Today's oil price

$91.86 per barrel

Daily change of 10/12/12 ( 91.16% )

Oil Quote Updated Oct-13-12 1:30 PM

Oil Prices Set to Fall Through 2017

Oil prices are expected to fall over the next five years as demand slumps and a ramp-up in production helps boost supplies, the International Energy Agency (IEA) said Friday.
The group, which represents the world’s 28 richest countries, said the combination will help “redefine the refining industry and transform global oil trade,” though it noted geopolitical risks will continue to loom over the oil supply chain.
The Paris-based IEA sees global oil product capacity growing to 101 million barrels of oil a day by 2017, above its earlier forecast of 95.7 million barrels.
Global demand is forecast to grow at an annual average of 1.1 million barrels a day over the next five years, compared with the IEA's earlier projection of 1.2 million barrels.
More of the growth in oil supply is expected to come from the Americas, buoyed by new drilling technologies in U.S. and Canadian oil sands. Growing output from reserves like the Bakken and Eagle Ford shales has helped propel U.S. domestic oil production to the highest level since 1995.
Looking to capitalize on the jump in production, oil major BP recently secured a license to ship U.S. crude oil to Canada and Royal Dutch Shell is reportedly applying for U.S. export licenses.
Oil production in Middle Eastern countries like Iraq is expected to continue ramping up despite diminishing appetite in North America, and that could help feed growing regional demand there.
“Iraq stands out as its production capacity is expected to enter a new growth phase, which may continue even beyond the forecast period,” the IEA said.
However, in other areas, such as Libya, security concerns may continue to constrain production growth over the next few years.
While some Western companies like BP (BP) have announced plans to return or ramp up production in Libya since the killing of long-time dictator Moammar Qaddafi a year ago,

the killing of a     U.S. envoy there last month resurrected safety fears.
The IEA, though, said it expects new supply sources to more than offset any decline in rates or outages elsewhere in the world, as well as the tough international sanctions on Iran.
At the same time, the spreading of refining capacity to emerging regions like Asia is expected to help offset decreases in other areas of the world.
Internationally traded crude volumes are projected to decline sharply, but the IEA said product trade is forecast to growth in both volume and scope.
Sweet crude oil was down about 0.50% Friday afternoon to $91.52 and is down about 6.84% from the start of year. It’s still up about 9.3% from 12 months ago.

Today's oil price

$91.36 per barrel

Daily change of 0.11 ( 0.12% )

Oil Quote Updated Oct-10-12 4:00 PM

Hotel REITs: Particularly Sensitive To Economic Concerns

Hotel REITs are a deeply cyclical sector. In economic upswings, profits are great, but in downswings, occupancy, room rates, and RevPar all suffer greatly. This sensitivity is a result of the industry's short "lease" structure. Unlike retail, commercial or residential where leases span years, hotel leases are counted in days and therefore, must be constantly "renewed."

The positive effect of short leases is that hotels are an excellent inflation hedge. Average daily rate (ADR) can easily be adjusted and is highly correlated with inflation. In fact, over the past 20 years, annual nominal ADR growth rate has been around 3.5%, while annual CPI was roughly 3.1% (Source: 2010 Smith Travel Research, Inc., U.S. Bureau of Labor Statistics).

The negative effect is that if the economy goes south, visitors do not renew, and that makes hotel stock prices particularly sensitive to economic concerns. Therefore, when doom and gloom are predicted, hotels have often been an effective way to short the economy. An example of this occurring is the third quarter of 2011.

Leading into the second half of 2011, hotels were poised to continue a strong recovery. June 2011's RevPar at $68.90 was the highest since August 2008, driven by a 3.5% increase in ADR and a 4.2% increase in occupancy from June. This healthy growth was occurring despite an anemic first half year GDP growth of less than 1%.

But concerns about the economy tipped the market into a significant retraction, with the S&P 500 sliding 17.95% between July 1 and October 3, 2011. The bad news in July and August 2011 was wide ranging -- from the debt ceiling crisis, to the U.S. credit rating downgrade, to the increasing likelihood of countries like Italy joining the ranks of Greece and Portugal. Stocks were hit hard, REITs were hit even harder, sliding 21.23%, and hotels were hit almost twice as hard, falling 38.12%.

Hotel REITs are hit extra hard in times of economic concern because of the immediate affects a slow economy can have on this sector. Here's a sample of what REIT professionals were saying in 2011 about the dive:

"What's happened is that during the late summer [of 2011] when we had so much turbulence in the equity markets and in the financial markets in general, primarily because of what was happening in Europe, but also what was happening with the U.S. congress, there was a great deal of concern about where the economy was headed and a lot of that spilled over into lodging because everyone knows how sensitive we are to how the overall economy performs."

- Ed Walter, President and CEO of Host Hotels and Resorts

"There's been a huge disconnect between Wall Street and Main Street when it comes to hotel REITs,"

- Ken Cruse, President of Sunstone Hotel Investors

Commenting on how he did not think the drop in hotel stock prices had much to with hotel fundamentals, "It was just overall global markets, the impact of the European recession, and there was a broader pullback in the market," [Jay Shah] says. "I think hotels and real estate stocks took it may be worse than others because they are financials and highly volatile."

- Jay Shah, CEO of Hersha Hospitality Trust

The hotel's sector sensitivity to economic news has, in turn, made hotels more volatile. In the first half of 2012, the highs are higher, and lows are lower:

Hotels could not recover in 2011 after the extra severe slide in July and August:

This volatility has contributed to Hotel REITs either being a big leader or big loser over the past six years:

While the hotel sector has led the nosedive in dividends over the past four years:

Outlook

Fundamentals for hotels look great. Through August 2012 RevPAR is projected to grow by 7.2% for the year. The lack of near-term supply should help the industry continue to raise rates, with ADR predicted to grow by 4.6%, while hotel demand is surpassing its pre-recession peak. Construction of new hotels has historically grown at an average of approximately 2% per year, but growth has been less than 1% over each of the past two years, and that rate is expected to continue.

But as we saw in the third quarter of 2011, rosy fundamentals will only support hotel stocks to a point, so I may shift my "hold" to a "sell" in this sector within the next 60 days if we begin to see new cracks in the economy or the beginning of a market correction. I believe we are entering a particularly high risk three- to four-month period. Some of my concerns are: (1) a S&P 500 negative third quarter earnings season after 11 consecutive quarters of gains; (2) an unemployment surge after the recent, possibly too good to be true, drop to 7.8% -- the largest move since 1983; (3) an unresolved fiscal cliff; (4) a return of European debt crisis headlines; and (5) a post-election market slide. These are concerns that all market participants must be cognizant of -- and deserved or not -- that often have an amplified effect on hotel REIT stocks.

Preferred Alternative

An alternative to owning hotel REITs outright is to purchase preferreds. Preferreds have historically yielded between 6.3 and 9%, but most rates have recently dropped to a 5.6 to 6.5% range as investors' appetites for REITs grow.

There are solid hotel REITs with preferreds that have significantly higher yields. I like Chesapeake Lodging Trust's new preferred (CHSP-PA), with a coupon rate of 7.75%. CHSP is profitable with a healthy cash flow -- the most important factor to consider when purchasing preferreds. The trust's holdings consist of 14 upper-upscale hotels (a sector less prone to market swings). Additionally, the trust has a promising outlook, and has recently experienced significant insider buying.

Fed chose mortgage bonds to bolster housing gains

The Federal Reserve structured its latest stimulus program around the purchase of mortgage bonds after members agreed that helping a nascent housing recovery was a good way to lift the broader economy.
Minutes of the Fed's Sept. 12-13 meeting released Thursday also show that most members now agree that tying a future increase in short-term interest rates to economic measures, such as a specific unemployment rate, could be effective. But members agreed to hold off on the change to work out the details.
After the meeting the Fed said it would keep buying mortgage bonds until the job market showed substantial improvement. The Fed also extended its plan to keep its benchmark short-term interest rate near zero until mid-2015 and left open the possibility of taking other steps.
The Fed has already purchased more than $2 trillion in bonds since the 2008 financial crisis. The latest program seeks to spend $40 billion a month to buy mortgage bonds without an end date set.
Many participants agreed at the meeting that more bond purchases would provide support to the economy by putting downward pressure on longer-term interest rates. That encourages more borrowing and spending, which drives growth.
According to the minutes, Fed members compared the effectiveness of buying Treasury bonds to that of mortgage-backed securities.
"Some participants suggested that, all else being equal, (mortgage bond) purchases could be preferable because they would more directly support the housing sector, which remains weak but has shown some signs of improvement of late," according to the minutes.
A few members expressed skepticism that additional bond purchases would help. And they raised concerns that more bond buying could increase the risk of higher inflation at a later time.
Mortgage rates have been below 4 percent all year. While home sales are rising, they remain well below healthy levels.
On Monday, Chairman Ben Bernanke defended the aggressive policies during a speech to the Economic Club of Indiana. The Fed needs to drive down long-term borrowing rates because the economy isn't growing fast enough to reduce high unemployment, Bernanke said.
He also sought to reassure investors about the Fed's timetable for keeping its short-term rate ultra-low. The plan doesn't mean the Fed expects the economy to be weak through 2015, he said, noting that policymakers plan to keep rates low well after the economy strengthens.

Dollar and precious metals at a glance

Key currency exchange rates Monday, compared with late Friday in New York:
Dollar vs: Exchange Rate Pvs Day
Yen 78.34 78.69
Euro $1.2967 $1.3025
Pound $1.6036 $1.6140
Swiss franc 0.9330 0.9300
Canadian dollar 0.9766 0.9790
Mexican peso 12.8115 12.7968
Metal Price (troy oz.) Pvs Day
NY Merc Gold $1773.50 $1778.60
NY HSBC Bank US $1775.00 $1775.00
NY Merc Silver $33.982 $35.516

Today's oil price

$89.46 per barrel

Daily change of 0.42 ( 0.47% )

Oil Quote Updated Oct-08-12 12:00 AM