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Tesla’s inroads to China offer challenges to match the opportunity (NASDAQ:TSLA)

Xiaolu Chu

It would be difficult to argue that Tesla’s (NASDAQ:TSLA) bet on China years ago hasn’t borne fruit for investors. Only about four years after breaking ground in China, the company announced the production of its millionth car in the country and established a firm foothold in the world’s largest market for electric vehicles.

However, a growing level of geopolitical tension between the US and China over Taiwan and China’s “no limits partnership” with Russia, heavy handed regulatory measures pursued by the Chinese state, tougher competition from domestic competitors, and consistent COVID-related supply chain issues leave the automaker in arguably as precarious a position as it’s ever been in the country.

As such, a report from Reuters that the automaker is “reevaluating the way it sells electric cars in China” is perhaps unsurprising.

Trade Tensions and Taiwan

Following the election of Joe Biden in 2020, there was a hope among many China-reliant businesses that trade tensions would simmer down from the tumultuous Trump era for Sino-American ties. Indeed, essays from Biden’s National Security Advisor Jake Sullivan amidst the campaign encouraged continued competition, but also an ability to coexist with China.

However, the result has been much to the contrary as testy exchanges between diplomats at a 2021 summit in Alaska set the tone for only tenser relations. The desire of China’s diplomats to “tell the China story well” clearly included a rebuke of any efforts they saw as constraining China’s ascendance. President Xi Jinping made that clear when declaring that “any foreign force” that would attempt to bully China “ will find their heads bashed bloody against a great wall of steel forged by over 1.4B Chinese people” in a speech marking the 100th anniversary of the Chinese Communist Party.

Among the latest flash points, Speaker Nancy Pelosi’s visit to Taiwan, a de-facto independent nation that China considers its territory, only stands to inflame tensions on the topic already stoked by President Biden’s consistent undermining of US strategic ambiguity. Military drills conducted around the island following the visit have only raised alarms among Taiwanese military officials.

Obviously an invasion of Taiwan would make just about any business operation in China untenable, not to mention its catastrophic impact on tech via the critical hit it would deal to the semiconductor industry. Yet, even apart from that doomsday scenario, the escalation of cross-strait tensions only stands to worsen Sino-American relations and create a politically more difficult situation for a US company drawing the bulk of its profits from China. That could come from US pressure to withdraw, especially if a more openly hawkish administration is installed in coming years, or if China decides to punish one of the more prominent US-based companies operating in the country. Beijing has certainly not been reticent to use its power to punish Western companies it sees as running afoul of its interests.

“As to the mounting triangular tensions between the U.S., China, and Taiwan, this isn’t Tesla’s own doing, but they’re caught right in the middle of it,” Esquire Digital Chief Legal Analyst Aron Solomon told SeekingAlpha. “Musk’s personal hedge against this is that he has not spoken publicly against China or their government officials.”

Indeed, Elon Musk’s typically candid commentary on regulators and politicians has been noticeably absent in regards to China. In fact, Musk even penned a column for China’s state censors in August, a move indicative of Tesla’s eagerness to please regulators rather than rock the boat. Additionally, strong production in China is clearly a benefit for China itself, which could stave off adverse action by the Chinese state.

“The Chinese government doesn’t have a whole lot of incentive to attack Tesla (TSLA),” Wiley Angell, Chief Market Strategist at Ziegler Capital Management, told SeekingAlpha.

He explained that the major factory that stands to employ a significant amount of Chinese citizens while selling into the Chinese domestic market should appear as a win-win.

“One of the greatest strengths of Tesla is its diversification into the two largest EV markets in the world,” Angell said.

Nonetheless, Tesla’s (TSLA) status as a US company is undeniable, making it unclear how much goodwill the ultimately foreign automaker can buy in the country.

Increasing Competition

Even aside from its status as a US automaker, competition from the likes of Nio (NIO), Li Auto (LI), Xpeng (XPEV), and BYD Company (OTCPK:BYDDY) add to pressure by pitting Tesla against Chinese firms in a market dictated by “national champions”. In fact, BYD recently surpassed Tesla in sales across China.

For example, BYD delivered 163,042 cars in July, with plug-in hybrids accounting for more than half of its sales. Tesla (TSLA), by comparison, sold 28,217 China-made vehicles in the month. Meanwhile, Li Auto (LI) delivered 10,422 Li ONEs in July, a 21% jump from 2021, XPeng (XPEV) delivered 11,524 Smart EVs, a 43% leap from the prior year, and NIO (NIO) delivered 10,052 vehicles, about a 27% increase from 2021.

It is worth noting that Tesla notched a record high 78,906 vehicles sold in June, perhaps portending well for the automaker, especially as it emerges from production slowdowns. A clearer picture on “normal” delivery rates would provide far more certainty on the path forward for Tesla. In any event, the trajectories of many of its Chinese peers appear extraordinarily positive, begging questions as to just how big the pie to be divided up amongst the automakers can truly be.

Pandemic Production Pauses: A Thing of the Past?

Another open question concerns China’s pursuit of Zero-COVID policies. While Chinese premier Li Kieqang has played “good cop” to Xi Jinping’s “bad cop” on draconian lockdowns of late, making maskless visits across the country to promote reopening, the prospect of renewed lockdowns remains a threat. This is especially so as the 20th Party Congress that stands to extend President Xi’s term approaches.

“Whatever the associated social and economic costs, the [Zero-COVID] policy makes sense to Xi in terms of some of his aims for the party congress,” a recent Asia Society report reads. “The March 17 PBSC meeting readout noted Xi’s admonition that the principle of ‘people first, life first’ should be paramount in the government’s response. This formulation aligns with his effort to be crowned ‘the people’s leader,’ leaving little room for argument.”

The report adds that there is little evidence of any disagreement within the leadership, despite Li’s public tours to reassure businesses. The alternative of China’s hospitals being overrun with patients shortly before the Congress would be the truly unacceptable outcome, the report supposes. Overall, abandonment of the hardline lockdown policy ahead of late October appears overly optimistic.

As such, Tesla’s (TSLA) production problems might not be fully in the rear view mirror. Considering the importance of China to Tesla’s full-year targets, the potential for another shutdown would be a major problem. That is not to mention recent shutdowns, supply chain problems, and even blackouts driven by a heatwave across the country.

“The elephant in the room for the stock will be the Everest-like uphill climb for deliveries in 2H needed to hit roughly 1.4M units for the year with many on the Street being skeptical about this number IF any Covid shutdown comes back to China the rest of the year,” Wedbush analyst Dan Ives wrote in a note shortly after Tesla’s Q2 report. “The Austin and Berlin factory ramps are proceeding well, but really do not become major factors until 2023 with all the production pressure on the shoulders of Fremont and Shanghai.”

Wiley Angell, Chief Market Strategist at Ziegler Capital Management, likewise noted this risk. Though, he lauded the company’s ability to manage the situation and overcome even a production problem as drastic as the one seen in the spring.

“Elon Musk was able to navigate that situation pretty well,” he told SeekingAlpha. “He was able to work with the Chinese government to get workers back to work as quickly as possible given the pretty tight lockdowns that they had.”

Read more on Tesla’s delivery cycle shifts in China.

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Santos gets $1.4B offer for PNG LNG stake from Papua’s state oil company (OTCMKTS:STOSF)

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Santos (OTCPK:STOSF) said it received a binding conditional offer from Kumul Petroleum Holdings, Papua New Guinea’s national oil and gas company, to buy a 5% interest in the PNG LNG liquefied natural gas project for US$1.4B plus ~$300M in project finance debt.

Santos (OTCPK:STOSF) said Kumul paid $55M to be held in escrow to secure the offer, which will remain open for acceptance until December 31 and is conditional on Kumul obtaining waivers on some pre-emptive rights by other PNG LNG project partners.

With the sale of a 5% stake, Santos (OTCPK:STOSF) would own 37.5% of the project, still ahead of operator Exxon Mobil (NYSE:XOM) with 33.2%, while Kumul Petroleum would own 21.8%, with the remaining shared between Japan’s JX Holdings and Papua New Guinea’s state-owned Mineral Resources Development Co.

Santos (OTCPK:STOSF) became the largest shareholder in PNG LNG, Papua New Guinea’s largest resource project, with its takeover of Oil Search Ltd. last year.

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Falling home prices shouldn’t collapse the financial system, says hedge funder who made $4 billion betting on the 2008 housing crash

The U.S. housing market is experiencing one of the most rapid and dramatic shifts in its history.

The reason is pretty simple: Spiked mortgage rates are sidelining buyers across the country. 

And it’s far from over. Last week, Fed Chair Jerome Powell even went as far as to call it a “difficult correction.”

While the speed and breadth of the slowdown have some Americans worried about a repeat of the 2008 housing bust and subsequent global financial crisis, others aren’t as concerned. John Paulson, the hedge funder who famously pocketed $4 billion betting against the U.S. housing market in 2008, is among those who believe history isn’t repeating itself.

“We’re not at risk of a collapse today in the financial system like we were before,” Paulson told Bloomberg on Sunday. “Yeah, it’s true, housing may be a little frothy. So housing prices may come down or they may plateau, but not to the extent it happened [in 2008].”

A tale of two Wall Street oracles

Paulson, who started his hedge fund (which has since been converted to a family office), Paulson & Co., in 1994 and boasts a net worth of $3 billion, believes that the housing market is on stronger footing than it was at the start of the Great Financial Crisis.

“The underlying quality of the mortgages today is far superior. You don’t even have any subprime mortgages in the market,” he said. “In that period [2008], there was no down payments, no credit checks, very high leverage. And it’s just the opposite of what’s happening today. So you don’t have the degree of poor credit quality in mortgages that you did at that time.”

After the blow-up of the 2008 housing bubble and subsequent global financial crisis, senators passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in order to ensure the stability of the U.S. financial system and improve the quality of U.S. mortgages.

The act created the Consumer Financial Protection Bureau (CFPB), which is tasked with preventing predatory mortgage lending. In the years since the CFPB’s creation, the average credit rating of homebuyers has improved dramatically. Leading up to the 2008 housing bust, U.S. homebuyers’ average credit rating was 707. In the first quarter of this year, it was 776, according to data from Bankrate.

Bank of America Research analysts led by Thomas Thornton also found that the portion of buyers with so-called “superprime” FICO scores of 720 or above hit 75% this summer. During the years preceding the 2008 housing bust, just 25% of buyers boasted similarly strong credit.

The Dodd-Frank Act also established the Financial Stability Oversight Council which monitors the health of major U.S. financial firms and sets reserve requirements for banks, and the Securities and Exchange Commission (SEC) Office of Credit Ratings which verifies the credit ratings of major firms after critics argued private agencies gave misleading ratings during the financial crisis. Both of these regulatory bodies have helped to improve the resiliency of the U.S. financial system and banks during times of economic stress.

Paulson noted on Sunday that banks were highly leveraged during the financial crisis and took risks that would be seen as unacceptable in today’s markets after the Dodd-Frank act established the Volcker Rule, which prevents banks from making some specific types of risky investments.

“The problem, in that period of time, was the banks were very speculative about what they were investing in. They had a lot of risky subprime, high-yield, levered loans. And when the market started to fall, the equity quickly came under pressure,” he said, noting that the average bank now has three to four times as much equity as they did during the Great Financial Crisis of 2008, which makes them less susceptible to default.

While Paulson isn’t worried about a repeat of 2008, hedge funder Michael Burry, who also rose to fame predicting and profiting from the Great Financial Crisis, as depicted in the book and movie “The Big Short,” has warned for years that he believes the global economy is in the “greatest speculative bubble of all time in all things.”

Burry argues that central banks created a bubble in everything from stocks to real estate with loose monetary policies after the Great Financial Crisis, and pandemic-era spending meant to boost the economy only made things worse.

Now, as central bank officials around the world shift stances to fight inflation and continue raising interest rates in unison, the hedge fund chief argues asset prices will fall dramatically.

“There is risk growing in many sectors. The unfettered narrative feeding itself until the absurdity explodes, revealing the folly to all and easily starting a revolution,” Burry said in a cryptic, since-deleted Sept. 21 tweet.

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The U.S. housing market stares down an even bigger economic shock—mortgage rates near 7%

Unbeknownst to buyers lining the sidewalks outside of frenzied open houses this spring, the Pandemic Housing Boom was already in its final inning. In March, Fortune published a pair of articles titled “The housing market enters uncharted waters“ and “An economic shock just hit the housing market“ arguing just that: The red-hot housing market would quickly shift in the face of spiked mortgage rates, which had jumped from 3.2% in January to over 4% by late March.

Not only did higher mortgage rates help to cause the Pandemic Housing Boom fizzle out, but it was replaced by what Federal Reserve Chair Jerome Powell now calls a “difficult correction.”

“For the longer term what we need is supply and demand to get better aligned so that housing prices go up at a reasonable level and at a reasonable pace and that people can afford houses again. We probably in the housing market have to go through a correction to get back to that place,” Powell told reporters last week. “This difficult [housing] correction should put the housing market back into better balance.”

The bad news for mortgage brokers and builders? This housing correction is far from over.

In fact, the shock hitting the U.S. housing market continues to grow: On Monday, the average 30-year fixed mortgage rate jumped to 6.87%. That marks both the highest mortgage rate since 2002 and the biggest 12-month jump (see chart below) since 1981.

Anytime the Federal Reserve flips into inflation-fighting mode, things get challenging for rate sensitive industries like real estate. Higher mortgage rates lead to some borrowers—who must meet lenders’ strict debt-to-ratios—losing their mortgage eligibility. It also prices some buyers out of the market altogether. A borrower in January who took out a $500,000 mortgage at a 3.2% rate would be on the hook for a $2,162 monthly principal and interest payment over the course of the 30-year loan. At a 6.8% rate, that monthly payment would be $3,260.

The economic shock caused by elevated mortgage rates, of course, underpins the ongoing housing correction. The housing correction is the U.S. housing market—which had been based on 3% mortgage rates—working towards equilibrium. As buyers pull back, the housing correction will cause inventory levels to rise and home sales volumes to fall. It’s also putting much of the nation at risk of falling home prices.

We’re already starting to see home price declines in bubbly housing markets like Austin, Boise, and Las Vegas. However, home price declines have yet to hit the whole country. According to Zillow, just 117 housing markets saw home price declines between May and August. In another 500 plus housing markets, prices were either flat or prices rose.

But more markets could soon move into the falling home price camp. As long as mortgage rates remain near 7%, housing analysts tell Fortune we’ll see downward pressure on home prices in the near term.

“The longer that [mortgage] rates stay elevated, our view is that housing is going to continue to feel it and have this reset mode. And the affordability resetting mechanism right now that has to happen is on [home] prices,” Rick Palacios Jr., head of research at John Burns Real Estate Consulting, tells Fortune.

The big question: How much can “pressurized affordability”—a 3 percentage point jump in mortgage rates coupled with frothy home prices—push home prices lower? Unlike the 2008 housing crash, this time around we don’t have a housing supply glut nor a subprime crisis.

Want to stay updated on the housing correction? Follow me on Twitter at @NewsLambert.

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