Losers and Winners of the Oil Boom

Delta Airlines, once the most profitable airline in America, will soon go bankrupt.

Pilots and employees have given back billions in voluntary cuts, but it’s still not enough to save the company.

Delta has already lost $10 billion, and now, with fuel costs surging, the company is losing money at an even faster pace. It could file for Chapter 11 within days.

Already, investors in Delta Airlines have lost nearly 99% of their money. The company’s shares, which traded over $70 a few years ago, slumped to a meager $1.20 yesterday, down another 5.5% just in one trading day. Soon they’ll be worthless, and even investors who bought them at “bargain-basement prices” will be wiped out.

The Next Big Losers
of the Oil Boom

The next major industry to get killed by rising energy prices is bound to be U.S. auto manufacturers, particularly General Motors.

Earlier this summer, as gas prices were rising, sales on GM’s gas-guzzling cars and SUVs were plunging. So in order to postpone the day of reckoning, the company has been practically giving away its cars and SUVs, offering huge, employee-only discounts to everyone.

In June, the huge discounts worked, and GM’s sales surged. In July, sales continued to rise, but at a much slower pace. And now, in August, despite a further extension of the discounts, GM’s sales are falling again.

Executives at Chrysler and Ford are livid. GM’s cut-throat prices are forcing them to slash their own prices, even though they know cut-throat pricing borders on financial suicide. But they have no choice. Unless they stay competitive, they lose precious market share. And if they lose market share to GM, they’re dead.

I’m not the only one saying this: A top Ford marketing executive has publicly declared that GM’s desperate pricing strategy poses “a big danger” for the entire U.S. auto industry.

Industry analysts finally agree. Until just a few weeks ago, they were cheering GM’s aggressive sales tactics. Now, they’re admitting the big auto maker’s actions are “extremely harmful.”

Everyone sees the handwriting on the wall — except perhaps for GM executives. Just yesterday, for example, Chairman and CEO Rick Wagoner said the automaker’s turnaround plan for its struggling North American division is on track. But in practically the same breath, he admitted “North America is missing, and missing badly.”

Wagoner also said GM is making “good progress” in improving the quality of its cars. But on the very same day, the company announced that faulty brakes forced them to recall about 800,000 SUVs and pickups in 14 northern states. That’s not exactly a sign of good quality.

Used Car Market
Falling Apart

Soon after automakers began offering big discounts on their new cars, the bottom fell out of the USED car market.

All over the country, used car dealers have been swamped and they now have an estimated 300,000 more vehicles on their lots than they’d normally expect at this time of year. Trade-in values for gas-guzzling SUVs have plunged. Trade-in values for luxury cars have plunged even further.

So now, General Motors has a new problem: The collapse in the market for used GM cars is going to drag down the market for their new cars. Buyers walk into new car showrooms. They find out they’re going to get peanuts for their trade-ins. So they walk out of the showrooms in disgust.

Their reasoning: Why invest in a model that’s going to lose its value so quickly? And what good is the big discount on the new car if it’s mostly wiped out by the equally deep discount on the trade-in?

The End Game

Recently, GM announced its worst quarterly loss since the company narrowly skirted financial collapse 13 years ago. In response, they laid off 25,000 workers. And in the near future, you can expect a whole new round of lay-offs.

But it doesn’t matter how many people they lay off — because they’re buried under an avalanche of debt. Last I checked, they owed 284 BILLION dollars. For every dollar of cash they had left, they owed $9. The interest alone is killing them. And every time the Fed raises interest rates, they have to pay more.

General Motors’ finances are so bad their bonds were downgraded to junk earlier this year. And last week, Moody’s went one step further, dropping its long-term rating to junk as well.

Moody’s downgraded GM’s senior unsecured credit rating two levels to Ba2. It downgraded GMAC’s rating to Ba1. And it explained that the main reasons for its downgrades were the same reasons I’ve been stressing in my reports.

GM is bulldozing its Buick headquarters in Flint, Michigan. It’s laying off another 1,500 workers in Australia. It’s selling the majority stake in its mortgage subsidiary, GMAC Commercial Holding Corp. It’s extending the employee discount campaign again. But nothing’s working.

Delphi, GM’s former parts subsidiary, has already threatened to file for Chapter 11 bankruptcy by October 17 if its union does not provide relief. Don’t be surprised if one day, in the not-too-distant future, General Motors does the same.

But while some companies are trapped by the oil boom, for others, it’s a great profit windfall …

The Next Big Winners
of the Oil Boom

Even before oil prices surged this week in the wake of Hurricane Katrina, China was on a rampage to secure oil supplies.

First, it was CNOOC’s bid for Unocal, shot down by the U.S. Congress. Then, China’s largest state-owned oil company, CNPC, bid $4.2 billion for the Canadian-based PetroKazakhstan, seeking access to 12% of PetroKazakhstan’s rich oil reserves.

Now, get ready for more.

Reason: For oil-hungry China, PetroKazakhstan is just an appetizer, barely replacing the reserves it was seeking with Unocal. And even Unocal would have satisfied only a small fraction of China’s ravenous appetite for energy.

Right now, for example, Larry’s looking at three companies that he thinks are likely takeover candidates by one of China’s state-owned oil companies.

THE FIRST, based in South America, is one of the largest oil companies in the world. Its operations range from South America, to Africa, to the Caspian Sea, and to Southeast Asia.

The company has over 11 billion barrels of proven oil reserves, plus the equivalent of 19 billion cubic feet of natural gas. Its cost of extracting and refining its oil and gas reserves are among the lowest in the world, at less than $3 per barrel.

The company’s market value (less long-term debt), at $54 billion, is peanuts compared to the value of its assets. Do the math: $54 billion divided by 11 billion barrels of oil effectively values the company’s oil at under $5 per barrel.

THE SECOND COMPANY he’s eyeing is a Canadian-based firm with oil reserves around the world, a large chunk of them in West Africa and Yemen.

This company’s reserves are currently valued at just over $13 a barrel. That’s more than what CNOOC bid for Unocal, but it’s still a very attractive play for a Chinese oil company.

THE THIRD COMPANY is a multinational oil producer with over 170 million barrels of oil in Asia. That’s not a large amount, but it’s located in an area that’s readily available to China.

Even without takeovers, the opportunities are great — just based on the momentum of the oil markets. And if he’s right about the takeovers, you can multiply those opportunities several times over.

Huge Investor Losses vs.
Huge Investor Profits

So as you can see, while some companies are delivering huge losses to investors, others are opening up equally large profit opportunities.

Investors in General Motors have seen their wealth slashed by nearly two-thirds as GM’s shares plunged from their 2000 high of nearly $95 per share to this year’s low of $24.67.
When billionaire Kirk Kerkorian bid for the stock, it rallied back to the high $30s. But now, with fuel prices surging, even that rally is fading. GM’s shares closed at 34.45 yesterday, and I think they’re headed for under $20 a share on the next move … and to $10 or lower next year.
Ford’s decline has been equally steep — from a peak of over $37 to a low of $6.58 this year. Its recent rally to $11.50 was weaker than GM’s. And at $9.75, the stock’s closing price yesterday, investors who bought at the peak, have now lost close to three quarters of their money.

Never before have we seen such a stark contrast between what investors have lost in stocks like GM and Ford and what they have gained in energy stocks!

For example, the Oil Services HOLDRS, a basket of oil service companies which I have been following regularly here in Money and Markets, has surged from a low of just under 45 in 2002 to its recent high of 119.30 on August 11.

Two weeks ago, it corrected back down to as low as 110.46, but it’s still clearly in an accelerated, blast-off phase. Moreover, in recent days, it appears to be building up for another surge which could begin at almost any time.

Some investors think it’s too late. They see oil prices surging past $70 and they automatically assume that’s already high enough. But back in 1979, crude oil reached $96.81 in today’s dollars, according to InflationData.com. And that was at a time when demand for energy was not nearly as strong.

Other investors blindly assume there’s no window to buy energy stocks or their options. But just in the past two weeks, there have been at least four such windows, as prices dipped temporarily and then ratcheted higher. Investors who bought on these dips are already in profit territory.

Moreover, even at 115.97, where it traded this morning in electronic trading, it’s still below its mid-August peak, while oil itself is already well ABOVE that peak.

My Top 5 Recommendations
to Avoid the Losers
and Ride the Winners

Recommendation #1

Stay away from industries most likely to get killed in this environment. That includes airlines and auto companies that are slammed with surging energy costs.

PLUS it also includes Fannie Mae, Freddie Mac, Citigroup, Bank of America, and other banks or mortgage companies that are vulnerable to one of the chief consequences of rising energy prices — inflation and higher interest rates.

Recommendation #2

Unless you’re using a specialized trading strategy, get rid of all bonds rated double-B or lower. These are the bonds that, like GM’s bonds, are classified as “junk.” And long before companies fail, the value of these bonds can fall in half or more.

Recommendation #3

The safest, most liquid parking place for your cash right now is money funds that invest exclusively in short-term U.S. Treasury securities. The Treasury securities are guaranteed by the U.S. government. And since they’re short term, your principal is not negatively affected by rising rates.

In fact, your yield improves every time the Fed raises interest rates. And unlike an ordinary money market fund or bank CD, all your interest income is exempt from most local and state income taxes.

Four of my favorites — giving you the best combination of safety, liquidity, and low fees — are American Century Capital Preservation Fund, Fidelity Spartan U.S. Treasury Fund, and USGI U.S. Treasury Securities Cash Fund, and the Weiss Treasury Only Money Market Fund.

Recommendation #4

To greatly improve your income, there’s one relatively conservative oil stock I especially like because it offers a strong, steady yield, currently over 9%. That’s almost three times what you can get in a money market fund. If you live on interest income, this can be a wonderful improvement for you.

In addition, this stock offers significant appreciation potential. Since I first recommended it in my Safe Money Report, subscribers following my recommendations should already have gains of more than 50%.

(For the details, see my report, “9% Yield Plus Potential for Large Capital Gains” available free with a risk-free subscription to my Safe Money Report.)

Recommendation #5

Investors who have bought energy stock options on the dips I told you about have done especially well. They know that, even if their timing is wrong, the most they can lose is the amount they invest. And the most they need to put at risk is 5% or 10% of the capital they’d use if they were buying the shares outright.

For example, with the three China takeover candidates companies Larry’s looking at right now, for just $3,400, you can own call options that represent a total of 1,200 shares worth about $67,400. That’s little more than 5% of the shares’ cost, giving you almost 20-to-1 leverage.

If he’s right and the market begins to look at these companies as takeover candidates, he figures the $3,400 could be worth as much as $16,800, in as little as six months.

For specific instructions, consider his Energy Options Alert.

Good luck and God bless!

Martin

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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