Saturday, December 31, 2011

$100 a barrel oil in 2012 Seems Unreasonable

  Everyone in the economic forecasting business is admitting that they had the 2011 worldwide GDP growth forecasts all wrong, and that goes from the Federal Reserve to established investment bank and private forecasters, and to all the talking heads on television, who crib their numbers from others anyway.

China is slowing significantly from its 8% rate of GDP growth, Europe as a whole may be slipping into an actual recession, and U.S. forecasts for 2012 are moving towards a 1-1.5% GDP mid-range estimate.  The auto industry commentators are noting fewer miles driven by domestic motorists.  Truck miles are not really growing, partly because of growing efficiency by the largest operators and retail owners like Wal-Mart, and by economic factors in 2011. 

I understand that Iran is threatening to block shipments through the Strait of Hormuz, but this seems like empty saber rattling, since the entire world knows that too much energy flows through the strait for this to be permitted.  In fact on December 28th, a communique from the U.S. Fifth Fleet said the following: "Anyone who threatens to disrupt freedom of navigation in an international strait is clearly outside the community of nations; any disruption will not be tolerated."

Meanwhile, a few propaganda pictures allegedly of Iranian submarines on naval maneuvers appeared on Internet news sites.  Honestly, the pictures reminded me of my eighth grade history book which had charcoal and pencil drawings of the Monitor and the Merrimack at the Battle of Hampton Rhodes.  I don't believe that these vessels provide a credible threat that would justifyr the "20-$30 a barrel risk premium" some analysts suggest are in oil price projections. 
Again, what exactly is driving a forecast of $100 a barrel oil in 2012?  A reasonable hypothesis?  A world awash in liquidity and market speculation.  Another interesting issue is the collapse of natural gas prices in the U.S., driven by high inventories and a mild winter.

The above graph comes from Professor Mark Perry's blog, Carpe Diem.  It inputs the record low prices reported in today's press, such as the New York Times.

We've talked about natural gas in many previous posts as being a fuel that should gain market share, particularly in electricity generation, for several reasons, including price and lower greenhouse gas emissions associated with using the fuel.  Now the price differential borders on incomprehensible, even before the 2012 petroleum forecasts. What gives?

If there are intrepid forecasters out there who could explain $100 a barrel oil for me, I'd love to hear from you. 

Thursday, December 29, 2011

A Lump of Coal for the Fed

 A blogger at Wall Street Rant called attention to a full release of the Federal Reserve's Emergency Lending Program 2007-2009.  The charts he shows were from a Bloomberg analysis of a half trillion dollars in currency liquidity swaps which did not identify the borrowers who used this facility. Soon after this, the Wall Street Journal carried both a video and and article by Dr. Gerald O'Driscoll, formerly a VP of the Federal Reserve Bank of Dallas, in which he triangulates about $100 billion in currency swaps which most probably went from the Fed via the ECB to reeling European banks in the period from early December to about December 21, 2011.  Joyeux Noel to our European brothers and sisters from our Federal Reserve!

After all the monetary Three Card Monte which the Fed has played to keep interest rates low, make bank bondholders whole, pad the compensation of global bank executives, reward the risk trade, penalize savers and force them to risky assets in search of return, I say " a lump of coal, Bob Cratchett!"  It is heartening to know that the Fed promises to be more transparent, which is just as valuable as the Federal Government promising to be more fiscally prudent. 

Dr. O' Driscoll says in his video interview that we probably don't know which European banks are the most vulnerable, and that's true.  However, we can make some educated guesses.

The V-Lab Group at Stern School of Business runs their global risk list in two ways: (1) simulating the effects on the global financial sector of a a 40% semi-annual market decline, and (2) without the cataclysmic simulation, measuring  the change in risk profiles assuming a 2% daily market decline.  Without the simulated cataclysm, the biggest risk banks are European banks: Deutsche Bank, BNP Paribas, Credit Agricole, Barclays, followed by Bank of America to break the European streak, and then HSBC, ING, and Societe Generale.  None of these names are too surprising.

With the cataclysmic simulation of a market meltdown, the ultra high risk banks are the US, global TBTF ("too big to fail") banks: Bank of America, JP Morgan Chase, and CitiGroup.  Nothing much is too surprising here either.

So after all the meetings, the trans-Atlantic shuttle bank diplomacy, and all the posturing among European leaders and the IMF, it seems that the global system is just as risky, if not more so, than we were at mid-year 2011.  Our markets had a Santa rally, and finished with a hangover.  "God bless us all, every one!"

More Blues at Sears

Back in February, in a post about the dubious benefits of shareholder control, we noted Sears as an example:

"The recent case of Sears comes to mind. Much was made, rightly so, of the fact that the management simply couldn't run or merchandise stores very well. Shareholders voted with their feet and sold the stock. The story then became the value of the underlying prime real estate that Sears owned or controlled. Meanwhile, another terrible cast of executives were busy fiddling while Kmart burned slowly. Enter hedge fund manager Ed Lampert who took control of Sear merged it with Kmart, while confusing both sets of customers, who were distinct segments of consumers. Years later, Sears' repeated experiments with soft goods have failed miserably, but we didn't need to a change of control to know they couldn't execute. The appliance and home and garden segments are still the reason most people enter the store. An iconic brand of American retailing seems on the precipice of going the way of Woolworth, W.T. Grant and Montgomery Ward. Last year ended with Sears comps down 6% for December and 3.8% for the year. The environment in Sears stores is positively funereal. Most of the analysts have downgraded to neutral or under perform, with a few sells. Has shareholder control been beneficial in this case? I don't believe so."

Recent results, along with a relatively small number of store closings, raise more questions than answers for me.  It seems clear to me that Ed Lampert has no real interest in turning Sears around, which will require investment in systems, store remodels, and a savvy, motivated management, which means more lousy quarters until a turnaround could take effect.  By the way, CBS MarketWatch "Lump of Coal" winner Bruce Berkowitz initated his large purchase of Sears for Fairholme Fund because of the investment by Lampert.

Here's what Berkowitz had to say about Sears back in 2008:
"I (Berkowitz)  think that he's (Lampert)  going to do it. And it's very reminiscent of what happened with Warren Buffett and Berkshire Hathaway in the early days (a laughable analogy!). If you play back the tape, Warren Buffett bought into Berkshire Hathaway, a textile mill, and he took many years to try and turn it around. He had deep respect for the employees; he really gave it his best shot. And then when he realized it wouldn't work, he then started to redeploy the assets and the free cash that was coming out of this industry that was destined to die. And that's how Berkshire Hathaway started.

Sears is the same situation. Sears has a great real-estate portfolio, and people are behaving as if it can only be used as retail space. And they have brands; some of them are quite good. The company has over $50 billion of revenue and is making money, and people are acting as if it's a company that's bleeding to death. People aren't looking at it in the right way. They are measuring it based as a retailer, and they are measuring it based on short-term net income profitability. But there are many more dimensions to Sears. Real estate can have a higher and best use. Today's anchor to a mall can be tomorrow's multipurpose, multiuse building where you can have office buildings, retail, and residential spaces."

Of course, the best thing that could happen would be that he turns around Sears and Kmart and it's a grand-slam home run. The worst thing that happens is he gives it his best shot and starts to find higher and better uses for all of the assets, from land to trademarks to online. If you can see three or four different ways where you can make an awful lot of money with a guy who has a record of making an awful lot of money, it's not such a bad thing."

What's the end game here? As a retailing story it has the familiar feel of Mervyn's or Monkey Ward's before they succumbed to liquidation.  I can't help but feel, without doing the analysis, that it has to be a vulture real estate transaction at the end game.  Right now, for example, we are just beginning to hear about rising demand for non-hospital medical real estate, for all sorts of specialty clinics and diagnostic centers.  There is also some suggestion that demand for non-conventional educational space may spill over into traditional shopping centers.  Sears still has lots of visible, high traffic anchor locations with good parking facilities. 

If traditional institutional shareholders throw in the towel and become apathetic, that's the perfect environment to prepare for a series of maneuvers that creates value for those who bought the stock right and who are willing to wait. 

Wednesday, December 21, 2011

Deutsche Telekom: Still Nobody Home

U.S. markets are in an uproar about the failure of the ATT-DT deal for T-Mobile.  The management of Deutsche Telekom has, in our opinion, bungled its US investment right from the start.  An acquisition of Sprint by one of the U.S. wireless behemoths has already been deemed anti-competitive, as has now the acquisition of T-Mobile.  If maintaining some semblance of competition is important then some sort of partnership between T-Mobile and Sprint would seem to have the best potential for regulatory approval, as well as offering opportunity to add value. 

In all the talk, the fundamental problem is being overlooked: the U.S. wireless industry is killing itself slowly with its irrational pricing paradigms.  New customers are lured in with money-losing deals, while the most profitable customers are left to themselves, with the option of switching to get one of these deals.  Much of the movement to Sprint among people I know was driven by their irrationally priced "all in one" plans with unlimited data access.  Most of these people complained about the phone coverage but suffered it for the data plans.  Not surprisingly, Sprint gained lots of prepaid subscribers, but lost money, which is not a recipe for sustainable value. 

Surely, data plan users should be charged by the volume, time period, speed, and types of data that they are downloading over cellular networks.  Gas and electric utilities charge by the time period and time of year, since everyone accepts that it is the cost of building and sustaining the peak load capacity that has to be paid for at the margin. Cable is different because of the monopoly status of local carriers and the fact that their networks were built with generous subsidies.  Wireless is really just another utility.  Credit Suisse too notes the elephant in the room: "declining profitability of the whole U.S. (wireless) market." 

Sprint's disastrous commitment to buy 30.5 million i-Phones for $20 billion will keep the company in the red until 2014, according to the Wall Street Journal and other sources.  T-Mobile, by contrast, is projected by Credit Suisse to generate $5 billion in EBITDA or better in 2011, which would meet or exceed early 2011 guidance. Credit Suisse, which has recently reinstated coverage of DT, projects 2012 EBITDA of about $5 billion for T-Mobile, despite negative industry fundamentals and economic weakness.  This is pretty good performance in the face of strategic and operational mismanagement from the parent company.  An acquisition of Sprint would not make financial sense nor would it pass regulatory muster. 

Performance of the DT parent is another story altogether.  DT sports a 7.9% dividend yield today, and the German government's large stake in DT precludes management from pursuing any strategies that might add shareholder value but that would require reducing the dividend.  According to Credit Suisse, the ROIC for DT will be in the 5% range for 2012 and 2103.  The stock is rated by Credit Suisse as "Underperform."  All of this complicates the future of T-Mobile and puts its valuable franchise at risk.  U.S. regulators should be working proactively to ensure that corporate inaction or irrationality does not inadvertently make the U.S. wireless industry anti-competitive. 

However, a partnership makes sense, with perhaps Sprint differentiated as the "Wal-Mart of Wireless" and T-Mobile as the preferred brand for price conscious, loyal postpaid customer who wants a global network.  Data hogs should be priced so they either pay their freight or go to Verizon where they will generally pay more for their plans anyway.  A partnership would only work, in my opinion, if (1) it went away from encouraging adverse selection and churn by only talking price; (2) stopped letting the data hogs crowd profitable users out of the trough, and (3) the partnership didn't cut costs to the point where the service culture of T-Mobile disappeared.  Good people are leaving T-Mobile in droves.  This would have to stopped and the company would have to find a way to become a "hipper" organization to work for as opposed to say, ATT. 

Credit Suisse opines that after the failure of the ATT-TMo deal, TMo is left with "more spectrum, less debt, and a bigger range of U.S. options." We have always believed this to be the case, as it certainly is now.

Monday, December 19, 2011

A Lump of Coal For Fairholme

MoneyWatch's Bruce Jaffe today bestowed a 2011 "Lump of Coal" award on  Bruce Berkowitz of the Fairholme Fund.   It's a funny piece, and it's tongue-in-cheek, but this is serious business.  Both retail investors and 401(k) programs can wind up putting bad investment options into their portfolios because of the inordinate market influence of  ratings from Morningstar and Lipper. 

Any investment manager, even the good ones, can have bad spells, sometimes prolonged.  However, if their discipline and process are consistent, and they learn from the mistakes, investors may choose to stay the course and not lose their shirts. Ratings ought to talk more about fundamentals than personalities.  MarketWatch notes that Fairholme is down about 30% year-to-date, and given the continuing uncertainty about how the fund is managed, perhaps Morningstar should consider taking back their Manager of the Decade award, just as college football programs vacate results for NCAA violations!

Footnote: Another example we cited in our earlier post was Fairholme's curious bet on Bank of America, which  is flirting with breaking $5 per share in late trading.

Sunday, December 18, 2011

Bond Stats Suggest US Economic Improvement

Ward McCarthy's Fixed Income Group at Jeffries (JEF) issued their bond market update last week.  To follow up our previous post on China's ability to forestall a hard landing, JEF had some good statistics from the U.S. Treasury on foreign holdings of Treasury securities.  As of the October 2011 reporting period, China's holdings of U.S. Treasury securities were $1.134 trillion.  The next biggest foreign holders were Japan at $979 billion and the U.K. at $408 billion.  Chinese holdings represented 24% of total foreign holdings, which might actually be an underestimate of their holdings because of the consistent upward revisions to Chinese holdings in the past. 

Total Chinese holdings of foreign assets may be in excess of $2.5 trillion, although this estimate is not  for the same period from the U.S. Treasury.  The point is the same made in the previous post: there is a lot of high powered money to be put in service should the Chinese economy be subject to severe economic stresses from a collapse of its export markets in Europe and the U.S. 

McCarthy's group was fairly pessimistic about the U.S. recovery back in August, but they note that some bond market technicals suggest that bonds are discounting modest improvement in the U.S. economy from here.  They note, for example, JP Morgan's issue of a 30 year bond with the lowest coupon of any high quality, financial issuer since 2005.  JPM's coupon of 5.40% was 250 bp above the 30 year T bond. The group also suggests that investor appetite remains strong for high quality corporate paper in the primary market, particularly from financial issuers.  Go figure, but it's interesting data as the high quality corporate market winds down until Q1 2012.

Friday, December 16, 2011

China's Future: Western Optimism and Chinese Pragmatism

Back in March, we posted about a declining phase in Chinese growth and the need for a new economic model.  Hedge funds which have made bets on a "hard landing" for China are likely to be disappointed.  The reasons are rather simple.  In Western financial markets, shocks are transmitted quickly through financial speculation, markets turn volatile and overshoot before a new equilibrium is found.

This scenario shouldn't apply to China.  Investments are controlled by the government and directed into jumbo, state run enterprises.  The government is sitting on vast hordes of liquid currencies and securities, and the currency is managed.  Financial markets are not all transparent. Numbers cannot be trusted. Look at the long running fiasco at Sino Forest, which would have collapsed within weeks on any major international exchange.  Sophisticated investors are as powerless as retail investors in a pink sheets stock. 

The Chinese landing won't be a hard landing.  It will be more like a King Air that loses both its engines.  If the Chinese government is a good pilot, the plane will continue to fly and glide to a landing, perhaps with some bumps at the end.  This isn't to say that there won't be  prices to be paid among segments of the Chinese population.  The private sector folks who have made quick fortunes on light manufacturing will be chastened by recessions in their customer countries.  Since the Chinese model is a mercantilist, managed model with humongous external balances and muted internal demand, a steady hand on the stick can bring the plane in. 

The longer run question is what happens when China continues to pursue its own nationalistic, pragmatic interests.  Isolation from the international community could be an unintended  and undesirable consequence.  We've written before about sweeping Chinese claims in Pacific waters around contested islands.  In the absence of an operative Law of the Sea Treaty, the U.S. has no basis to dispute any of these claims, except to object and refer to customary international law. 

As an example of China's thumbing its nose at Western trade management mechanisms, we have the Chinese government slapping tariffs and anti-dumping charges on SUV's exported by General Motors.

    credit: David Gray/Reuters in New York Times, 12/15/2011
Even though the Government is said to have conducted a two year study into the issue of subsidies and dumping, their results weren't shared with the Office of the US Trade Representative, even as a courtesy. 
With the already high levels of taxes and fees, GM's commitment to this potentially lucrative market is likely to yield no results in a profitable vehicle line.  Meanwhile the sight of its Buick SUV's covered in dirt and clay on a Chinese pier does nothing for the brand equity either.  Don't think that this little poke in the eye wasn't carefully orchestrated. 

Besides indignation, the U.S. has no meaningful response, except pushing papers and filing claims.  There may not be as much gold in Shangdu as hoped for GM and other US exporters.

Sunday, December 11, 2011

Mutual Fund Ratings Need Lots of Work

Morningstar and Lipper are the market leaders in mutual fund ratings, just as Standard and Poors, Moody's and Fitch are for credit ratings.  Their benchmarks for mutual fund ratings are widely used by sponsors and consultants for corporate defined contribution plans. 

Morningstar uses traditional MPT statistics in their evaluations, but the reports are still like beauty contests, formerly based on "stars" and now on a fuzzier system of "Gold," and "Silver."  Even funds which have mediocre performance and high expenses are not rated "Sell" or "Avoid."  In this way, the ratings have the same issue as sell-side equity research: too many 'buys" and few "sells."   For an illustrative example,  I want to focus on two well known funds with large asset bases, Fairholme and Sequoia.

Both of these funds have received accolades from Morningstar: Fariholme's founder and manager Bruce Berkowitz was named "Manager of the Decade," and Sequoia's co-managers Bob Goldfarb and David Poppe were named "Domestic Equity Managers of the Year for 2010." 

In the case of Fairholme, the meteoric rise in assets under management is well documented, but hard to understand. Fairholme created a catchy slogan for itself, "Ignore The Crowd."  It suggests a Warren Buffet-like value investing, or contrarian discipline. 

While Fairholme's assets were growing, I visited their website many times and even printed out the fund literature.  Besides the slogan, I couldn't understand what kind of analyst support was there for all the contrarian stock picks.  When Morningstar talks about the T. Rowe Price funds, by contrast, the Morningstar analysts often comment about the size of the analyst staff supporting the manager of a T Rowe fast-growing fund. 

Managing money, at the very root of the process, requires experienced, diligent, market savvy, financially and analytically sophisticated analysts who aren't afraid to challenge market valuations and assumptions.  Looking at Fidelity Management and Research, for example, the manager who oversees FMR's single biggest slug of assets with a long, consistent and distinguished track record is Will Danoff.  Will was Fidelity's retail sector analyst early in his career, when I called on him from the sell side.  Will Danoff, Rich Fentin and other portfolio managers who were former analysts, would always come to meetings with notebooks in which they had carefully recorded data from every previous interaction they had about a particular stock and about the company's management team.  You always had to be on your toes and remember your previous conversations with them, because they certainly did with those composition notebooks! 

Fairholme, by contrast, was always a black box.  Assets continued to pour in, the fund rode the market upward, and more assets followed.  Then came a series of peculiar investments, St. Joe, and Bank of America, which we have written about in earlier posts on this blog.  One of the funds periodic reports had a puff paragraph about St. Joe being a real estate play on the Florida Panhandle becoming the next Riviera, after a new international airport was built, on land adjacent to St. Joe holdings.  Sounds good, but it didn't pan out, and Bruce Berkowitz eventually became Chairman of St. Joe in a bizarre turn of events. 

Then, after saying that financial stocks were black boxes with poor disclosures and questionable asset valuations, Fairholme plunged into a large position in Bank of America.  What was this based on?  What changed in the philosophy towards megabanks?  This investment also culminated in a farcical conference call sponsored by Fairholme with the hapless Bank of America management.  The call was supposed to clear the air with Wall Street by allowing the skeptics to ask their toughest questions.  Nothing of the kind happened, and the stock went down right after the call. 

Soon after that, came the soap opera surrounding the departure of the mysterious Charles Fernandez, who was made co-manager of Fairholme Fund, director of the Fund, and President of the management company in 2008. I couldn't find anyone in the investment management business who knew anything about Fernandez.  This strange appointment raised no alarms among the fund rating companies.  In the fall of 2011, Mr. Fernandez left in more public, but equally mysterious circumstances to his arrival.  We'll stop here, but remember that through this long time period, Morningstar gives their rating of  Manager of the Decade to Mr. Berkowitz.

All the while, investors who rely on Morningstar got no insight into the people, processes, culture, analyst support, and compensation at Fairholme Funds.  However, reading analyst reports on other funds and fund families, those kinds of items were covered, to some extent.

Switching to the Sequoia Fund, the fund management company Ruane Cunniff Goldfarb has a long history, dating back to the predecessor company, Ruane Cunniff, co-founded by legendary value investor Bill Ruane, who I had the pleasure to meet and call on early in my career as an analyst.  The philosophy behind the Fund was, and remains, a Graham and Dodd, fundamental value approach.  Turnover is extremely low, which is beneficial both for trading expenses and for taxes. 

An interested investor, or an analyst at Morningstar or Lipper, could find decades of financial press and fund publications all telling an unchanging story about the approach and culture of the management company.  The importance of people, namely analysts, was always stressed.  Process was evident.  Sequoia had a long period of under performance relative to its peers, in the large value segment.  It held way too much cash for my tastes, something which I don't understand when you're collecting a healthy fee; its concentrated portfolio was dominated by holdings of both classes of Berkshire Hathaway. 

The bottom line is the fund continued to be managed according to its philosophy and beliefs.  Eventually, day-to-day management of the fund passed to Bob Goldfarb and David Poppe. Nothing changed.  However, when markets collapsed and valuations came in, the portfolio was transformed pretty dramatically.  Now the fund is classified as a Large Blend fund, because it has some growthy stocks in it, as opposed to down and out value plays.  People, process, philosophy, culture, analytical support, and compensation were all transparent and consistent.

I read carefully the published transcript of their Analyst Day, where the fund managers and analysts are made available to answer investor questions about their stock positions and anything else on the minds of the owners. An investor can count the number of analysts, learn their names and read about them speaking about valuation techniques and about the investment thesis for a stock they recommended. This transcript  is supplied by the management company, and so an owner doesn't have to mount a due diligence effort or rely solely on fund rating companies. 

 The fund rating companies seem to be putting out journalistic marketing pieces and are inconsistent in how they treat different funds.  There are no "Sells" in their research, which is something for which sell side equity research was castigated.  They can and should do a much better job.

Friday, December 9, 2011

Guaranteed To Fail: A Great Analysis of Systemic Risk

Guaranteed To Fail is one of the best books on the global financial meltdown and its aftermath. If you have any interest in these issues, I offer it as recommended reading. It reflects some pioneering applied research by Professors Viral Acharya, Matthew Richardson, Van Niewerburgh, and Lawrence White. It is concise and well written.  Many of the points they make have been corroborated by other reputable researchers in the field, and their final achievement is the establishment of the Stern School V-Lab, which is an analysis of systemic risk to the global financial system far superior to the banal and manipulated models  like VaR and self-administered bank stress tests.

We know now, for example, that in recent times of financial crisis, correlations among asset classes have converged, thereby vitiating the traditional benefits of portfolio diversification.  We also know that individual security betas and correlations within sectors like the banks change dramatically; yet, most published estimates of these betas and correlations are poor estimates and misleading for policy and financial management.  The Stern V-Lab does daily estimates of all these factors using a variety of powerful modeling techniques, and it uses them to generate daily estimates of systemic risk and the contribution to systemic risk by individual banks.

Acharya et al focus on the role of  the Government Sponsored Entities(GSE's) Fannie Mae and Freddie Mac in the crisis, noting that they were run as the largest hedge funds on earth.  The GSE's were run at a gearing ratio of 39:1!  The authors note that 15% of the mortgage purchases went to low quality mortgages, totalling $1.7 trillion.  These estimates are very consistent with findings of the Congressional Research Service and by Professor John Coffee of the Columbia University School of Business. 

In addition to leverage issues, the GSE's woefully undercharged for their mortage backing service.  They charged $0.20 per $100 of mortgage assets, which still allowed the entities to record revenues of $7 billion. They were also woefully underreserved by design, since this highly leveraged business model maximized executive compensation, which was built on private industry comparables. Reserves were built at $0.45 per $100 of mortage assets. Please refer to the above discussion to recall what they were buying. 

According to the CRS, "In broad terms, the GSEs purchased slightly more than $169 billion of private label subprime MBS in 2006 and 2007; they purchased slightly less than $58 billion of Alt-A MBS in the same time period out of combined total mortgage purchases of $1.677 trillion. At the end of 2007, the subprime and Alt-A MBS represented 13.5% of the GSEs’ total assets."   These assets, purchased under political pressure from Congressional leaders and by private originators like Countrywide Financial, were among the most toxic in the marketplace. 

The authors note that the 2007 vintage had 23% of loans with equal to or greater than 80% LTV and 18% with FICO scores below 660.  The 2006 vintage was composed of 23% subprime mortgages and 15% interest-only loans.  These vintages were purchased in a concentration of zip codes which had historically poor mortgage performance, according to an analysis done by the Columbia Business School. 

Former Federal Reserve Bank of St. Louis President Bill Poole, a Professor at Johns Hopkins when I was a graduate student, noted in this week's conference at the Witherspoon Institute  that the big bailout costs have been for Fannie Mae and Freddie Mac.  According to his estimate, they stand at $150 billion and counting. 

In the Stern book, the authors quote Minneapolis Fed President Narayana Kocherlakota as saying that the Federal Reserve's balance sheet in twenty years will likely still have $250 billion of mortgage backed securities on the books.  Unwinding the Fed's $2 trillion balance sheet will not be easy, as we've written about before. 

Right now, 59% of all financial sector liabilities are underwritten by taxpayers in some way.

Having at look at today's V-Lab, among the Global Systemic Risk Top 10 Banks, we find at the top in descending order, Deutsche Bank, BNP Paribas, Credit Agricole, and Barclays plc.  We find a German bank, two French banks, and a British bank.  No European capital will be immune from the ongoing stalemate in the euro crisis, whether in the currency union or not.  Incidentally, Bank of America is also in the top 10. 

It's great food for thought, and if you're so inclined, beyond reading "Guaranteed to Fail," have a look around at the V-Lab. 

Friday, December 2, 2011

Got Shale?

Let's start with a simple picture about the natural gas picture in the United States.  According to the Energy Information Administration, 2009 proved reserves of natural gas were 284 Tcf (trillion cubic feet).  Proved reserves are those volumes of natural gas that "geologic and engineering data demonstrate with reasonable certainty to be recoverable under existing economic and operating conditions."  Proved reserves are what we know is out there, and what we can recover without subsidies or experimental technologies. 

69% of the proved reserves are within the lower 48 states, of which 183 Tcf are onshore and 13 Tcf offshore in the Gulf of Mexico.  61 Tcf are said to be proved reserves in shale, or 21% of the total proved reserve base.  Shale has always been classified among "unconventional resources," along with coalbed methane and tight gas.  Shale's proved reserve totals have grown sharply in recent years, coinciding with the beginning of their separate reporting in 2008. 

It would be interesting to look at the methodology and cost estimates that went into describing the "current economic and operating conditions" for shale.  We have such patchy data and limited history, but even with all the hoopla, shale reserves are at best 21% of the proved reserve base.

When one looks at production of natural gas in the U.S., shale weighs at 14-20% of production, depending on the year and the way the data are reported. 

Let's pursue the 69% of our natural gas reserves that in the lower 48. How's that for an idea!  Let's forget BP and take the freeze off operations in the Gulf of Mexico to grow the production and reserve base out there.  There's plenty of onshore gas, according the EIA statistics, in Texas and other southwestern states. 

Imports currently account for about 11% of domestic consumption (again the number might vary slightly).  Gas prices have been flat and appear to be falling.  In an environment of falling prices, it's not good economics to produce from sources which may  have higher total costs, especially external, environmental costs like shale. 

The New York Times reports today about situations in Pennsylvania where landowners sign leases for gas production in order to get a steady monthly income stream; now the owners find their drinking water contaminated, and tailings from the drilling left on the property and simply reseeded.  The companies tell then, "It's your problem, now." These owners are at a tremendous information disadvantage when dealing with the gas companies, which are behaving almost as badly as those in the original  Pennsylvania oil rush. 

Shale, in some ways, seems just like the ethanol gold rush.  We jump headlong into an energy source of marginal economic, social and environmental value, with lots of consequences that were poorly understood while trade associations  beat the drums and regale the politicians. Sound familiar?

Even for natural gas, we may be able to be relatively energy efficient simply because the economic forecasts are for flat to down gas consumption in the coming years due to the lingering economic slowdown and energy saving efforts. There are large supplies of LNG that could be imported, for which we have the capacity and which would have few environmental issues.  Going for zero gas imports, given the alternative of ramping up shale production doesn't seem like an obvious trade-off to me. 

How about some more nuanced and thoughtful discussion of these issues?