Wednesday, January 14, 2015

Dollar’s Updraft Taxes CFOs

An unexpected surge by the U.S. dollar is causing headaches for finance chiefs.
Not only did the currency’s strength weigh on year-end earnings, but it is clouding this year’s outlook, complicating corporate borrowing and pension accounting. It is even shaking CFOs’ belief the Federal Reserve will raise interest rates in 2015.
As the dollar rises, it lowers the value of revenue companies take in overseas and makes U.S. exports costlier and less competitive. Both factors can have a big impact on corporate results. The S&P 500 companies, for example, rely on foreign markets for over 45% of their sales.
In last year’s third quarter, North American and European companies recorded $8 billion in currency losses, according to FiREapps, which advises companies on managing currency risk.
Since then, the dollar has continued to rise. The WSJ Dollar Index has climbed more than 7.5%, hitting a roughly 11½-year high this month. The index tracks the dollar against a basket of 16 currencies, including the euro, the Japanese yen and the British pound.
The dollar’s surge has been driven by expectations that the Fed will raise U.S. short-term interest in the coming months, as well as a flight to safety as economies in Europe and Asia falter.
To protect against currency fluctuations, many companies hedge their bets with contracts that lock-in exchange rates. Some of their foreign units also make their goods or buy supplies abroad to avoid importing parts from the U.S. The stronger dollar makes those imports costlier. 
But those strategies offer only limited protection.
On Jan. 20 International Business Machines Corp. will report a blow to year-end earnings because its hedges didn’t provide enough cover, said finance chief Martin Schroeter during a conference call with analysts on Oct. 20. In addition, IBM’s management has thrown out its forecast for the year. 
IBM had said it would chalk up adjusted profit of $20 a share in 2015, but it plans to lower its projection this month. “We have some real macro headwinds in the form of a strong dollar,” Mr. Schroeter said.
Oracle Corp. last month told investors that its revenue would have risen 7% in the quarter ended Nov. 30 had the dollar’s value been stable. Instead, the software company reported half that growth.
Oracle co-CEO Safra Catz said the currency effect was double what she expected three months earlier. She added that the strengthening dollar would reduce Oracle’s profits in the current quarter by about four cents a share, and that the currency’s “unusually high volatility” made even that figure iffy.
The rapidly declining value of the ruble, meanwhile, has made it difficult for Apple Inc. to set prices in Russia, prompting the gadget giant to halt online sales of its products there. Currency fluctuations also led Apple to raise its prices for app downloads in Canada, the European Union and Russia, a step it has rarely taken. General Motors Co. stopped delivering vehicles to its Russian dealers. 
Apple CFO Luca Maestri warned investors in October that the rising dollar was “becoming a significant headwind” in the fiscal first quarter ended in December. The company is slated to report quarterly earnings on Jan. 27.The dollar’s movement is making it riskier for American companies to borrow money in foreign markets.
Verizon Communications Inc. sold $5.4 billion of bonds in Europe last year, but the telecom company would think twice about doing something like that again soon, said CFO Fran Shammo.
That’s because Verizon swaps the foreign debt into dollars via contracts with banks, which take on the risk of exchange-rate changes. But, if the dollar value of that foreign debt falls too far, the company might have to put up cash as collateral under the terms of those contracts.
“That’s real cash,” said Mr. Shammo. “So we have to manage the risk and not just raise as much as we want outside the U.S.”
Of course, the strong dollar can be a boon for some businesses. Networking-gear maker Ciena Corp. , for example, saved $15.4 million on research and development costs in Canada last year because of the weaker Canadian dollar.
Demand for the dollar also has helped drive down U.S. interest rates. Worried about Europe’s economy and emerging markets, investors have snapped up dollars to buy U.S. Treasury notes. That’s pushed yields on the 10-year Treasury note below 2%, which has seldom occurred since the summer of 2013.
Corporate-bond yields fell to an average of 3.02% last week, down from 3.27% this time last year, according to Barclays PLC.
Although falling yields make it cheaper for companies to borrow, they are playing havoc with corporate pension plans.
Declining interest rates more than doubled pension deficits to $343 billion at the 40% of the Fortune 1000 companies that have defined-benefit pension plans and December year-ends, according to consulting firm Towers Watson.
“We might have a growing gap in pension funding,” if rates drop, said Carol Roberts, CFO of International Paper Co. The paper and packaging company’s pension plan had a $2.2 billion funding deficit at the end of 2013.
International Paper also been taking accounting losses from a Russian joint venture, which reports finances in rubles that must reflect current exchange rates. It recorded a $70 million accounting loss during the third quarter.
“In the world we live in today,” Ms. Roberts said, “we just expect volatility.”
Corrections & Amplifications
IBM Chief Financial Officer Martin Schroeter said during an Oct. 20 conference call with analysts that the company’s earnings would take a hit from the stronger dollar. An earlier version of this article failed to note when Mr. Schroeter spoke. 
—Maxwell Murphy and Shira Ovide contributed to this article.

Sunday, January 11, 2015

How Crude Oil’s Global Collapse Unfolded

So much for the notion of peak oil, which was popular a few years ago. Aivars Lode
By Russell Gold
Since the 1970s, Nigeria has sent a steady stream of high-quality crude oil to North American refineries. As recently as 2010, tankers delivered a million barrels a day.
Then came the U.S. energy boom. By July of this year, oil imports from Nigeria had fallen to zero.
Displaced by surging U.S. oil production, millions of barrels of Nigerian crude now head to India, Indonesia and China. But Middle Eastern nations are trying to entice the same buyers. This has set up a battle for market share that could reshape the Organization of the Petroleum Exporting Countries and fundamentally change the global market for oil.
On Friday, crude prices dropped to their lowest level in five years after the International Energy Agency cut its forecast for global oil demand for the fifth time in six months. That signaled to investors that the world economy would struggle in the coming year, sending the Dow Jones Industrial Average tumbling by 315.51 points, or 1.8%, to 17280.83. That’s the Dow’s biggest weekly percentage loss in three years.
Since June, the IEA has cut its demand forecast for 2015 by 800,000 barrels, while it says U.S. oil output will rise next year by 1.3 million barrels a day.
The drop in global oil prices from over $110 a barrel to under $62 on Friday has been portrayed as a showdown between Saudi Arabia and the U.S., two of the world’s biggest oil producers. But the reality is more complex, involving Libyan rebels and Indonesian cabdrivers as well as Texas roughnecks and Middle Eastern oil ministers. It reflects both the surging supply of crude and the crumbling demand for oil.
And the oil-price plunge may not end soon. Bank of America Merrill Lynch says U.S. oil prices could drop to $50 in 2015.
The roots of the price collapse go back to 2008 near Cotulla, Texas, a tiny town between San Antonio and the Mexican border. This was where the first well was drilled into the Eagle Ford Shale. At the time, the U.S. pumped about 4.7 million barrels a day of crude oil.
In 2009 and 2010, the global economy improved, demand for oil increased and crude prices rose, creating a large incentive to find new supplies. In Cotulla and elsewhere, U.S. drillers answered the call. “There was, for lack of a better term, an arms race for oil, and we found a ton of oil,” says Dean Hazelcorn, an oil trader at Coquest in Dallas.
Today, two hundred drilling rigs blanket South Texas, steering metal bits deep underground into the rock. Once drilled and hydraulically fractured, these wells yield large volumes ofhigh-quality oil; at the moment, the U.S. is producing 8.9 million barrels a day, thanks to the Eagle Ford and other new oil fields.
Americans aren’t pumping more gasoline or otherwise using up all that new crude, and under U.S. laws dating back to the 1970s, it has been almost impossible to export.
As a result, American refineries snapped up inexpensive crude from Texas and North Dakota, using it to replace oil from Nigeria, Algeria, Angola and Brazil, and almost every other oil-producing nation except Canada.
OPEC sent the U.S. 180.6 million barrels in August 2008, a month before the first Eagle Ford well; in September 2014, it shipped about half that, 87 million barrels. That is about 100 fewer tankers of crude arriving in U.S. ports. They went elsewhere.
For a long time, it seemed like the world’s growing appetite for oil would soak up all the displaced crude. By 2011 prices began to hover between $90 and $100 a barrel and mostly stayed in that range.
But earlier this year, another trend began to come into focus, catching Wall Street energy analysts and other market watchers by surprise. In March, many analysts predicted global demand for crude oil would grow by 1.4 million barrels a day in 2014, to 92.7 million barrels a day. 
That prediction proved wildly optimistic.
Vikas Dwivedi, energy strategist with Macquarie Research, says a widespread deceleration of global economic growth sapped some demand. At the same time, several Asian currencies weakened against the U.S. dollar.
The cost of filling up a gas tank in Indonesia, Thailand, India and Malaysia rose, just as these countries were phasing out fuel subsidies. In Jakarta and Mumbai, drivers cut back.
“The fact that supply growth was strong shouldn’t have taken anybody by surprise,” Mr. Dwivedi says. But demand for oil “just fell off a cliff. And bear markets are fed by negative surprises.”
Rising supply and falling demand both put downward pressure on prices. Throughout the summer, however, fears of violence in Iraq kept oil prices high as traders worried Islamic State fighters could cut the countrys oil output.
Then two events tipped the market. In late June, The Wall Street Journal reported the U.S. government had given permission for the first exports of U.S. oil in a generation. While the ruling was limited in scope, the market saw it as the first crack in a long-standing ban on crude exports. Not only was the U.S. importing fewer barrels of oil, it could soon begin exporting some, too. This news jolted oil markets; prices began to edge down from their summer peaks.
On July 1, Libyan rebels agreed to open Es Sider and Ras Lanuf, two key oil-export terminals that had been closed for a year. Libyan oil sailed across the Mediterranean Sea into Europe. Already displaced from the U.S. Gulf Coast and eastern Canada, Nigerian oil was soon replaced in Europe, too. Increasingly, shipments of Nigerian crude headed toward China.
Oil prices began to decline. By the end of July, a barrel of U.S. crude fell below $100. In early September, the IEA, a Paris-based energy watchdog, noted there had been a “pronounced slowdown in demand growth.” A month later, oil prices fell below $90 a barrel.
By the middle of September, Petroleum Intelligence Weekly, a widely read industry newsletter, said both sides of the Atlantic Ocean were “awash in oil.” Nigeria, it declared, “needs to find new customers for its light, sweet crude streams in Asia.”
Saudi Arabia didn't want Nigeria to develop long-term relationships with refinery buyers in Asia. In late September, the kingdom decided to shore up its hold on them by, effectively, holding a sale. The Saudis cut their official crude price in Asia by $1 a barrel; within a week, Iran and Kuwait did the same.
Two weeks later, the IEA again lowered its full-year projection of demand growth by 200,000 barrels a day to a meager annual increase of 700,000 barrels, nearly half of what it expected at the beginning of the year. Oil prices fell nearly $4 a barrel on the news.
At this point, the oil market appeared to be in free fall. Of the 23 trading days in October, the price of crude fell by more than $1 on eight days. It rose by $1 on one day. Traders’ attention turned to OPEC, which has traditionally played the role of market stabilizer by cutting production when prices fall and raising production when prices rise. Many OPEC members, reliant on the cash oil brings in to pay for generous social programs, didn’t want to cut.
Saudi Arabia’s powerful oil minister, Ali al-Naimi, was silent for weeks. The country had been burned in the past when it cut its oil output, only to see other countries continue to pump—and steal its customers.
And it was already feeling competition, says Abudi Zein, chief operating officer of ClipperData, a New York firm that tracks global crude movement. Colombia, which historically has sent most of its oil to the U.S., is finding its biggest buyer this year is China, a critical market for OPEC, he said.
“For the Saudis, Asia is their growth market,” Mr. Zein says. “The Nigerians and Colombians are being kicked out of their natural markets in North America. Saudi had to do something.”
At its regular meeting in Vienna in late November, the cartel kept production unchanged. U.S. and European oil prices fell another $7 per barrel.
On Wednesday, Mr. al-Naimi, the Saudi Arabian oil minister, was asked whether OPEC would soon act to cut exports. “Why should we cut production?” he asked. “Why?”