Monday, November 29, 2010

Consumer Protection and The Fed: A Bad Idea

The debate on Capitol Hill has been centered around whether or not Elizabeth Warren is the right person to head the new Bureau of Consumer Financial Protection. Economist Simon Johnson has been leading the chorus for Warren's candidacy, and in her speeches she seems to pay homage to the right themes. Who heads the agency is somewhat of a red herring; there's a bigger issue. The new consumer agency will be housed in the Federal Reserve Bank, and it will have a blank check as to the extent of its funding. That is a genuinely bad idea.

While the Fed has bank oversight in its charter, the key mandate for a central bank is to provide stability and liquidity to the banking system through monetary policy instruments that serve to maintain a stable currency. Over time, the mandate has been commingled with that of choosing a monetary policy path that keeps output close to potential. The most politically oriented discussions around the Fed have centered on its role vis-a-vis full employment and output growth. Until recently, the Fed has been able to maintain its independence around these aspects of its charter.

If the new Bureau of Consumer Financial Protection were housed and insulated within the Fed structure, it would bloat and dilute its charter. In addition, the new agency would be outside the purview of Federal Reserve regulation and control. This is a perfect situation for Congressional and Presidential meddling with no accountability. Since financial services are our biggest growth industry, the budgets and ambit of the new watchdog would expand uncontrollably over time.

St. Louis Federal Reserve President James Bullard is quoted by Dow Jones as saying, "The Fed's only engagement with this independent agency is to fund it." This is a bad idea for the Federal budget and a very bad idea for the continuing independence of the central bank. Let's focus on issues and stop focusing on personalities.

Don't Muck Around With Oil Sands

Canada is experiencing a mini-gold rush of multinational companies looking to develop projects around the Alberta tar sands. In the midst of the seventies oil crisis, one of my research groups did a lot of work on the Athabasca River tar sands, but not much development work came of it. There's no doubt that production from oil sands has become important for U.S. oil imports from Canada, but it's a questionable resource to be focusing on for environmental and economic reasons.

The Athabasca River deposits are bitumen deposits. The easiest way to think about this is to go out to an asphalt driveway and imagine that it were hot enough to melt the asphalt into a thick sludge. Now imagine mining, handling and processing this sludge for light and middle distillate products that industry and consumers need, like jet fuels, lubricants, and gasoline. The mining operations used to be strip mining, although it has moved away from that somewhat. The level and scale of the equipment is truly mind boggling. The energy input and the water requirements are enormous. The main reason these resources are garnering the attention is the relatively relaxed governmental regulatory structure in Canada versus places like Russia, West Africa, and the Middle East where more easily exploitable resources exist.

Using 2000 data, the global output of carbon into the environment was about 6.2 GtC/year, of which 1.7 GtC/year came from worldwide coal plants burning low grade coal at 32% efficiency. (Pacala & Socolow in Science) Increasing the efficiency of coal plants or, better still, switching to gas-fired base capacity can contribute one "stabilization wedge" to reducing the path of carbon emission, and one wedge is worth 1 GtC/year. This kind of project is eminently doable and gas is now plentiful in high quality resources. Building pipeline infrastructures would create demand for materials and jobs. The nuclear portfolio should also increase as the per kWh costs decline as plant designs are standardized and become more modular. In fact, the Chinese government's largest utility in Hong Kong has just announced such a plan to switch its electricity generation capacity away from coal and towards nuclear and natural gas. If China, as the largest emitter of carbon dioxide from burning coal, is thinking about this kind of future, why is America not doing so? And we chastise others for lagging on environmental issues?

A multi-fuel, portfolio approach using high quality fuels that can produce what consumers want is the way to go. Mucking around with heavy oil sands is not a sensible proposition.

Sunday, November 28, 2010

Al Gore Turns on Ethanol

The Wall Street Journal had an online feature on Al Gore's epiphany on ethanol. Speaking to some Greek financiers, he estimated that the benefits of ethanol were "trivial," according to the Op Ed piece. "It's hard once such a program's put in place to deal with the lobbies that keep it going." Wow! In a sentence, that's the problem with our legislative system, but that's for another occasion.

"One of the reasons I made that mistake is that I paid particular attention to the farmers in my home state of Tennessee, and I had a certain fondness for the farmers in the State of Iowa because I was about to run for President." Amazing.

We've talked about the ill-conceived ethanol cult in many posts, and it's always been clear to us that this was no silver bullet for greenhouse gases or for energy independence. If Mr. Gore is not running for any office, perhaps he should lead the choir about letting corn-based ethanol's subsidies and mandates fade away. No party is going to take this on, though.

Monday, November 15, 2010

Helping Haiti Won't Be Easy

The New York Times has two front-page stories on Haiti. The longer story, which earnestly strives to be a feel good story is about a private girls' school in Port-au-Prince that is striving to reopen post-earthquake. In a smaller, front-page story the Times told about the spreading cholera outbreak in Haiti, affecting six out of the ten national d├ęparttements; WHO estimates that over 270,000 people could be affected in the coming years. A telling item in the story? A Haitian epidemiologist is quoted commenting about the outbreak. Meanwhile, the Director-General of the Ministry of Health, M. Gabriel Timothee could not be found for comment.

The school story tells of a government study calling for a billion dollar investment in Haitian primary school education. The World Bank meanwhile calls for an emergency investment of $500 million. The simple fact of the matter is that Haiti, even in the most ideal case, could not absorb and deploy anything near these amounts effectively. It's sad, but it's reality. Not a feel good story.

The Johns Hopkins School of Advanced International Studies sent a group of student down to Haiti in 2007 to report on conditions and to frame short and long-term policy recommendations. It's a good precis of how Haiti got into its current condition. Haiti is currently #12 on the Fund for Peace list of Failed States. According to the SAIS report, there are "no institutions through which funds may be channeled." In turn, this requires that "they (the international donor agencies and organizations) take over the basic functions of the state." This is the fundamental dilemma. The donors have to step in and become the shadow government, which is resented by the Haitians as being demeaning and neo-colonialist.

However, the World Bank itself knows that between 1995-2005, over $585 million was deployed for infrastructure projects, especially roads to facilitate commerce and communication. To date, no account can be given for the money, and the infrastructure is still deplorable.

The report makes the salient point that Presidential power in Haiti tends to become highly personalized. A Presidential candidate traditionally gets strong support from one of the power groups: the elites, the urban masses and rural poor, and the armed gangs and militias. The candidate leans on one group and then demonizes the others. For example, Jean-Bertrand Aristide, a charismatic ex-priest spoke the language of liberation theology which resonated with the urban poor who swept him into office. Unfortunately, power corrupted Aristide to the point where the SAIS report describes his governing philosophy as "kleptocracy." As is often done in U.S. foreign policy, we chose to support Aristide, even as the Haitian elites and other groups had pushed him out, and we helped to bring him back for more disastrous rule. Government transitions in Haiti are also traditionally violent, despite the existence of all the trappings of French governmental administration.

Like many other Third World countries, "Pervasive corruption continues to undermine the Haitian state and is a central contributor to Haiti's ongoing conflict." So, despite the resilience of the Haitian people, the best intentions of religious and humanitarian organizations, and the nation-building programs of agencies like the World Bank, it is very difficult to see how the beleaguered people of Haiti can be lifted up from their current plight without a totally different model of deploying aid and holding the government accountable.

The United Nations Stabilization Mission for Haiti (MINUSTAH) has been deployed since 1990, but its role has become unclear. This is an international organization that could serve as a clearinghouse for coordinating the efforts of the patchwork quilt of private and public agencies at work in Haiti. Because of the cholera outbreak, and the continuing lack of potable water, electricity, and sanitation, don't expect significant progress until something fundamental changes.

Tuesday, November 9, 2010

Chevron Follows Exxon Mobil's Natural Gas Play

Chevron today announced the the acquisition of Atlas Resources, which greatly expands its production and reserve bases in both conventional and non-conventional natural gas. This is very much mimics Exxon Mobil's acquisition of XTO, which we've written about before. This latter acquisition is being blamed for the significant under performance of XOM.


If the United States is serious about reducing greenhouse gas emissions and reducing our dependence on foreign oil, then windmills are not the answer. To paraphrase Dorothy, "Toto, I've a feeling we're not in Holland any more." One way to make a significant dent in our carbon emissions would be to generate more of our electricity from natural gas rather than from coal.


Pacala & Socolow's 2004 article in Science laid out the concept of "stabilization wedges," meaning different ways of building up a significant wedge-shaped reduction in carbon emission by combining strategies like conservation, better buildings, and a changed fuel portfolio. It's still a fine article to read for its way of formulating solutions.


They write that it is possible to reduce the nation's carbon emission rate by 1 GtC per year (1 Gigaton of carbon=1 billion tons of carbon) by swapping gas baseload power for coal baseload power in electricity generation. In 1996, according to the Energy Information Administration, natural gas accounted for about 14% of electricity generation, whereas the proportion rose to 24% in 2009. Both Exxon Mobil and Chevron project rapid growth in demand for natural gas to 2030.


Natural gas power plants generate 1,135 lbs. of carbon per megawatt-hour of electricity generated, which is one-third to one-half the level of a coal-fired plant, depending on the grade of coal used, according to MIT research. As it is, many plants switch between coal and gas fuel sources at the margin. For example, in 2009 when natural gas prices fell sharply due to recession and inventory overhang, gas supplanted coal in many plants. However, the idea of this stabilization wedge would be to switch the baseload capacity to gas versus coal, which means replacing 1,400 gigawatts of 50% efficient coal-based capacity with new, natural gas plant.


Were this to happen, gas production would go up by a factor of four from 2004 levels, according to Pacala and Socolow. What's keeping this kind of meaningful change from happening? First, it's easier to feed political pork to renewable fuel mandates, especially running up to the recent midterm elections. Second, companies are reluctant to invest in their basis businesses with a long-term horizon, and it's much easier to focus on share buybacks and financial engineering. Third, and most telling according to most researchers, is the failure to establish a carbon tax that would serve to internalize some of the externalities associated with dirty fuel sources like coal.


Some industry researchers were proposing carbon taxes of $40-$50 per ton. Now, along come some researchers from MIT who have a patent and pilot operations for natural-gas based, solid oxide fuel cell plant that they say will have the lowest lifecycle costs per killowatt-hour over straight natural gas or coal-based electricity. What's the problem besides the lack of a scaled-up plant? The capital costs are said to to be 3-4x those of conventional plants. Absent some sort of carbon tax, it will always be the case that pulverized coal will continue to be the cheapest fuel source, but one that has high environmental and public health costs. The MIT folks say that a carbon tax of $5-$10 per ton would be sufficient to switch the economics to their unconventional gas plant. Unfortunately, there seems to be little political will to start switching over from King Coal.


I get very concerned when I hear about shale gas and other unconventional sources as being our salvation, and I also believe that carbon sequestration is equivalent to having a high school biology class learn anatomy by doing brain surgery. There are much easier ways to make a dent in our carbon budget, and a switch to gas in power generation is a solution with which we already have a lot of experience.

The bets placed by Exxon Mobil and now by Chevron reflect, in part, some of these strategic market dynamics.

Monday, November 8, 2010

Join the Club, or Not.

President Obama's trip to India was overdue, and it seemed to have all the usual bells and whistles. Today came a big announcement: the United States supports the notion of India becoming a permanent member of the United Nations Security Council. There were smiles and warm fuzzies all around. President Manmohan Singh beamed, the Wall Street Journal reported.


There's just a few problems with the invitation to join this exclusive club. First, there was the suggestion that India should initiate a rapprochement with Pakistan first. This is unlikely to be of real interest to the powers in Islamabad; meaning the ISI, the Pakistani military, the Pakistani Talaban, and the weak central government. Pakistan and its enablers will not abide India's membership. Next, there was the suggestion that India could join after the Council restructured. It's unlikely that the current permanent members have any interest in doing this, except.....


Permanent members of the Security Council each have the power of the veto over any resolution that is politically unpalatable. "Restructuring," among other things could make some future permanent members of the Council join without the veto right. In other words, it's back to the image of barrister Mohandas Gandhi boarding a railway train with a first class ticket and being sent to steerage. Some are more equal than others. "The world is a ghetto," as the song by War goes.


Even though Indian educational, scientific and cultural exchanges with the Peoples Republic of China have been on the upswing for years, China is definitely not in favor of India becoming a permanent member of the Security Council. The PRC has both philosophical and pragmatic reasons for not wanting to share the global political platform with India, its neighbor and friendly rival.

Put this altogether, and the offer today to support India as a permanent member of the U.N. Security Council is nothing more than a photo opportunity and an empty promise.


On a different topic, the nicest images of the Obama visit are the President and the First Lady interacting with young children at different sites. They both are clearly enjoying meeting the kids and engaging with them; the kids are clearly pleased to see the First Lady and President of the United States as people with similar skin colors. Travel, even in the cocoon of a Presidential visit, can make deep impressions. This is good stuff, and over time good things may emerge from "First Contact."

Move My Office

If this keeps up, Federal Reserve Chairman Ben Bernanke should move his office to the White House. The cacophony about QE2 continues to undermine the Fed's independence and role in monetary policy, as it appears that there is now a philosophical divergence between the Federal Reserve Chairman and a number of Governors, who appear to be talking more like traditional central bankers.

Let's think about traditional, non-monetary sources of inflation, apart from commodity price shocks and one-time events. Pressures from non-monetary sources should be reflected in capacity utilization rates in key industries, or in labor market measures, such as hours worked, overtime, unfilled job orders, and hourly labor rates. On all of these measures, there is no evidence of imminent inflationary pressure to be found. In the Chairman's own words, "We see an economy which has a very high level of under utilization of resources and a relatively slow growth rate."

What's fundamentally wrong with the continuing reliance on monetary instruments like QE2? Fed Governor Kevin Warsh, quoted in today's Wall Street Journal, says, "The Federal Reserve is not a repair shop to fix broken fiscal, trade or regulatory policies." It is, however, acting as if it were such a repair shop, providing band aids for the continuing lack of any coherent fiscal policy initiatives to improve capacity utilization, investment, or the labor markets.

Chairman Bernanke has made comments about the effects of negative real interest rates helping consumers repair their balance sheets by driving equity prices higher. I thought we should have learned from former Chairman Greenspan's tenure that this isn't the brief of a central banker. The late Nobel Laureate economist Milton Friedman would be jumping up to object to this line of argument as well. For the broad swath of U.S. consumers, higher equity prices are primarily reflected in the market values of their 401(k)'s. Unless they were to take out loans against these, they should have no impact on consumption. In Friedman's theory, they would look through this paper effect and conclude that there was no true increase in their permanent income, and hence they would not raise their consumption levels. This entire line of reasoning is misguided and off-target.

Where the Fed's QE initiatives appear to be succeeding is in driving down the value of the U.S. dollar, and creating a new carry trade where the funds are flowing to emerging markets and commodities. Unfortunately, these policies stimulate reactions by our trading partners in a negative feedback loop. So, Wall Street wins and Main Street continues to have the street lights out. Let's see if an emboldened Republic leadership and a chastened Democratic leadership can cobble together some meaningful budget reductions and fiscal stimulus that encourages investment. That would be nice.

Tuesday, November 2, 2010

Closing the Book on JOE

I listened to the third quarter earnings conference call by the St. Joe Company, and I have to close the book on this story, but here's what I noted. After the usual formalities, and before the
Q&A, the CEO gave a verbal overview of the company's historical evolution and business strategy; he seemed to be doing an elevator pitch to answer the question, "What is St. Joe?" It is something that needs to be done on a grander scale and on a more thorough basis in their public disclosures. I'm sure that their shareholders encouraged something like this. It was a good start, but less than effectively realized.

Next, the CFO gave a very dryly formulated description of their impairment review process for long-lived assets, concluding with the statement that the process showed their long-lived assets to be appropriately valued at the end of the third quarter. The external auditors were cited as reviewing the analysis and process, although it was not clear what period the review covered. Later in the call, the CFO noted that the company had taken $196 million in impairments over the past three years, meaning that it was not averse to taking write downs where warranted. Again, it's good to deal with the issue directly, but it could have been done in the context of a positive statement about shareholder value.

The company did address at least two points that were covered in the Greenlight Capital presentation by David Einhorn. The first was the suggestion by Greenlight that Southwest Airline's investment in gates at Panama City International Airport was in tatters. St. Joe, which is on the hook to make up any Southwest losses for three years, noted that the Southwest Airlines investment in the gates was "profitable from day one," and that the third summer quarter exceeded the airline's expectations, generating the best profit since the signing of the agreement. There's no doubt that the talcum powder, white sands of the Florida Panhandle could make an attractive tourist destination, but the key questions are "For how many people with what kinds of budgets?" and "When?"

The second point addressed the suggestion by Mr. Einhorn that St. Joe had given away access to the airport site to the airport authority and now needed to get "through the fence access" in order to share in future development rights. On the face of it, this seemed like a giveaway. In fact, this isn't true, according to the company. Through the fence access rights were reserved to St. Joe and enshrined in the original agreement with the airport authority, and rights conferred on the authority were limited to the development of aviation infrastructure, such as runways and supporting structures.

The analyst questions from Raymond James, Keefe Bruyette Woods, JMP Securities, and Morningstar were alternately fawning, vague, and unlikely to produce research that would generate additional institutional ownership. Towards the end of the call, one analyst dwelt tediously on the specific lease terms for a single CVS drugstore, as if this by itself made any difference to the valuation of the company or its prospects. My advice to the company would be to work hard on telling your own story better, with clear financial metrics.

There was a question about cash burn rates relative to $196 million in cash and when the company would get to profitability. Unfortunately, the CFO didn't really complete the answer to the question. If I understood, his comment was that cash S,G&A expense, excluding one-time items, declined 21% year-over-year, so the management had their eyes on the till. He didn't venture a forecast on profitability.

We're going to close the book on this JOE story, but I wouldn't expect to see the company gaining additional shareholders until the runway to shareholder value creation becomes visible.