Prepared by Berkeley Futures Ltd.
Bad Vibrations
(January 22, 2001) For investors around the world, the fact that Californians are experiencing occasional power black outs is probably not of great concern. However, the problems with California's power industry will have been an important consideration behind the Federal Reserve Bank's decision to cut U.S. interest rates earlier this month.
As a result of planning and environmental restrictions, no new power stations have been built in California for ten years. Yet the state has been at the forefront of the U.S. economic expansion with Silicon Valley a particularly high consumer of energy. Static supply and rising demand mean that, whereas 20 years ago California used to produce 65 percent of its energy requirement, this figure has now dropped to below 50 percent. In the past, the deficit has been remedied by a seasonal swapping of energy with the neighboring states of Oregon, Washington, and Idaho. In the spring and summer, melting snow in the northern states meant that they could send surplus hydro-electric power (HEP) south to California where demand was high due to the use of air conditioners in the hot summer months. Mild Californian winters meant the flow of power could be reversed when the more northerly states needed extra supplies for central heating. An unfortunate combination of circumstances has disturbed this cosy relationship. As a result of cold weather in California, the state has remained an energy importer. Further north, unusually dry weather has meant that reservoir levels are low and therefore less power has been produced from HEP.
As the graph shows, the price of natural gas has jumped more than threefold over the past year to reach a 10-year record on the New York Mercantile Exchange. Normally the laws of supply and demand would mean that most of this price rise eventually found its way to the customers, with the utility companies bearing some of the higher costs in lower profits. However, four years ago California partially deregulated its power industry and, as a result, there is no control on the wholesale price of gas, but retail prices are capped. As they have no means of passing on their ballooning input costs, the two largest utility companies have run up debts of $11 billion and are facing imminent bankruptcy.
NYMEX Natural Gas
Primark Datastream.
It is the ripple-effects of this problem that so worried the Fed.
California accounts for 12 percent of the U.S. gross domestic product.
If it were an independent country, it would rank sixth in the world in
economic terms. Californian households may have to pay an extra $1000 surcharge
on their energy bills this winter and for the country as a whole, energy-related
spending now accounts for 4.7 percent of after-tax personal income as compared
to 3.8 percent a year ago. Higher energy costs will curb consumer spending.
Energy-intensive companies have also been badly affected. Aluminum smelters in the region were forced to close down over the summer as it was not economic for them to pay the higher energy costs and it is not known when they will reopen. Other high energy businesses are finding their profit margins being squeezed and there is a knock-on effect on the banks--particularly those with exposure to the utility companies.
It is perhaps not surprising that, in the light of these developments,
Alan Greenspan cited "high energy prices sapping household and business
purchasing power" as one of the reasons behind the decision to cut rates.
Pounding Into Shape?
For the last year or so, the Confederation of British Industry (CBI) has led the rallying cry by manufacturing industry for a weaker pound in order to help the competitive position of UK exports, particularly for sales to the European Union. How much help is actually needed from the exchange rate is open to question, as the UK managed to register trade surpluses with the EU in September and October last year, the first time that this has happened since the statistic started in 1988. However, since November of last year, there has been a sharp change in the value of the pound against the Euro. This has come about not so much from a weakness of the pound, but from a combination of a weaker dollar and a general resurgence in the value of the Euro as the market has reassessed the relative growth prospects of the two regions. This has had a twofold benefit for the UK, since raw material costs are held down by sterling strength against the dollar, whilst export prices to Europe become cheaper. The question, of course, is whether these trends will continue and we will try to look for clues to the answer by examining the technical outlook for the pound against the dollar and the Euro.
Sterling/Dollar
The pound has made strong gains against the dollar since the end of November, only to falter in recent days. This is a little surprising as the break above $1.4800 appeared to confirm the completion of a double bottom formation, producing a target of $1.5650. However, the reversal of recent days, including a move back below $1.4800, puts this interpretation into question, perhaps part of the problem being that the Relative Strength Indicator (RSI) was above 70 when the break took place. There is another neckline in evidence on the chart and this is currently at $1.5085. If the current correction does not decline below $1.4456, then this second neckline retains its importance with regard to providing upside targets. Interestingly, the 70-day moving average also provides support in this area, being currently at $1.4520. With the RSI reading now down to 51.1 and several strong supports in evidence, it is likely that the downward correction of the pound against the dollar will not be long lasting. As stated, the key level for any rally is now the neckline resistance at $1.5085 and, if this is broken, the target would become $1.6200. An achievement of this target would imply the breaking of the downward trend line that has been in existence since October 1999 and is currently at $1.5700.
Euro/Sterling
Looking at the daily Euro/sterling chart there are two chart patterns
evident. The first is a double bottom formation centered around the neckline
at £0.6415. The second is a channel whose resistance line is currently
at £0.6430 and whose support line is at 0.6170. Both these levels
are rising at the rate of eight points per day. The price has just tried--and
failed--to burst above the neckline and the top of the channel. This implies
a corrective period and one would normally look for the lower trend line
of the channel to be tested next, especially as the RSI is still slightly
overbought at 65.7. However, double bottom patterns are usually very strong
signals of major turnarounds and so it is uncertain if the correction will
get as far as the bottom of the channel. A clear break and close through
£0.6415 would give a target of £0.7250, higher than the Euro
has ever been against the pound since it came into existence. However,
to put this in perspective, back in 1995 the pound's value against the
Deutschemark was 2.1860 and the Euro equivalent would be £0.8965.
An intermediate objective of £0.6690 would be given from the channel
break. Only a break below the channel support line turns the outlook negative
for the Euro.
January 22, 2001 Berkeley Futures, Ltd. 38 Dover Street, London, UK, W1X3RB 0171-629-1133