have sought to educate themselves on the various ways to establish exposure to natural resources and the factors that impact prices of these investment vehicles. Many have embraced ETFs and ETNs as efficient options, gravitating towards low cost vehicles that offer low maintenance strategies. And while a prolonged rally in commodity markets has delighted many investors, some have expressed frustration over gaps between exchange-traded commodity products and hypothetical spot returns [see also How to Trade Natural Gas Futures: UNG and Beyond].

This confusion arises from a lack of education and diligence on the part of investors who assume that commodity funds will deliver returns that correspond to spot prices. While some precious metals funds seek to deliver returns that correspond to spot, achieving this type of exposure is not possible in many markets–the physical properties of resources such as oil, corn, and natural gas make physical replication impossible.

So many commodity products invest in futures contracts linked to the actual commodity, allowing for exposure to resources without taking physical possession. What some have failed to grasp is that there are nuances related to futures-based investment strategies that can have a material impact on bottom line returns [see also 25 Ways To Invest In Natural Gas].

Contango has become a four-letter word among commodity investors, the culprit responsible for disappointing returns from futures-based products. Yet some fail to understand exactly what contango is and how it impacts futures prices–concepts that anyone interested in exposure to commodities should understand.

Example: Natural Gas Futures

Perhaps the most widely-cited example of the adverse impact of contango is the United States Natural Gas Fund (UNG), a product that invests primarily in front month futures contracts. UNG’s returns have differed significantly from a hypothetical return on spot natural gas over the last several years as a result of the futures-based strategy implemented. UNG rolls its holdings near the middle of each month, selling the near month contract and buying the next month contract.

To illustrate how contango can impact returns to a hypothetical natural gas fund, we’ll walk through the trades a fund might make over the course of several months in order to meet its investment objective. Let’s assume that out natural gas fund has $100 million in assets on January 1, which it invests in near month natural gas NYMEX futures contracts (i.e., contracts for February delivery). We’ll assume the fund rolls holdings on the 15th of every month, selling near month contracts and buying the second month contracts [see also The Ultimate Guide To Natural Gas Investing].

On January 1, spot natural gas is trading at $4.00/million BTU. We’ll assume the contract for February delivery is trading at $4.10, reflecting both costs of storing the underlying until that point and market expectations over future price movements. NYMEX natural gas contracts represent 10,000 mmBtu, so the fund in question would buy 2,439 contracts at $41,000 each.

January 1
Contract $/mmBtu # Contracts Value
Spot $4.00
BUY February Contracts $4.10 2,439 $100 million

Fast forward to January 15, when the fund begins to roll its holdings. Spot natural gas is still trading at $4.00, but the price of February futures has dropped to $4.05. The fund sells its contracts, generating proceeds of $98,780,488. It uses those proceeds to invest in March contracts, which are trading at $4.10. The fund’s exposure to natural gas contracts is now represented by 2,409 March contracts [see also Crude Oil Guide: Brent Vs. WTI, What’s The Difference?].

January 15
Contract $/mmBtu # Contracts Value
Spot $4.00
SELL February Contracts $4.05 2,439 $98.8 million
BUY March Contracts $4.10 2,409 $98.8 million

Spot natural gas prices have held steady at $4.00/mmBtu, but the fund has already lost 1.2% of its value through the “roll” process.

We’ll jump forward to mid-February, the point at which our hypothetical fund would sell its March contracts and roll into April futures. Spot gas prices have added more than 1% over the last month, climbing to $4.05. With expiration nearing, March contracts are still trading at $4.10 and April futures are slightly more expensive at $4.15. In order to maintain exposure, our fund sells March contracts for no gain and rolls into April futures:

February 15
Contract $/mmBtu # Contracts Value
Spot $4.05
SELL March Contracts $4.10 2,409 $98.8 million
BUY April Contracts $4.15 2,380 $98.8 million

The value of the fund remains the same over this month, though natural gas prices appreciated. Since the beginning of the year, spot natural gas prices are now up about 1.3% while our fund is down 1.2%.

We’ll carry the example forward for one more month to complete the illustration. Come the Ides of March, spot natural gas prices have dropped back down to $4.00. April futures are now trading at $4.05 and May contracts are priced at $4.10. As the fund rolls, the number of contracts held continues to decline–a nuance of futures investing in contangoed markets [see also 25 Ways To Invest In Crude Oil]:

March 15
Contract $/mmBtu # Contracts Value
Spot $4.00
SELL April Contracts $4.05 2,380 $96.4 million
BUY May Contracts $4.10 2,351 $96.4 million

After less than three months, natural gas prices are at the beginning-of-year levels. But our natural gas futures investment vehicle has lost about 3.6% of its value by rolling from cheap contracts to more expensive contracts on a regular basis. Carrying this process out on a recurring basis can result in investors incurring a significant “roll yield” in order to maintain their exposure to commodity prices.

Lesson To Learn

Many investors focusing on establishing exposure to commodities concentrate on the impact that changes in supply and demand will have on spot natural resource prices. While these considerations are obviously important, it’s critical to also take into account the impact that the lope of the futures curve can have on returns. As the example above highlighted, contangoed markets can create strong headwinds for many commodity funds and commodity ETFs, even when the degree of contango is moderate and the holding period is relatively brief [see also Beyond UNG: Three Intruiging ETFs To Play Natural Gas].

It should be noted that the presence of contango in futures markets shouldn’t necessarily deter investors from a product. There are countless examples of contangoed commodity products posting big gains despite flying into the wind. Education is the key to successful investing, particularly when it comes to commodities.

Disclosure: No positions at time of writing.

Inverse VIX ETNs: Free Money?

by Michael Johnston on February 9, 2011 | ETFs Mentioned: SPY • VIX • VXX • XIV

As the ETF industry has expanded in recent years ongoing innovation has given investors more precise tools for accessing various corners of the stock and bond markets, as well as securities that deliver exposure to previously hard-to-reach asset classes and investment strategies. Many of the exchange-traded products to debut over the last several years utilize futures contracts and derivatives to achieve their objectives, introducing additional complexity and risk factors. When used correctly, these products can be powerful tools to hedge exposure, speculate on short term price swings, or implement advanced strategies. But they also introduce the potential to get burned when used incorrectly.

The volatility ETP space has exploded over the last year or so, as investors have embraced the exchange-traded structure as an efficient way to access an asset class that has the potential to deliver valuable diversification benefits but that can be hard to access and maintain for many investors. Because the VIX (and other volatility indexes, such as the one linked to CVOL) tend to spike when equity markets are falling the correlation between the VIX and stocks is generally close to -1.0, giving the products in the Volatility ETFdb Category appeal for investors looking to smooth overall volatility or install a partial equity market hedge.

But the various VIX ETPs are similar to many commodity products in that they don’t offer exposure to the spot VIX, but rather achieve exposure to this asset through futures contracts. Because the market for VIX futures is generally in steep contango–especially in the short-term, the impact of contango on returns can be significant when positions are held open for multiple trading sessions. Since debuting in early 2009, the iPath Short-Term VIX Futures ETN (VXX) has lost more than 90% of its value–a considerably bigger drop than the 60% decline in the spot VIX over the same period.

Volatility ETPs can perhaps be best thought of insurance policies; when equity markets encounter turmoil, they can be expected to perform well and will be one of the best ways to cushion the blow felt by many portfolios. But in return for the unparalleled protection during crises, investors pay a hefty premium in the form of a steep roll yield to maintain exposure to futures contracts.

Recent innovation in the ETF space has produced products that essentially allow investors to play the role of the insurance company, essentially exploiting the steepness at the short end of the VIX futures curve. The VelocityShares Daily Inverse VIX Short-Term ETN (XIV), for example, will deliver returns equal to the inverse of the S&P 500 VIX Short-Term Futures Index, a benchmark that offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500 Index.

An inverse VIX ETN may seem like an odd concept; because the VIX and equity markets generally move in opposite directions, a bet that volatility will drop might seem like another way of betting that equity markets will rise–in which case establishing exposure to stocks might seem like a more logical play. But because XIV seeks to deliver results that correspond to the inverse of a futures-based index, it has the potential to perform well in markets where stocks and the VIX are flat. That’s because the steep contango in VIX futures markets that creates headwinds for investors in a “long volatility” fund like VXX generates tailwinds at the back of those invested in XIV.

A look at January performances shows some pretty interesting returns. The spot VIX rose by about 10% last month, but VXX was down by about 15% on the month–illustrating just how significant the impact of contango can be on a futures-based fund. But the more intriguing performance is that of XIV; the “inverse VIX” ETN was up 15% during a month when the spot VIX increased 10%.

That jump came after XIV surged by about 25% in December, a month that saw both the spot VIX and VXX tumble as global equity markets staged a year-end rally. During the two month stretch, XIV climbed a whopping 51%; the VIX and VXX dropped by 27% and 38%, respectively, during the same period. And XIV’s impressive gains blew out SPY, which added a relatively meager 11%:

XIV’s track record is obviously limited, but the ETN’s ability to generate gains in periods of both rising and falling volatility should be intriguing to various types of investors.

XIV does, of course, come with some risks. Because the exposure to the underlying index resets on a daily basis, oscillating markets–where gains are followed by losses and vice versa–can potentially result in return erosion (similar to the manner in which leveraged ETFs functioned during 2008). And while XIV managed to gain ground when the VIX jumped in January, it likely wouldn’t move higher if volatility markets staged a repeat of 2008. The VIX closed at an all time high of 80.86 in November 2008, jumping by nearly 300% over a three month stretch.

Many investors have expressed frustration over the nuances of futures-based products, lamenting the “return lag” that such a strategy often produces. But XIV gives investors to jump over to the other side of the table and exploit the upward sloping futures curve. The ETF boom has made various alternatives more accessible than ever, and XIV is one alternative ETF that is worth a closer look.

Up until the 1990’s there was no generally accepted way to measure real “fear” in the markets.
Today, the VIX indicator is one of the tools used to gauge fear.
VIX will often move inversely to the equity market.

The VIX represents one measure of the market’s expectation of stock market volatility over the next 30 day period.

The S&P/ASX 200 or S&P 500 index/US VIX is primarily used as an indicator of investor sentiment and market expectations.
A volatility index at relatively high levels generally implies a market expectation of very large changes in the S&P/ASX 200 or S&P 500 index/US over the next 30 days,
while a relatively low volatility index value generally implies a market expectation of very little change.
When the VIX (^VIX) rises, expected volatility of the S&P 500 index (^GSPC) rises, and when the VIX falls, expected volatility of the index also falls.  Often a rise in the VIX corresponds to a fall in the S&P 500 as volatility is associated with falling markets more than rising markets.

Vix volatility index S&P/ASX 200 VIX Chart

For contrarians, low readings on the VIX are bearish, while high readings are bullish.
The VIX rises when put option buying increases; and falls when call buying activity is more robust. (Note: A put option gives the purchaser the right — but not the obligation — to sell a security for a specified price at a certain time. A call option is a right to buy the same.)

 

The VIX is quoted in percentage points and translates, roughly, to the expected movement in the S&P 500 index over the upcoming 30-day period, which is then annualized. “VIX” is a registered trademark of the CBOE.

The VIX is calculated as the square root of the par variance swap rate for a 30 day term[clarify] initiated today

 

The price of call and put options can be used to calculate implied volatility, because volatility is one of the factors used to calculate the value of these options. Higher (or lower) volatility of the underlying security makes an option more (or less) valuable, because there is a greater (or smaller) probability that the option will expire in the money (i.e., with a market value above zero). Thus, a higher option price implies greater volatility, other things being equal.

 

“Be fearful when others are greedy and to be greedy only when others are fearful” is a well-known adage attributed to the famed investor,

 

  • S&P 500 VIX Short-Term Futures ETN (NYSEVXX) and S&P 500 VIX Mid-Term Futures ETN (NYSEVXZ) launched by Barclays iPath in February 2009.
  • S&P 500 VIX ETF (LSEVIXS) launched by Source UK Services in June 2010.
  • VIX Short-Term Futures ETF (NYSEVIXY) and VIX Mid-Term Futures ETF (NYSEVIXM) launched by ProShares in January 2011.
  • The S&P/ASX 200 VIX (ASX Code: XVI)

Benefits of LNG

Liquefied natural gas (LNG) projects are driving an unprecedented level of investment in Australia, while also delivering reliable and cleaner energy to Asia.

Australia has seven LNG projects under development that will cost industry about $200 billion to build – an investment of more than $1200 per second over the next five years.

In 2012-13, Australia shipped 23.9 million tonnes of LNG cargoes, earning $13.7 billion in export revenue. Australia’s LNG exports are expected to quadruple over the next five years.

 

 

Woodside Petroleum’s plans for a huge LNG venture at James Price Point in WA using its Browse gas were ditched last April. Shell and PetroChina have twice deferred their $20 billion-plus coal seam gas-based Arrow LNG venture in Queensland.

 

et into bed with LNG customers

Joining up with gas customers in LNG projects has grown to a new scale in recent years. LNG buyers used to take just a few per cent at most in export projects, but much chunkier holdings are increasingly the norm.

CNOOC owns 50 per cent of the first LNG production unit at BG Group’s Queensland Curtis LNG and Sinopec has 25 per cent of Santos’s GLNG project.

Such alliances bring deeper pockets and a valuable entry point into prized LNG sales markets.

PetroChina’s 50 per cent of Shell’s Arrow project, for example, has given the project a built-in customer, however long it takes to get the gas developed.

Co-operation, not competition

One of the glaring mis-steps in Australia’s LNG history has been the lack of consolidation among rival projects that should have had more sense.

The three giant look-alike LNG plants being built side-by-side on Curtis Island in Gladstone are a case in point, resulting in billions of dollars of duplicated investment and making gas shortages worse.

The separate development of Woodside’s Pluto venture and Chevron’s Wheatstone is another case in point, because the offshore fields lie side by side and some claim the reservoirs are one and the same.

Learning from those mistakes, LNG players look determined to take a more rational approach in future. ConocoPhillips and Santos are talking up co-operation in the Browse Basin, where gas could be piped to Conoco’s Darwin LNG plant, or to Inpex Corporation’s Ichthys plant. In Queensland, Arrow gas has for some time looked more likely to flow into one of the three existing LNG projects, rather than into a stand-alone plant.

The result could be different ownership stakes in expansion trains at LNG projects, compared with the foundation projects, in line with the ownership of the gas resources that feed the extra capacity.

Oil Search managing director Peter Botten said a recent company strategic review had employed consultants to take a close look at global LNG projects.

It found most Australian projects were not profitable at lower oil prices, unlike in Papua New Guinea. “A number of projects across the world become pretty marginal at $US80-$US85 and if you believe the oil price is going to stay in that range of $US80-$US90, that will start to impact ­future investments for projects,” Mr Botten told The Weekend ­Australian.

“If you spent your money, you’re still likely to produce but I’m sure that oil price will attenuate new projects.”

He also warned that the game could change for projects that were still marginally economic as big oil companies dealt with falling cashflow.

 

 

The most likely future LNG projects in Australia are three Woodside-operated Browse floating LNG plants off Western Australia, which would use major partner Shell’s technology, and a $US10bn fourth-train expansion of the Gorgon LNG plant being built by Chevron and which has Shell and ExxonMobil as ­partners.

London-based JPMorgan oil analyst Fred Lucas said the lower oil price was expected to lead to “big ticket” project deferrals.

“The prospect of another ­potentially prolonged period of much lower than expected oil ­prices should see big oil’s boards reach for the ‘save cash, preserve value, protect the dividend’ ­restructuring folder,” Mr Lucas said.

“We expect the first company signals on 2015 upstream capital expenditure to point to lower than prior guidance.”

JPMorgan estimates that a $US25 drop in oil prices to $US80 during 2015 and 2016 would mean $US38bn of lost free cashflow for Shell.

Credit Suisse analyst Thomas Adolff, who covers big oil from London, said many LNG projects were based on Brent staying at $US90-$US100.

Cashflow for Woodside, Oil Search, BHP, Santos, and Origin will be slashed, big writedowns will be on the table, new LNG projects such as Woodside’s Browse will be rendered uneconomic, oil majors will have less money and appetite to expand existing LNG projects such as Gorgon, and Chevron is unlikely to keep funding its central Australian chase for shale gas with Beach ­Energy.

 

Wrapping up major gas projects in Australia

 

Katherine St Lawrence

 

Gas Today — February 2010

 

Despite global financial uncertainty and the possibility of major economic reform under carbon reduction legislation, Australia’s gas industry hasn’t slowed. Katherine St Lawrence looks at some of the major projects currently under development across the country.

 

While LNG has dominated the focus of the Australian gas industry in recent times, a number of major gas projects, including power generation and transmission, are progressing, promising to deliver natural gas to homes, industry and for export.

 

Gas for export

 

Late last year, Federal Minister for Resources and the Environment Martin Ferguson said “Australia’s abundance of energy resources provides an enormous competitive advantage for Australian industry. But the great challenge we face is to keep it that way.”

 

He said the challenges of export involve exploiting the nation’s gas resources “in a way that advances the nation’s economic and environmental interests while providing energy security for our trading partners.”

Article continues below…

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Chevron gets gas

 

The Western Australian LNG project that made the biggest headlines in 2009 was certainly the Chevron-operated Gorgon LNG Development. After a final investment decision in September, Chevron, in joint venture with Shell and ExxonMobil, awarded a succession of contracts for work on the project.

 

The project is based on the installation of a subsea gathering system of pipelines from the Gorgon and Jansz fields to Barrow Island, where gas will be processed by three proposed 5 million tonnes per annum (MMt/a) LNG trains. LNG will be shipped to international markets – Chevron has signed agreements with Chubu Electric Power, Nippon Oil, Osaka Gas, and Tokyo Gas for the supply of LNG from the project – while compressed domestic gas will be delivered via a 90 km subsea pipeline, connecting with the onshore Dampier to Bunbury Natural Gas Pipeline.

 

Chevron also plans to commercialise its Wheatstone gas field, located 145 km off the Pilbara coast, through the proposed 8.6 MMt/a Wheatstone LNG Development. The field contains an estimated 4.5 trillion cubic feet (Tcf) of gas, which would be processed by two initial 4.3 MMt/a trains, with a possible additional three trains. Chevron has also signed an agreement with Apache and Kuwait Foreign Petroleum Exploration Company for the provision of natural gas to the project from their Julimar and Brunello fields, located on the North West Shelf. The development will also involve a 250 million cubic feet per day (MMcf/d) domestic gas plant. Woodside Browses for LNG

 

Woodside Petroleum’s Pluto LNG Project, located on the Burrup Penninsula, Western Australia, will process gas from the offshore Pluto and Xena gas fields. The project is underpinned by two 15-year sales agreements with Kansai Electric and Tokyo gas for a total of up to 3.75 MMt/a of LNG. The first 4.3 MMt/a LNG train was 82 per cent complete at the time of writing, on track for first gas in late 2010 and first LNG in early 2011. Woodside expects to add a second and third train pending a final investment decision scheduled for the end of 2010 and end of 2011, respectively.

 

Woodside, in joint venture with BHP Billiton, BP, Chevron and Shell, is also developing the Browse LNG Project, which involves offshore facilities and two LNG processing trains, each with a capacity of 7 MMt/a.

 

Feedstock gas will be sourced from the Brecknock, Brecknock South and Tarosa (formerly known as Scott Reef) fields, estimated to contain reserves of over 14 Tcf of gas and 370 MMbbl of condensate. The fields are located approximately 425 km north, northwest of Broome in Western Australia. The onshore facilities will be located on a site just south of James Price Point. The first cargo from Browse could be delivered from late 2012–14 subject to additional appraisal and customer negotiations. This will require a final investment decision to be made by mid-2012.

 

The progress of the project was boosted by a recent renewal of retention leases in the area. Western Australian Minister for Mines and Petroleum Norman Moore encouraged the joint venture partners to work together to achieve the earliest possible commercialisation of the Browse resources. “We look forward to seeing this significant resource being developed for the benefit of both the Browse joint venture and the Australian community.”

 

Queensland LNG Projects

 

A number of LNG projects have been proposed on the Queensland coast, along with pipelines to carry CSG from the Surat and Bowen basins to fuel the projects. In November 2009, Queensland Premier Anna Bligh championed the state’s resources, saying “The gas reserves in Queensland rival anything in Western Australia, and we want to make sure Queenslanders benefit through jobs, growth, and economic opportunity.”

 

Australia Pacific LNG (APLNG), a joint venture between Origin Energy and ConocoPhillips, has proposed a four-train CSG to LNG project utilising Origin’s Queensland CSG reserves and resources. The partners finalised a draft environmental impact statement in January 2010, and expect a final investment decision by December 2010. The $35 billion project will involve a 450 km pipeline from Origin’s CSG tenements in the Surat and Bowen basins.

 

Santos’ GLNG Project will include a 435 km pipeline linking a compression station at Santos’ Fairview and Roma CSG fields in the Surat Basin to the liquefaction plant to be located at Gladstone. Train 2 is expected to commence operation one year after the first GLNG train. A gas supply of approximately 1,200 TJ/d will be required for the two LNG trains. The site could contain up to five LNG trains if required, with a maximum potential production of 10 MMt/a.

 

Arrow Energy is involved in two LNG projects, both to be supplied from its Surat Basin CSG tenements. Its proposed 467 km, 600 mm diameter Surat to Gladstone Pipeline will carry gas to the Queensland coast from the CSG fields.

 

The $776 million Shell Australia LNG (SALNG) Project, a joint venture between Shell and Arrow Energy, will involve up to four LNG processing trains with a total capacity of up to 16 MMt/a of LNG.

 

Arrow has also signed a Heads of Agreement to supply 150 terajoules per day (TJ/d) of gas to LNG Limited for the proposed $410 million Gladstone ‘Fisherman’s Landing’ LNG Project. The design will provide for an initial 2 MMt/a plant, and additional LNG trains of a similar size, subject to the availability of further gas.

 

BG Group/QGC plan to develop the $8 billion onshore Queensland Curtis LNG Project for the production and export of LNG on the Queensland coast, including a 380 km pipeline from QGC’s Surat Basin CSG tenements to a port site. The LNG processing plant and export terminal at Curtis Island will have an initial production capacity of 8.5 MMt/a from two LNG trains, with provision for a third train.

 

Exploring gas

 

As Australia’s ever-growing gas industry enters 2010, the focus is on low emission fuel and security of supply. Natural gas offers a cleaner and plentiful option, and the industry has the opportunity to establish gas as the fuel of choice.

 

In 2009, Federal Minister for Resources and Energy Martin Ferguson said that natural gas exploration holds the key to Australia’s energy needs.

 

“We have an obligation to unlock the wealth of Australia’s vast petroleum resources for the benefit of all Australians. Australia’s gas resources are important to supply affordable and reliable energy for Australian industry and households, and also to supply the growing clean energy needs of our neighbours in the Asia Pacific. They are key not only to Australia’s energy security, but to the region’s energy security.”

 

Apache Energy and Santos are currently developing an onshore gas plant to process gas from their offshore Reindeer Gas Field. The $260 million proposed Devil Creek Gas Plant will receive gas via a 105 km offshore pipeline from a minimum facility wellhead platform at the field.

 

An onshore gas pipeline will tie-in to the existing Dampier to Bunbury Natural Gas Pipeline. The proposed production capacity is approximately 110 TJ/d of sales gas with first gas targeted for mid-2010. Clough will perform engineering, procurement and module fabrication works for the gas plant, while John Holland will construct the gas plant and onshore gas pipeline.

 

Inpex’s Ichthys Gas Project is currently being developed in the Northern Territory. The project involves the construction of an 885 km pipeline linking the offshore gas field to the onshore processing plant at Blaydin Point, Darwin.

 

The project is expected to have an initial capacity to produce 8.4 MMt/a of LNG, approximately 1.6 MMt/a of LPG and 100,000 bbl/d of condensate at peak. Front-end engineering and design work is underway for both offshore and onshore components of the project. The first shipment of LNG is scheduled to be loaded in 2015.

 

Natural gas in the pipeline

 

The largest gas transmission projects in Australia are expansions of major existing pipelines.

 

One of the largest scale transmission projects currently underway is the Stage 5B Expansion of the 1,596 km Dampier to Bunbury Natural Gas Pipeline (DBNGP), located in Western Australia. Following Stages 4 and 5A which increased the pipeline’s firm full haul capacity by a total of 225 TJ/d, the $700 million 5B expansion project involves an additional 110 TJ/d of capacity, including 440 km of looping and compressor station upgrades. This stage of the expansion is due for completion in the first half of 2010.

 

Epic Energy has proposed an expansion of its South West Queensland Gas Pipeline and associated Queensland to New South Wales/South Australia (QSN) Link. The expansion project, dubbed QSN 3, will involve 940 km of 18 inch looping and further compression at the inlet of the pipeline at Wallumbilla. QSN 3 will expand the capacity of the pipeline from 168 TJ/d to approximately 380 TJ/d.

 

Meanwhile, Jemena has recently expanded its Queensland Gas Pipeline, which connects gas fields in the Surat and Cooper basins to markets in Gladstone and Rockhampton. The capacity of the 627 km pipeline is being increased to 49 PJ/a through the addition of compressor stations at Rolleston and Banana, and 113 km of looping from Moura to Bell Creek. At the time of writing, construction of the project was complete and Jemena was completing commissioning activities.

 

Gas fires up

 

While coal and natural gas are the lowest cost sources for electricity generation, gas-fired generation is gaining momentum as a lower emissions fuel. According to the Australian Energy Regulator’s report State of the Energy Market 2009, there is over 2,200 megawatts (MW) of committed gas-fired generation capacity across the national electricity market.

 

In Queensland, two major gas-fired power projects were completed in 2009 – the Braemar 2 Power Station and the Mt Stuart Power Station Expansion. A joint venture between ERM Power and Arrow Energy, the 450 MW Braemar 2 Power Station comprised three 150 MW generation units. The plant, which supplies the Queensland electricity grid, became fully operational in July. The 100 km Braemar 2 Pipeline, also completed in 2009, carries coal seam gas (CSG) to the power station from Arrow’s fields in the Surat and Bowen basins.

 

Origin Energy completed commissioning on the expansion of the Mt Stuart Power Station in December 2009. The project included the installation of an additional 126 MW gas turbine generator, which increased the output of the station by 45 per cent to a total capacity of 414 MW. Works to expand the station began in February 2009. The station currently runs on kerosene but has been designed so that the generators can run on natural gas in the future.

 

Origin is also constructing a 630 MW power station in the Darling Downs region of Queensland, which comprises three 120 MW gas-fired turbines and a 270 MW steam turbine. CSG will be processed at Origin’s Spring Gully gas processing plant, then transported through existing pipeline infrastructure to Wallumbilla. A 200 km pipeline from Wallumbilla to the Darling Downs Power Station was commissioned in June 2009. The company has synchronised the first gas turbine to the Queensland electricity grid, and expects full commissioning of the power station in the third quarter of 2010.

 

Origin is developing a $1.2 billion natural gas-fired power station in western Victoria, 12 km west of Mortlake. The 1,000 MW Mortlake Power Station will be built in stages adjacent to the existing Moorabool to Heywood 500 kV high voltage transmission line. The plant will be supplied with natural gas, from the offshore Otway Gas Project, in which Origin holds a 67 per cent interest, via the 83 km, 500 mm diameter Mortlake Pipeline.

 

Delta Electricity opened the 667 MW Colongra Gas Generation Plant, located within the grounds of the existing Munmorah Power Station site on the New South Wales central coast in December 2009. A 9 km lateral pipeline connects the facility to Jemena’s 236 km Wilton to Newcastle Gas Pipeline.

 

ERM Power has been granted final approval to build the $700 million, 660 MW Wellington Power Station in central western New South Wales. The power station, to be located in Wellington, 50 km south of Dubbo, will comprise four 165 MW open cycle gas turbines. Gas for the plant will be sourced from the Young compressor/gas hub facility of the Moomba – Sydney Gas Pipeline via a proposed 220 km gas pipeline. The power station is expected to come online in 2001–12.

 

The share price performance of the four ASX listed Oil & Gas producers in the LNG sector has been less than spectacular.  There is an exception to be found in a junior O & G exploration and development company, Liquefied Natural Gas (LNG), whose share price is up 65% year over year.  However, the company has had its struggles in the past.  Here is a five year price performance chart for LNG:

In 2009 LNG was exciting investors with progress on its Fisherman’s Landing LNG project in Gladstone, including signed agreements with purchaser Golar LNG and natural gas supplier Arrow Energy.  The share price began to collapse as LNG tried to sell the entire project to Arrow; a deal that failed to materialise.   LNG management pushed ahead with development, convinced its business model of linking suppliers of natural gas with LNG exporters coupled with its patented processing technology could be successful.  LNG has developed a technology – OSMR (Optimized Single Mix Refrigerant) – which cuts LNG plant processing costs in half with a 30% increase in efficiency.  As of this date LNG maintains its 100% ownership of Gladstone Fisherman’s Landing, but the company now describes the project as in “care and maintenance” status with negotiations for securing a gas supply in progress.

Investor interest in LNG was rekindled in December 2012 when the company announced it had set its sights on the US LNG market, through a wholly owned subsidiary, Magnolia LNG LLC.  Since then the share price has risen and fallen with news on the progress of the new Magnolia LNG project, located in the US state of Louisiana at Lake Charles.  So far, the news has been good, with the securing of a financing partner and a series of successful capital raises to fund development of the project in the proposal stages.   In addition there have been a string of key strategic agreements including one with Kinder Morgan Pipeline Partners for its Louisiana pipeline.  Magnolia expects final permitting in mid-2015, with construction to commence thereafter and production start-up by mid-2018.  Project potential is for eight million tonnes of gas per annum.

With a footprint in both the US and Australia, LNG is generating market interest and multiple news reports of late.  The stock is hot and heats up with more positive news.  The latest was the signing of an agreement with Latin American energy provider AES Development Group for production capacity rights.  Supplying Latin American countries allows LNG to avoid the potential pitfall of the size limitations of the Panama Canal for large LNG transport carriers and further delays in expansion plans for the Canal.  The announcement of the AES agreement propelled the share price from around $0.30 to an intraday high of $0.58 before falling back down to earth.

Despite its promise, cautious investors realise the 2018 production start-up target is a veritable eternity away.  Why invest in a speculative, high risk junior with no diversification in other energy assets when the performance of the major players has been tepid at best?  Here are some performance indicators for the ASX Oil & Gas Producers with LNG exposure:

Company

(CODE)

Share Price 52 Week % Change Forward P/E

(FY2015)

5 Year Expected P/EG 2 Year Earnings Growth Forecast Dividend Yield 5 Year Total Shareholder Return
Woodside Petroleum (WPL) $31.86 +6% 14.43 2.56 4.4% 5.5% 4.1%
Origin Energy (ORG) $14.39 +12% 17.99 1.7 9% 3.5% 3.6%
Santos Ltd

(STO)

$13.64 +5% 13.9 1.28 38.7% 2.2% -1.7%
Oil Search Ltd

(OSH)

$8.61 +12% 14.84 0.54 91.9% 0.51% 11.3%

 

Woodside Petroleum (WPL) is the only ASX stock with an LNG facility in production.  The Pluto LNG project began shipping in mid-2012 following multiple cost overruns and production delays.  However, the exuberance of bearish investors was not long-lasting as once Pluto went into operation Woodside started upgrading its production forecasts for Pluto within a matter of months.  Woodside is also involved as operator in another Australian LNG production facility in the Northwest Shelf (NWS).  Despite its experience with the NWS and the revenue generation from Pluto, sceptical investors and analysts are looking instead to the company’s latest LNG “problem child”, the Browse LNG project.  Woodside has rejected a land-based processing facility in favour of the industry’s latest advancement, a floating liquefied natural gas processing facility (FLNG).  In addition, the company is considering an FLNG for its newly acquired stake in the Leviathan gas field off the shores of Israel.

Woodside is now seen by some as a mature dividend payer with limited growth opportunity.  The 2013 Full Year results were somewhat disappointing, but fell within most analyst estimates.  Of Australia’s major broking houses, only JP Morgan has an Overweight recommendation on WPL, although the Full Year results led to a decrease in the price target from $40.26 to $39.47.  With the Browse project nowhere near completion, the Leviathan project in start-up stages, and no news on the company’s Sunrise gas project, analysts wonder about the growth prospects for Woodside.

Origin Energy Limited (ORG) is a diversified energy company covering electricity generation, retail and wholesale sale of electricity and gas, as well as exploration and production of oil and gas.  The company has a minority interest (37.5%) in the Australia Pacific LNG project (APLNG) along with Conoco Philips with the same interest and Sinopec with 25% interest.  The project will supply an LNG processing facility under construction near Gladstone.  The pipeline is nearing completion and production is expected to begin in mid-2015.  APLNG has also suffered from cost overruns, or blowouts in analyst-speak.

In sharp contrast to rival Woodside, Origin gets four bullish recommendations from Australia’s seven major broking houses.  Yet the share price movements of the two companies over the past five years are virtually mirror images of each other.  Here is the chart:

Origin’s recently released Half Year results showed modest increases but the company disappointed investors with its lack of guidance for 2014.  However, according to Origin management the APLNG is now on track, although an analyst at Deutsche Bank noted any lift from the APLNG would not come into play until FY 2016.

Santos Limited (STO) is in an LNG partnership project with Malaysia’s Petronas, France’s Total, and South Korea’s Kogas, with Santos the largest stakeholder at 30% interest.  The GLNG project (Gladstone Liquefied Natural Gas) is now reportedly 75% complete with first shipments to take place sometime next year.  Shareholders of Santos also suffered the pain of declining share prices in the wake of cost overruns and construction delays on this project as well.

The company’s Full Year 2013 results released on 21 February missed the mark, with a 17% decline in underlying net profit.  Despite management’s claim that GLNG is on track, analysts at UBS, Credit Suisse, and Macquarie caution that more cost overruns may be in the offing.  The stock price fell on the news.  Here is a one month price movement chart:

With its seductively low five year estimated P/EG of 0.54 and hefty two year earnings growth forecast of more than 90%, one would expect analysts to be largely bullish on Oil Search Limited (OSH).  Thomson/First Call reports 15 analysts covering the stock with only one Underperform and one Hold, while ten analysts rate OSH as a Buy and 3 as a Strong Buy.  While it trades on the ASX, Oil Search is based in Papua New Guinea where it is in the business of exploration and development of oil and gas.  The company’s entry into the LNG wars is the Papua New Guinea LNG (PNGLNG) project where it holds a 29% interest, along with majority holder and operator Exxon Mobil, Santos, Nippon Oil, and others.  This project is reportedly 95% complete and scheduled to begin shipping in the third quarter of this year.  The company recently acquired an interest in a joint venture that controls the Elk/Antelope resource, the largest undeveloped gas resource in Papua New Guinea.

The share price for Oil Search is up 700% over ten years, rewarding its long term shareholders with an average annual rate of total shareholder return of 24.3%.  Here is the chart:

More cautious investors might be attracted to the healthy dividend yields from Woodside and Origin Energy while investors interested in growth potential could consider Santos and Oil Search; but what of the junior upstart, Liquefied Natural Gas Limited (LNG)?

This company trades in the over the counter (OTC) market in the US under the ticker symbol LNGLY with average volume around 1400 shares.   There is another stock in the world with the code, or ticker symbol, LNG.  This one trades on the New York Stock Exchange (NYSE) and represents a company called Cheniere Energy.  Based in Houston, Cheniere built LNG import terminals at a place called Sabine Pass in Louisiana back when it was certain the US would begin to run short on natural gas supplies.  Certainty can be an elusive commodity and as hydraulic fracturing unleashed a flood of natural gas in the US Cheniere’s facility, completed in 2008, sat idle.  In a move that now seems obvious; the company began the conversion process from an import terminal to an export terminal and was the first to get US Department of Energy (DOE) approval back in May of 2011.   More approvals and permits would be needed, especially for exporting to non FTA countries, i.e., countries with which the US does not have a Free Trade Agreement.  But investors took notice and the share price began to rise.   It wasn’t long before the bears roared out of their dens in droves pointing to the high costs and competition and a host of other doom and gloom issues surrounding the future of LNG exports in the US.  Some investors lost heart and ignored the stock as it reached a low of around $9 in May 2011.  One year later the stock was up to around $18 but, solidly in the teeth of market bears, the share price retreated, dropping to around $14.00 by November 2012.  Some took the risk, and today the US LNG ticker symbol trades around $50.  The following chart tells the tale:

 

The share price performance of the four ASX listed Oil & Gas producers in the LNG sector has been less than spectacular.  There is an exception to be found in a junior O & G exploration and development company, Liquefied Natural Gas (LNG), whose share price is up 65% year over year.  However, the company has had its struggles in the past.  Here is a five year price performance chart for LNG:

In 2009 LNG was exciting investors with progress on its Fisherman’s Landing LNG project in Gladstone, including signed agreements with purchaser Golar LNG and natural gas supplier Arrow Energy.  The share price began to collapse as LNG tried to sell the entire project to Arrow; a deal that failed to materialise.   LNG management pushed ahead with development, convinced its business model of linking suppliers of natural gas with LNG exporters coupled with its patented processing technology could be successful.  LNG has developed a technology – OSMR (Optimized Single Mix Refrigerant) – which cuts LNG plant processing costs in half with a 30% increase in efficiency.  As of this date LNG maintains its 100% ownership of Gladstone Fisherman’s Landing, but the company now describes the project as in “care and maintenance” status with negotiations for securing a gas supply in progress.

Investor interest in LNG was rekindled in December 2012 when the company announced it had set its sights on the US LNG market, through a wholly owned subsidiary, Magnolia LNG LLC.  Since then the share price has risen and fallen with news on the progress of the new Magnolia LNG project, located in the US state of Louisiana at Lake Charles.  So far, the news has been good, with the securing of a financing partner and a series of successful capital raises to fund development of the project in the proposal stages.   In addition there have been a string of key strategic agreements including one with Kinder Morgan Pipeline Partners for its Louisiana pipeline.  Magnolia expects final permitting in mid-2015, with construction to commence thereafter and production start-up by mid-2018.  Project potential is for eight million tonnes of gas per annum.

With a footprint in both the US and Australia, LNG is generating market interest and multiple news reports of late.  The stock is hot and heats up with more positive news.  The latest was the signing of an agreement with Latin American energy provider AES Development Group for production capacity rights.  Supplying Latin American countries allows LNG to avoid the potential pitfall of the size limitations of the Panama Canal for large LNG transport carriers and further delays in expansion plans for the Canal.  The announcement of the AES agreement propelled the share price from around $0.30 to an intraday high of $0.58 before falling back down to earth.

Despite its promise, cautious investors realise the 2018 production start-up target is a veritable eternity away.  Why invest in a speculative, high risk junior with no diversification in other energy assets when the performance of the major players has been tepid at best?  Here are some performance indicators for the ASX Oil & Gas Producers with LNG exposure:

Company(CODE) Share Price 52 Week % Change Forward P/E(FY2015) 5 Year Expected P/EG 2 Year Earnings Growth Forecast Dividend Yield 5 Year Total Shareholder Return
Woodside Petroleum (WPL) $31.86 +6% 14.43 2.56 4.4% 5.5% 4.1%
Origin Energy (ORG) $14.39 +12% 17.99 1.7 9% 3.5% 3.6%
Santos Ltd(STO) $13.64 +5% 13.9 1.28 38.7% 2.2% -1.7%
Oil Search Ltd(OSH) $8.61 +12% 14.84 0.54 91.9% 0.51% 11.3%

 

Woodside Petroleum (WPL) is the only ASX stock with an LNG facility in production.  The Pluto LNG project began shipping in mid-2012 following multiple cost overruns and production delays.  However, the exuberance of bearish investors was not long-lasting as once Pluto went into operation Woodside started upgrading its production forecasts for Pluto within a matter of months.  Woodside is also involved as operator in another Australian LNG production facility in the Northwest Shelf (NWS).  Despite its experience with the NWS and the revenue generation from Pluto, sceptical investors and analysts are looking instead to the company’s latest LNG “problem child”, the Browse LNG project.  Woodside has rejected a land-based processing facility in favour of the industry’s latest advancement, a floating liquefied natural gas processing facility (FLNG).  In addition, the company is considering an FLNG for its newly acquired stake in the Leviathan gas field off the shores of Israel.

Woodside is now seen by some as a mature dividend payer with limited growth opportunity.  The 2013 Full Year results were somewhat disappointing, but fell within most analyst estimates.  Of Australia’s major broking houses, only JP Morgan has an Overweight recommendation on WPL, although the Full Year results led to a decrease in the price target from $40.26 to $39.47.  With the Browse project nowhere near completion, the Leviathan project in start-up stages, and no news on the company’s Sunrise gas project, analysts wonder about the growth prospects for Woodside.

Origin Energy Limited (ORG) is a diversified energy company covering electricity generation, retail and wholesale sale of electricity and gas, as well as exploration and production of oil and gas.  The company has a minority interest (37.5%) in the Australia Pacific LNG project (APLNG) along with Conoco Philips with the same interest and Sinopec with 25% interest.  The project will supply an LNG processing facility under construction near Gladstone.  The pipeline is nearing completion and production is expected to begin in mid-2015.  APLNG has also suffered from cost overruns, or blowouts in analyst-speak.

In sharp contrast to rival Woodside, Origin gets four bullish recommendations from Australia’s seven major broking houses.  Yet the share price movements of the two companies over the past five years are virtually mirror images of each other.  Here is the chart:

Origin’s recently released Half Year results showed modest increases but the company disappointed investors with its lack of guidance for 2014.  However, according to Origin management the APLNG is now on track, although an analyst at Deutsche Bank noted any lift from the APLNG would not come into play until FY 2016.

Santos Limited (STO) is in an LNG partnership project with Malaysia’s Petronas, France’s Total, and South Korea’s Kogas, with Santos the largest stakeholder at 30% interest.  The GLNG project (Gladstone Liquefied Natural Gas) is now reportedly 75% complete with first shipments to take place sometime next year.  Shareholders of Santos also suffered the pain of declining share prices in the wake of cost overruns and construction delays on this project as well.

The company’s Full Year 2013 results released on 21 February missed the mark, with a 17% decline in underlying net profit.  Despite management’s claim that GLNG is on track, analysts at UBS, Credit Suisse, and Macquarie caution that more cost overruns may be in the offing.  The stock price fell on the news.  Here is a one month price movement chart:

With its seductively low five year estimated P/EG of 0.54 and hefty two year earnings growth forecast of more than 90%, one would expect analysts to be largely bullish on Oil Search Limited (OSH).  Thomson/First Call reports 15 analysts covering the stock with only one Underperform and one Hold, while ten analysts rate OSH as a Buy and 3 as a Strong Buy.  While it trades on the ASX, Oil Search is based in Papua New Guinea where it is in the business of exploration and development of oil and gas.  The company’s entry into the LNG wars is the Papua New Guinea LNG (PNGLNG) project where it holds a 29% interest, along with majority holder and operator Exxon Mobil, Santos, Nippon Oil, and others.  This project is reportedly 95% complete and scheduled to begin shipping in the third quarter of this year.  The company recently acquired an interest in a joint venture that controls the Elk/Antelope resource, the largest undeveloped gas resource in Papua New Guinea.

The share price for Oil Search is up 700% over ten years, rewarding its long term shareholders with an average annual rate of total shareholder return of 24.3%.  Here is the chart:

More cautious investors might be attracted to the healthy dividend yields from Woodside and Origin Energy while investors interested in growth potential could consider Santos and Oil Search; but what of the junior upstart, Liquefied Natural Gas Limited (LNG)?

This company trades in the over the counter (OTC) market in the US under the ticker symbol LNGLY with average volume around 1400 shares.   There is another stock in the world with the code, or ticker symbol, LNG.  This one trades on the New York Stock Exchange (NYSE) and represents a company called Cheniere Energy.  Based in Houston, Cheniere built LNG import terminals at a place called Sabine Pass in Louisiana back when it was certain the US would begin to run short on natural gas supplies.  Certainty can be an elusive commodity and as hydraulic fracturing unleashed a flood of natural gas in the US Cheniere’s facility, completed in 2008, sat idle.  In a move that now seems obvious; the company began the conversion process from an import terminal to an export terminal and was the first to get US Department of Energy (DOE) approval back in May of 2011.   More approvals and permits would be needed, especially for exporting to non FTA countries, i.e., countries with which the US does not have a Free Trade Agreement.  But investors took notice and the share price began to rise.   It wasn’t long before the bears roared out of their dens in droves pointing to the high costs and competition and a host of other doom and gloom issues surrounding the future of LNG exports in the US.  Some investors lost heart and ignored the stock as it reached a low of around $9 in May 2011.  One year later the stock was up to around $18 but, solidly in the teeth of market bears, the share price retreated, dropping to around $14.00 by November 2012.  Some took the risk, and today the US LNG ticker symbol trades around $50.  The following chart tells the tale:

 

Santos (ASX: STO) and AGL (ASX: AGK) have large economies of scale that can help keep their production costs lower, and have the investing power to afford major projects. Santos has just signed an agreement with Origin Energy (ASX: ORG) to share pipeline infrastructure, and deliver gas to the Curtis Island processing and export terminal, eliminating the need and cost of extra pipeline.

Queensland Gas Company, part of the BG Group, is nearing the completion of its $20.4 billion Curtis Island project where coal seam gas delivered to the site from the various pipelines running from South Australia and QLD will be converted into LNG for export.

In the Cooper Basin region, Beach Energy (ASX: BPT) produces the majority of its oil and gas there, and is actively expanding unconventional gas. Drillsearch (ASX: DLS), a $507 million gas and oil producer has been strongly increasing production there also, resulting in an earnings jump up from $9.9 million to $54.3 million in 2013.

 

Major Oil and Gas Companies in Australia

Many of the world’s largest oil & gas exploration and production companies have representation in Australia. Click on the links below to learn more about their exploration and production activities.

Apache Corporation

Apache Corporation is an independent energy company that explores for, develops and produces natural gas, crude oil and natural gas liquids. Apache is the second-largest operated volume producer of oil and gas in the Carnarvon Basin. It operates 16 oil and gas facilities, providing more than 30% of Western Australia’s domestic natural gas supply.

Arrow Energy
Arrow Energy is a leading coal seam gas company with five producing products, interests in three gas-fired power stations and plans to deliver a world-class liquefied natural gas export facility in Gladstone with an expected capacity of 8 million tonnes a year.

Australian Worldwide Exploration Ltd
Australian Worldwide Exploration (AWE) is an Australian-based oil and gas exploration and production company. AWE currently has oil and gas interests in Australia, New Zealand, Indonesia, Yemen, Vietnam and Argentina, and is actively reviewing additional growth opportunities.

Bass Strait Oil Company Ltd
Bass Strait Oil Company Ltd is a specialist oil explorer focused exclusively on southeast Australia. This region offers access to prospects of material scale in world-class basins, a database of modern 3D seismic data, established infrastructure and developing markets.

Beach Petroleum Ltd
Beach Petroleum is a long-established oil and gas exploration and production company based in Adelaide. Beach holds interests in more than 300 exploration and production tenements in Australia, New Zealand, Papua New Guinea, Egypt, Spain and Albania (subject to regulatory approval) and continues to seek additional domestic and international opportunities.

BHP Billiton Petroleum
BHP Billiton Petroleum is a key player in the global oil and gas industry.

Carnarvon Petroleum Ltd
Carnarvon is a Perth-based company. Its principal activity is oil and gas exploration and production and it has projects in Australia, Thailand and Indonesia.

Chevron Australia
Chevron is the largest holder of natural gas resources in Australia and these assets help meet the country’s and Asia’s growing need for energy.

ConocoPhillips Australia Pty Ltd
The third-largest integrated energy company in the US, ConocoPhillips has assets and operations in more than 30 countries and around 30,000 employees worldwide.

Cue Energy Resources Ltd
Cue Energy Resources is an oil and gas exploration and production company with a focus on South East Asia and Australasia. Cue’s petroleum assets are located in Papua New Guinea, Indonesia, New Zealand and Australia.

Eni
Eni is an integrated energy company, active in 77 countries with 78,400 employees. it operates in oil and gas exploration, production, transportation, transformation and marketing, in petrochemicals, oilfield services construction and engineering.

ExxonMobil Australia (Esso)
The ExxonMobil group of companies in Australia are subsidiaries of Exxon Mobil Corporation, the world’s leading petroleum and petrochemical company. ExxonMobil Australia has played a significant role in the development of Australia’s oil and gas resources and has a business history in this country stretching back over 110 years.

INPEX
INPEX is a worldwide oil and gas exploration and production company involved in more than 70 projects across 26 countries. Their projects in Australia and the Timor Sea include the Ichthys Project, Van Gogh, Bayu-Undan and Darwin LNG.

Magellan Petroleum Australia
Magellan Petroleum Australia engages in onshore oil and gas exploration and production in Australia and the United Kingdom.

Metgasco Limited
Metgasco is developing natural gas reserves and power supplies for the eastern Australian energy market. Metgasco has already established a large certified gas reserve position in New South Wales.

Mosaic Oil
Mosaic Oil is a successful Australian explorer and producer of oil and gas with assets in Queensland’s Surat-Bowen Basin as well as interests in New Zealand, Western Australia and southwest Queensland.

Nido Petroleum Limited
Nido Petroleum is an oil and gas exploration and production company whose business activities are focused on the offshore Palawan Basin, the Philippines. The company has headquarters in Perth.

Oil Search Limited
Oil Search is Papua New Guinea’s (PNG’s ) largest oil and gas producer.

OMV Australia Pty Ltd
The OMV Aktiengesellschaft is one of the biggest listed industrial companies in Austria and the leading energy group in the European growth belt. Australia and New Zealand is a core exploration and production (E&P) area of OMV and activities are focused on the Carnarvon and Bonaparte Basins of the North West Shelf, offshore of the western coast of Australia.

Origin Energy
Origin is a top 50 ASX listed company involved in gas and oil exploration and production, power generation and energy retailing.

QGC
QGC is a leading Australian coal seam gas explorer and producer focused on developing its world-class reserves for domestic and international supply. Much of its attention is focused on Queensland.

ROC Oil Company
ROC is one of Australia’s leading independent upstream oil and gas companies. The Sydney-based company has a strong operating emphasis, an international focus and a global workforce of 160 employees. Although ROC’s assets are spread across four geographic regions (Australia, China, Africa and UK), the company is predominantly focused on Asia and Australia.

Santos Limited
Santos is one of Australia’s leading oil and gas exploration and production companies, with high quality assets and projects throughout Australia and the Asia-Pacific region.

Senex Energy Limited
Senex is a Perth-based company with two core areas of activity: oil exploration and production in the Cooper Basin and coal seam gas appraisal development in the Surat Basin in southern Queensland.

Shell in Australia
Shell is a global group of energy and petrochemicals companies which employs around 2500 people in Australia. Shell has had a presence in Australia since 1901. Their business in Australia is broadly divided into “upstream” and “downstream”. The upstream business is based in Perth and finds, develops and supplies liquefied natural gas (LNG), condensates and liquefied petroleum gas (LPG) to overseas markets and natural gas to domestic customers in Western Australia. Shell Australia’s downstream operations are their refining and marketing businesses.

Strike Energy
Strike Energy is an oil and gas exploration and development company with high-margin production and active in some of the world’s most productive basins including Australia and the USA.

Stuart Petroleum Limited
Stuart Petroleum has headquarters in Adelaide. Since its inception as an oil and gas explorer Stuart Petroleum has drilled 34 exploration wells and 14 development wells.

Tap Oil Limited
Tap Oil Limited is an independent oil and gas exploration and production company with interests in Australia and South East Asia. Tap has headquarters in Perth.

Total in Australia
Total is a leading multinational energy company with 96,387 employees and operations in more than 130 countries. Total has owned acreage in Australia since 2005 and has interests in 10 offshore licences – four of which it operates – in Browse, Vulcan and Bonaparte Basins in the northwest.

Tri-Star Petroleum
Tri-Star is an oil and gas exploration and development company with oil and gas interests in the USA and Australia. Since 1989, the company has concentrated on the development of coal seam methane gas from the widespread, deep coal seams in the Bowen Basin area of central Queensland.

Woodside Energy Limited

Gas exploration and production company and one of the world’s largest leading producers of liquefied natural gas (LNG).

 

Avoid tax shocks by using reporting funds

Everybody hates taxes, especially the obscure, stealthy kind that you didn’t even know you were liable for. Enter off-shore funds1 – including many ETFs and index funds – that are subject to a weird and not-so-wonderful tax regime that could land you with a nasty tax bill.

The headline is that if you own an off-shore fund that isn’t either:

  1. A reporting fund, or
  2. A distributing fund

Then any capital gain you make on that fund is taxed as income rather than capital gains, when you sell.

That’s grisly for three reasons:

  1. Income tax is much higher for most people than capital gains tax (CGT).
  2. You can’t escape the tax using your tax-free £10,100 CGT annual allowance.
  3. Nor can you use capital losses elsewhere to offset the gain.

CGT is liable at 18% or 28%, whereas income tax bites in much more painful 20%, 40% or 50% chunks.

The upshot is that if you’re paying capital gains at income tax rates then you could be in for a tax bombshell that completely destroys the point of investing in low cost funds.

How do I avoid paying income tax on capital gains?

First, check:

  • Where your fund is domiciled. If home base is anywhere other than the UK then it’s an off-shore fund. This will also determine whether you need to take action against withholding tax. You’ll generally find domicile information in the fund factsheet, or in the fund ‘Management’ section of Morningstar.
  • Make sure the fund is classified either as a distributor fund or reporting fund. If it is, then there’s nothing to worry about.
  • If the funds are non-reporting / non-distributing but are safely tucked up in an ISA or pension then you can breathe a sigh of relief. Your assets are off the tax radar as far as Her Majesty’s Revenue & Customs (HMRC) is concerned.

Non-reporting offshore funds will be liable for income tax on capital gains

If you’ve bought funds listed abroad, then you probably do own non-reporting or non-distributing funds.

Funds must apply to HMRC for reporting / distributing fund status. But vehicles intended for the US or other foreign investor markets are unlikely to have qualified. Why would they bother with the administrative costs if the funds aren’t aimed at UK investors?

You will be liable for income tax on capital gains in such cases – although only when you sell, and if they’re not tax sheltered.

Where does my fund hide its status?

The key info might be buried anywhere, depending on the product provider’s whim.

  • The first place to look is on the fund’s factsheet or individual web page.
  • Others bury reporting / distributor status in the prospectus or some other fund supplement. Even then it’s not always clear the fund qualifies, as opposed to just having sent the forms to HMRC.

Scroll down to the Distributing Funds and Reporting Funds sections. You’ll need to download the relevant spreadsheets, then search by company name or the fund’s ISIN number using Excel’s Find function.

Beware the order isn’t always strictly alphabetical and the lists aren’t necessarily up-to-the-minute. That’s government cuts for you!

If you’re not sure about your fund’s status then contact the product provider and ask.

Can reporting / distributor status be revoked?

It’s entirely possible for a fund to lose its reporting status, though not as likely as it used to be when distributor status was the only option. As HMRC say, in their highly entertaining 209-page manual:

A fund, once granted reporting fund status, may rely on that status going forward subject to continued compliance with the reporting funds rules, which include making reports as described above for each period of account. A fund may exit the reporting funds regime on giving notice and there are rules that permit HMRC to exclude a fund from the regime for serious breaches or a number of minor breaches, subject to an appeals process.

So it could happen, but it would be suicidal for any index tracker to fall foul of the rules, which were designed to increase the attractiveness of the UK investment market, after all.

It’s also worth noting that reporting fund status is replacing the older distributor fund designation. Currently we’re in a strange either/or transitional phase. Distributor status should have been entirely swept away by mid-2012.

For our purposes, it doesn’t matter whether a fund has reporting or distributor status, as long as it has one of them.

Ignorance is no excuse

If you’ve inaccurately filed your tax return, blissfully unaware of the implications of the offshore tax regime, then HMRC are going to want any outstanding tax back with interest. And it could tag on an inaccuracy penalty, too, if it judges you filled in your form without due care and attention.

As a passive investor, my solution is simple. Avoid non-reporting funds like ebola-carrying monkeys, unless you can hide them away in an ISA or pension.

Take it steady,

The Accumulator