Petrocapita Update

December 2010
Petrocapita Update

IF YOU CAN KEEP YOUR HEAD WHEN ALL ABOUT YOU

ARE LOSING THEIRS ... YOU DON’T WORK FOR THE
FEDERAL RESERVE

Apologies to Mr. Kipling for using his work to create an

inflammatory headline.  

A considerable amount of ink is being spilled on the topic of

whether there is a recovery underway in the west and if so,
whether that recovery is sustainable. So much ink in fact that
one would have thought that when combined with the mighty
labors of our central banks to single-handedly create an ink
shortage this lowly substance would have been used up long
ago. 

Fortunately, or perhaps unfortunately depending on your view of

my monthly musings, we haven’t run out yet so let me give you
my view on the recovery debate - a recovery in nominal or real
terms?  With the printing presses running full time (ink supplies
notwithstanding) some form of nominal recovery will occur in the
western economies.  Sadly, it’s not going to be anywhere nearly
as satisfying as other post-war recoveries because it largely will
be an illusion in real terms.  Our recovery is not being built on the
sound fundamentals for growth:

–   Favorable demographics;

–    Low national debt levels;
–    High savings rates; and
–    Persistent trade surpluses.

Please take a moment and consider which so-called developed

nation has these characteristics.  Stumped?  None.  Now turn
your gaze to the emerging world - I doubt you are still stumped
as the list is long and obvious.  

1
Petrocapita Update (continued)
Take Canada as an example of a country suffering
from the western growth malaise.  Canada has:
–  An aging population;
–  Large unfunded liabilities for social benefits;
–  High total debt-to-GDP levels;
–  Low savings rates;
–  Large and increasing government intervention in
the economy;
–  Large fiscal deficits; and
–  An overly accommodative monetary authority.
I’m sorry to be the bearer of bad tidings but these
are not the seeds from which mighty recoveries
are grown.  By insisting on printing over the
systemic solvency issues in the financial sector,
by actively preventing the liquidation of decades
of mal-investment, by subsidizing speculation and
consumption to the detriment of production (and
so on) our valiant central bankers will not create a
recovery.  Unless these problems are addressed they
are creating an inflationary environment with poor
real growth dynamics - i.e. the ideal raw materials for
stagflation in the west.  The Canadian economy appears bifurcated between
What are our investment options?  It should come as
no surprise to anyone who has read one of my letters
that I believe its important to find investments in
politically stable regions of the world that are directly
exposed to emerging economy growth - i.e. regions
that export what the emerging economies need and
are not exposed to emerging economy competitive
advantages - i.e. regions that do not export what the
emerging economies make.
In my funds’ backyard, western Canada, energy
and agriculture are dominant industries. In fact,
western Canada, with only 10 million inhabitants,
is one of the world’s largest net exporters of both
energy and agricultural commodities.  As we know,
energy and food consumption undergo rapid growth
as a developing economy makes the transition to
a middle class standard of living. These markets
already appear to be tightening and demand is still
accelerating.  Here are some quick numbers to
give you an idea of western Canada’s resources
endowment:
Energy
–  Oil (13% of world reserves; 4% of world
production)
–  Uranium (8% of world reserves; 20% of world
production)
Agriculture
–  Potash (60% of world reserves; 30% of world
production)
–  Wheat (21% of the world export market)
–  Oil seeds (10% of the world export market)
–  Farmland (80% of Canadian total)
the lower growth east and the higher growth west.
Investing in western Canada provides exposure to
emerging market consumption patterns in energy
and agriculture in a politically stable market.  I believe
a good approach is to make direct investments
in commodity production assets - in addition to
providing less volatile exposure to commodity price
trends, production assets are excellent inflation
hedges that, unlike gold, generate cash flow.  
In addition, investors who have a value orientation
have been provided what I believe is an attractive
entry point into the Western Canadian conventional
oil market.  The credit crisis has caused financing to
2
Petrocapita Update (continued)

become scarce for junior oil & gas companies while
low natural gas prices are reducing their profitability.   rates at least 4% below their equilibrium level  then
They are being forced to sell assets to stay in
business. This has created a buyers’ market for the
acquisition of smaller oil production assets - assets
that are highly cash flow positive at current oil prices.
 
Shifting gears for a moment - I want to ask when
we gave permission for central banks to take over
the tax role of our governments?  Central bankers
now seem to feel free to increase the money supply
by any quantity they deem necessary to keep the
banking sector solvent.  In effect, they are extracting
a massive tax from savers everywhere via the
historically low interest rates they have engineered.   all?  Perhaps all this money printing will usher in a
When questioned about what they are doing with our
money they get downright testy and roll out the cliché
of “central bank independence”. 
Let’s take a look at what that vaunted
“independence” is costing Canadians using some
Bank of Canada (“BOC”) data.  There is C$1.2
trillion on deposit with Canadian chartered banks.  If
we assume that BOC actions are keeping interest
Canadian savers are being taxed by the BOC to the
tune of $50 billion annually in the form of lost interest
income. Canadian federal government income tax
revenues are approximately $150 billion, so is it not
accurate to say the BOC has unilaterally increased
Canadian income taxes by around 33%? 
Let me leave you with this.  If central banks really
believe that printing money and giving it to the
government and the banking sector is solving our
problems and is not inflationary why not print much,
much more and be done with the crisis once and for
new era of wealth, prosperity and low inflation - what
do you think? 
Kind Regards
Stephen Johnston - Partner
Petrocapita Income Trust & Agcapita Farmland
Investment Partnership

Stephen is a partner at Petrocapita, an energy investment fund built around the core premise that the world
is in a bull market in commodities driven by inflation and a step-change increase in demand and, accordingly,
that investments with direct or indirect exposure to commodities in a politically stable environment such as
Canada will provide above average returns. Petrocapita holds a portfolio of low risk, producing energy assets.

Stephen graduated from London Business School and is the founder of one of Canada’s largest farmland
investment funds, and Petrocapita. He has over 15 years experience as a fund manger – working for
organizations such as the European Bank for Reconstruction and Development, Societe Generale and Baring
Brothers.

Stephen has appeared on Business News Network and CBC News and been quoted in such media outlets as
Fortune, the Financial Times and The Globe and Mail.

3
 DISCLAIMER:

The information, opinions, estimates, projections and other materials

contained herein are provided as of the date hereof and are subject to
change without notice. Some of the information, opinions, estimates,
projections and other materials contained herein have been obtained from
numerous sources and Petrocapita Income Trust (“PETROCAPITA”) and
its affiliates make every effort to ensure that the contents hereof have been
compiled or derived from sources believed to be reliable and to contain
information and opinions which are accurate and complete. However, neither
PETROCAPITA nor its affiliates have independently verified or make any
representation or warranty, express or implied, in respect thereof, take no
responsibility for any errors and omissions which maybe contained herein or
accept any liability whatsoever for any loss arising from any use of or reliance
on the information, opinions, estimates, projections and other materials
contained herein whether relied upon by the recipient or user or any other
third party (including, without limitation, any customer of the recipient or
user). Information may be available to PETROCAPITA and/or its affiliates that
is not reflected herein. The information, opinions, estimates, projections and
other materials contained herein are not to be construed as an offer to sell, a
solicitation for or an offer to buy, any products or services referenced herein
(including, without limitation, any commodities, securities or other financial
instruments), nor shall such information, opinions, estimates, projections and
other materials be considered as investment advice or as a recommendation
to enter into any transaction. Additional information is available by contacting
PETROCAPITA or its relevant affiliate directly.

#400, 2424 4th Street SW Tel: +1.403.608.1256 www.petrocapita.com

Calgary, Alberta T2S 2T4 Fax: +1.403.648.2776
Canada