Monday, February 29, 2016

One-third of retail jobs to vanish by 2025

Britain’s retailers predict that almost 1m jobs in the sector — a third of today’s total — will disappear by 2025 as technology and the rising minimum wage reshape the industry.
Retailers currently employ one in six British workers — about 3m people — and the sector accounts for a tenth of the economy. 

But the British Retail Consortium, the industry’s trade body, believes that higher wage costs coupled with improved productivity will result in “fewer but better jobs” in the near future.
The BRC said up to 900,000 retail jobs would disappear within a decade and warned that small businesses and poorer areas would find it hard to adapt.
“What matters is who and where will be affected most by all this change,” said Sir Charlie Mayfield, chairman of the BRC and John Lewis. “These are the valleys to cross and the path through them needs to be charted with care.”
Leading retailers approached by the FT, collectively employing a quarter of the sector’s workers, declined to say whether their own plans were in line with the BRC’s striking forecast.
Dave Lewis, Tesco chief executive, said: “The combination of price deflation, business rate rises and growing labour costs is putting increasing pressure on a highly competitive sector which is already going through a time of great change.”But Sir Ian Cheshire, chairman of Debenhams, said there was “no doubt” the industry was changing fast and “there will be fewer retail jobs in the future”.
Industry analysts said that, while fewer people would be employed in traditional stores, the shift to online shopping would create jobs in call centres, technology operations and delivery networks.
The BRC’s warning comes a month before the introduction of the “national living wage” (NLW) — the government’s name for a new £7.20-an-hour minimum wage for those aged 25 and over that will reach £9-an-hour by 2020, one of the highest in the developed world.
The retail association said the projected rise — while not the only factor driving its job projections — would increase labour costs and accelerate the industry’s shift towards automation and online retail.
“The retail industry is supportive in principle of the NLW but the effects on employment have been underestimated,” the report said.
Some US retailers have already moved to paying higher wages, gambling that customers will reward shops where higher-calibre employees offer better service.
Walmart this month started paying its most junior US staff $10 an hour, nearly 40 per cent more than the federal minimum wage of $7.25. “Our customers and associates are noticing a difference,” said Judith McKenna, chief operating officer of the US business.
In the UK, the official estimate is that the increase in the minimum wage will only cost about 60,000 jobs by 2020. But economists are split over how it will affect Britain’s labour market, where employment is at record highs but productivity and pay growth are weak.
George Osborne, the chancellor, believes the policy will jolt Britain out of its “low-pay, low-productivity trap” because employers will be motivated to improve training for their low-skilled staff to make them “worth” the higher pay packet.
What matters is who and where will be affected most by all this change. These are the valleys to cross and the path through them needs to be charted with care
- Sir Charlie Mayfield, chairman of the BRC and John Lewis
Retailers may also benefit from a boost to consumer spending, since Britain’s lowest-paid workers will enjoy substantial pay rises between now and 2020.
But some economists fear that companies will respond to higher wage costs by making do with fewer workers. This would also raise overall productivity, but at the cost of higher unemployment.
The BRC called on the government to give the Low Pay Commission, the body charged with monitoring the effects of the NLW policy, a stronger mandate to make recommendations on the pace of increases, taking into account of the impact on different regions and sectors. It also said business rates should be reformed and the “apprenticeship levy” — a 0.5 per cent tax on payroll to fund apprenticeships — should be phased in.
A Treasury spokesperson said, “We are already seeing record employment rates and more people in employment than ever before. And taking into account the national living wage the independent Office of Budget Responsibility expects employment to rise by a further 1.1m by 2020.”

Sunday, February 28, 2016

Should Business Travel Be Obsolete?

Think about it: You can call, email, and even watch your counterparty on FaceTime, Skype, or GoToMeeting. So why do companies fork out more than $1.2 trillion a year – a full 1.5% of the world’s GDP – for international business travel?
The expense is not only huge; it is also growing – at 6.5% per year, almost twice the rate of global economic growth and almost as fast as information and telecommunication services. Computing power has moved from our laptops and cellphones to the cloud, and we are all better off for it. So why do we need to move brains instead of letting those brains stay put and just sending them bytes? Why waste precious work time in the air, at security checks, and waiting for our luggage?  
Before anyone starts slashing travel budgets, let’s try to understand why we need to move people rather than information. Thanks to a research collaboration on inclusive growth with MasterCard and an anonymized donation of data to the Center for International Development at Harvard University, we are starting to shed some light on this mystery. In ongoing work with Dany Bahar, Michele Coscia, and Frank Neffke, we have been able to establish some interesting stylized facts.
More populous countries have more business travel in both directions, but the volume is less than proportional to their population: a country with 100% more population than another has only about 70% more business travel. This suggests that there are economies of scale in running businesses that favor large countries.
By contrast, a country with a per capita income that is 100% higher than another receives 130% more business travelers and sends 170% more people abroad. This means that business travel tends to grow more than proportionally with the level of development.
While businesspeople travel in order to trade or invest, more than half of international business travel seems to be related to the management of foreign subsidiaries. The global economy is increasingly characterized by global firms, which need to deploy their know-how to their different locations around the world. The data show that there is almost twice the amount of travel from headquarters to subsidiaries as there is in the opposite direction. Exporters also travel twice as much as importers.
But why do we need to move the brain, not just the bytes? I can think of at least two reasons. First, the brain has a capacity to absorb information, identify patterns, and solve problems without us being aware of how it does it. That is why we can, for example, infer other people’s goals and intentions from facial expressions, body language, intonation, and other subtle indicators that we gather unconsciously.
When we attend a meeting in person, we can listen to the body language, not just the spoken word, and we can choose where to look, not just the particular angle that the video screen shows. As a consequence, we are better able to evaluate, empathize, and bond in person than we can with today’s telecom technologies.
Second, the brain is designed to work in parallel with other brains. Many problem-solving tasks require parallel computing with brains that possess different software and information but that can coordinate their thoughts. That is why we have design teams, advisory boards, inter-agency taskforces, and other forms of group interaction.
Conference calls try to match this interaction, but it is hard to speak in turn or to see one another’s expressions when someone is talking. Conference calls have trouble replicating the intricacy of human conscious and unconscious group interactions that are critical to solve problems and accomplish tasks.
The amount of travel should then be related to the amount of know-how that needs to be moved around. Countries differ in the amount of know-how they possess, and industries differ in the amount of know-how they require. Controlling for population and per capita income, travel is significantly more intense to and from countries and industries that possess or use more know-how.
The countries that account for the most travel abroad, controlling for population, are all in Western Europe: Germany, Denmark, Belgium, Norway, and the Netherlands. Outside of Europe, the most travel-intensive countries are Canada, Israel, Singapore, and the United States, a reflection of the fact that they need to deploy many brains to make use of their diverse know-how.
Interestingly, countries in the developing world differ substantially in the amount of know-how they receive through business travel. For example, countries such as South Africa, Bulgaria, Morocco, and Mauritius receive much more know-how than countries at similar levels of development such as Peru, Colombia, Chile, Indonesia, or Sri Lanka.
The fact that firms incur the cost of business travel suggests that, for some key tasks, it is easier to move brains than it is to move the relevant information to the brains. Moreover, the fact that business travel is growing faster than the global economy suggests that output is becoming more intensive in know-how and that know-how is diffusing through brain mobility. And, finally, the huge diversity of business travel intensity suggests that some countries are deploying or demanding much more know-how than others.
Rather than celebrate their thrift, countries that are out of the business travel loop should be worried. They may be missing out on more than frequent flyer miles.

Friday, February 26, 2016

Man Who Called Emerging-Market Rout Has a Warning for the Bulls

If John-Paul Smith is right, some of the world’s biggest investors are setting themselves up for a major disappointment.
The London-based strategist, one of few to anticipate the slump in emerging markets that began in 2011, sees no sign of a turnaround and says the current environment resembles that of the late 1990s, when crises in Southeast Asia and Russia roiled the entire asset class. His stance clashes with bullish pronouncements from money managers including BlackRock Inc., Franklin Templeton and Research Affiliates LLC -- an adviser to Pacific Investment Management Co. that predicts developing-nation assets could become the next “trade of a decade.”
While Smith lacks BlackRock’s trillions under management and Franklin Templeton’s global footprint, the founder of research firm Ecstrat Ltd. has a track record for getting it right on emerging markets. His consistently pessimistic outlook since late 2010 foreshadowed losses of more than 30 percent in the MSCI Emerging Markets Index, while he gave early warning of Russia’s 1998 stock-market crash as a strategist at Morgan Stanley in Moscow.
“If there is a historical analogy for emerging markets at the present time, it’s with the 1997-98 period,” Smith said in an e-mailed response to questions on Thursday.
He sees two major reasons for pessimism. The first is a lack of progress in reducing the state’s grip on developing-nation economies, a key part of his bearish thesis five years ago. Smith cites Brazil’s inability to move on from “state capitalism,” a model that’s helped plunge the economy into its worst recession in a century. He also worries about Russia, Turkey and Poland, where he says policy makers are moving in a more “authoritarian” direction.
Smith’s other big concern is China, where he predicts a financial crisis will strike as soon as this year. Nonperforming loans are poised to surge as borrowers pile on debt to repay their existing loans, he says, while companies face “big” asset writedowns as the economy slows and commodity prices sink.

“There is a significant possibility that China and Brazil, in particular, will have to undergo some form of economic or financial crises,” he said.
Smith admits that yields on emerging-market debt have grown more attractive in a world of rock-bottom interest rates and says that some developing-nation currencies, notably the South African rand and Mexican peso, look undervalued. But he’s unconvinced that emerging-market bonds would be immune to economic turmoil in China and Brazil. He says investors should focus on allocating assets to specific countries rather than making blanket bets on global emerging markets.

‘False Comfort’

Such caution is at odds with a growing number of bulls. BlackRock, the world’s largest money manager, said on Tuesday that developing-nation bond buyers are being compensated for challenges ranging from falling commodity prices to China’s economic slowdown. Christopher Brightman, the chief investment officer at Research Affiliates, argued in a post on Pimco’s website the next day that emerging-market stocks are “exceptionally cheap.”
“The exodus from emerging markets is a wonderful opportunity -- and quite possibly the trade of a decade -- for the long-term investor,” Brightman wrote. The MSCI Emerging Markets Index rose 0.5 percent at 10:29 a.m. in Hong Kong, paring a weekly decline.
Shares aren’t as cheap as they seem, according to Smith, who started Ecstrat in 2014 after a three-decade career at money managers and securities firms. While MSCI Inc.’s developing-nation index is valued at 1.3 times net assets, near the lowest level since the global financial crisis in 2009, Smith says corporate balance sheets are poised to get much less attractive as firms write down the value of their reported assets.
“Against this backdrop, the superficially low level of valuations gives a false comfort,” he said. “There will be significant write-offs.”

World trade records biggest reversal since crisis

Weaker demand from emerging markets made 2015 the worst year for world trade since the aftermath of the global financial crisis, highlighting rising fears about the health of the global economy. 
The value of goods that crossed international borders last year fell 13.8 per cent in dollar terms — the first contraction since 2009 — according to the Netherlands Bureau of Economic Policy Analysis’s World Trade Monitor. Much of the slump was due to a slowdown in China and other emerging economies.
The new data released on Thursday represent the first snapshot of global trade for 2015. But the figures also come amid growing concerns that 2016 is already shaping up to be more fraught with dangers for the global economy than previously expected. 
Those concerns are casting a shadow over a two-day meeting of G20 central bank governors and finance ministers due to start on Friday. Mark Carney, the Bank of England governor, was set to warn the gathering that the global economy risked “becoming trapped in a low growth, low inflation, low interest rate equilibrium”.
His comments will echo the International Monetary Fund, which this week warned it was poised to downgrade its forecast for global growth this year, saying the world’s leading economies needed to do more to boost growth. 
The Baltic Dry index, a measure of global trade in bulk commodities, has been touching historic lows. China, which in 2014 overtook the US as the world’s biggest trading nation, this month reported double-digit falls in both exports and imports in January. In Brazil, which is now experiencing its worst recession in more than a century, imports from China have collapsed. 
Exports from China to Brazil of everything from cars to textiles shipped in containers fell 60 per cent in January from a year earlier while the total volume of imports via containers into Latin America’s biggest economy halved, according to Maersk Line, the world’s largest shipping company. 
“What we are seeing right now from China is not only a phenomenon for Brazil; we are seeing the same all over Latin America, declining [Chinese export] volumes into all the markets,” said Antonio Dominguez, managing director for Maersk Line in Brazil, Paraguay, Uruguay and Argentina. “It has been going on for several quarters but is getting more evident as we move into the year [2016].” 
Chart: World trade by volume
However, there are some signs a trade rebalancing is under way in places such as Brazil. The collapse in Brazilian imports from China has been accompanied by a rise in exports from Brazil to Asia, driven in part by a 40 per cent depreciation of the real against the dollar over the past 12 months. 
“On a global level, most indicators suggest that trade growth will remain very weak,” said Andrew Kenningham, senior global economist for Capital Economics. “But we do not believe world trade is about to fall off a cliff.”
Largely because of currency swings and a collapse in the price of commodities the value of both exports and imports fell in every region of the world last year. 
The US, where a strong dollar has been a growing challenge for manufacturers, saw the value of exports fall 6.3 per cent in 2015 while the value of exports from Africa and the Middle East collapsed 41.4 per cent thanks largely to the dramatic fall in the price of oil. 
Chart: World trade by value
Measured in volume terms the picture was not as grim, with global trade growing 2.5 per cent. But that fell below global economic growth of 3.1 per cent, extending a depressing trend in the global economy. 
Before the 2008 crisis global trade grew at as much as twice the rate of global output for decades. Since 2011, however, trade growth has slowed to be in line with — or even below — the broader growth of the global economy, prompting some to raise questions about whether the globalisation that has been such a dominant feature for decades has peaked. 

The march of the zombies: Industry in China

OVERSUPPLY is a global problem and a global problem requires collaborative efforts by all countries.” Those defiant words were uttered by Gao Hucheng, China’s minister of commerce, at a press conference held on February 23rd in Beijing. Mr Gao was responding to the worldwide backlash against the rising tide of Chinese industrial exports, by suggesting that everyone is to blame.
Oversupply is indeed a global problem, but not quite in the way Mr Gao implies. China’s huge exports of industrial goods are flooding markets everywhere, contributing to deflationary pressures and threatening producers worldwide. If this oversupply were broadly the result of capacity gluts in many countries, then Mr Gao would be right that China should not be singled out. But this is not the case. 
China’s surplus capacity in steelmaking, for example, is bigger than the entire steel production of Japan, America and Germany combined. Rhodium Group, a consulting firm, calculates that global steel production rose by 57% in the decade to 2014, with Chinese mills making up 91% of this increase. In industry after industry, from paper to ships to glass, the picture is the same: China now has far too much supply in the face of shrinking internal demand. Yet still the expansion continues: China’s aluminium-smelting capacity is set to rise by another tenth this year. According to Ying Wang of Fitch, a credit-rating agency, around two billion tonnes of gross new capacity in coal mining will open in China in the next two years.
A detailed report released this week by the European Union Chamber of Commerce in China reveals that industrial overcapacity has surged since 2008 (see charts). China’s central bank recently surveyed 696 industrial firms in Jiangsu, a coastal province full of factories, and found that capacity utilisation had “decreased remarkably”. Louis Kuijs of Oxford Economics, a research outfit, calculates that the “output gap”—between production and capacity—for Chinese industry as a whole was zero in 2007; by 2015, it was 13.1% for industry overall, and much higher for heavy industry.
Scarier than ghosts
Much has been made of China’s property bubble in recent years, with shrill exposés of “ghost cities”. There has been excessive investment in property in places, but many of the supposedly empty cities do eventually fill up. China’s grotesque overinvestment in industrial goods is a far bigger problem. Analysis by Janet Hao of the Conference Board, a research group, shows that investment growth in the manufacture of mining equipment and other industrial kit far outpaced that in property from 2000 to 2014. This binge has left many state-owned firms vulnerable to slowdown, turning them into profitless zombies.
Chinese industrial firms last year posted their first annual decline in aggregate profits since 2000. Deutsche Bank estimates that a third of the companies that are taking on more debt to cover existing loan repayments are in industries with overcapacity. Returns on assets of state firms, which dominate heavy industry, are a third those seen at private firms, and half those of foreign-owned firms in China.
The roots of this mess lie in China’s response to the financial crisis in 2008. Officials shovelled money indiscriminately at state firms in infrastructure and heavy industry. The resulting overcapacity creates even bigger headaches for China than for the rest of the world. The overhang is helping to push producer prices remorselessly downward: January saw their 47th consecutive month of declines. Falling output prices add to the pressure on debt-laden state firms.
The good news is that the Chinese have publicly recognised there is a problem. The ruling State Council recently declared dealing with overcapacity to be a national priority. On February 25th the State-Owned Assets Supervision and Administration Commission, which oversees big firms owned by the central government, and several other official bodies said they would soon push ahead with various trial reforms of state enterprises. The bad news is that three of the tacks they are trying only make things worse.
One option is for China’s zombies to export their overcapacity. But even if the Chinese keep their promises not to devalue the yuan further, the flood of cheap goods onto foreign markets has already exacerbated trade frictions. The American government has imposed countervailing duties and tariffs on a variety of Chinese imports. India is alarmed at its rising trade gap with China (see article). Protesters against Chinese imports clogged the streets of Brussels in February. There is also pressure for the European Union to deny China the status of “market economy”, which its government says it is entitled to after 15 years as a World Trade Organisation member, and which would make it harder to pursue claims of Chinese dumping.
Another approach is to keep stimulating domestic demand with credit. In January the government’s broadest measure of credit grew at its fastest rate in nearly a year: Chinese banks extended $385 billion of new loans, a record. But borrowing more as profits dive will only worsen the eventual reckoning for zombie firms. 
A third policy is to encourage consolidation among state firms. Some mergers have happened—in areas such as shipping and rail equipment. But there is little evidence of capacity being taken out as a result. Chinese leaders are dancing around the obvious solutions—stopping the flow of cheap credit and subsidised water and energy to state firms; making them pay proper dividends rather than using any spare cash to expand further; and, above all, closing down unviable firms.
That outcome is opposed by provincial officials, who control most of the country’s 150,000 or so publicly owned firms. Local governments are funded in part by company taxes, so party officials are reluctant to shut down local firms no matter how inefficient or unprofitable. They are also afraid of the risk of social unrest arising from mass sackings.
China’s 33 province-level administrations are at least as fractious as the European Union’s 28 member states, jokes Jörg Wuttke, head of the EU Chamber: “On this issue, increasingly Beijing feels like it’s Brussels.” So Mr Gao’s claim that the problem is not entirely his government’s fault may be true in a sense. But in the 1990s China’s leaders did manage bold state-enterprise reforms involving bankruptcies and capacity cuts, that overcame such vested interests. To meet today’s concerns, the central government could provide more generous funding to local governments to offset the loss of tax revenues arising from bankruptcies, and also strengthen unemployment benefits for affected workers. 
If China’s current leaders have the courage to implement such policies, there may even be a silver lining. Stephen Shih of Bain, another consulting firm, argues that much quiet modernisation “has been masked in many industries by overcapacity”. For example, little of the fertiliser industry’s capacity used advanced technologies in 2011; most of the new capacity added since then has been the modern sort that is 40% cheaper to operate.
Baosteel Group, a giant state-owned firm, has been forced by Shanghai’s local authorities to shut down dirty old mills in the gleaming city. So its bosses have built a gargantuan new complex in Guangdong province with nearly 9m tonnes of capacity. This highly efficient facility has cutting-edge green technologies that greatly reduce emissions of sulphur dioxide and nitrogen oxides, recycle waste gas from blast furnaces and reuse almost all wastewater. “When the older capacity in China is shut down, we’ll have a much more modern industrial sector,” Mr Shih says. “The question is, how long will this take?”

Arrive full , leave empty: The India-China trade gap

SHIPS leaving Nhava Sheva port, across the harbour from Mumbai, tend to ride higher on the water than when they arrive. India’s trading statistics explain why: steel and other industrial goods from China weigh down the ships as they come in, to be replaced on the way out by fluffy cotton bales, pills and—given India’s perennial trade deficit in goods—empty containers.
India’s economy grew by 7.5% last year, cruising past China’s 6.9% growth. Yet the deficit in goods trade with China continues to widen (see chart), to over 2% of GDP last year. For Indian policymakers this is an irksome reminder of the weakness of the country’s manufacturers. Halving the trade shortfall with China would be enough to eliminate India’s overall current-account deficit, and thus the need for external financing.
The government’s ideas for shrinking the shortfall have been sadly predictable. The minimum import prices it imposed earlier this month on various grades of Chinese steel, which it claims are being “dumped” below cost, come on top of other anti-dumping levies and taxes on steel and myriad other products, from raw silk to melamine dinner sets. No country has used such measures as energetically as India over the past 20 years, according to the World Trade Organisation.
The commerce minister, Nirmala Sitharaman, has called for a devaluation of the rupee to curb imports and boost exports. Yet the rupee has been falling against the yuan for years, with little effect on trade. And a weakening currency could revive inflation, which falling oil prices and sound monetary policy have helped tame.
The government looks longingly at manufacturing’s 32% share of China’s GDP, roughly double the Indian figure. It sees factories as the ideal way to soak up the million-odd young workers who join the labour force every month. So it is showering sops on various industries. It is handing out subsidised loans to small-scale and labour-intensive industries such as ceramics and bicycle parts. Lightly-taxed “special economic zones”, many of which are set up to benefit a single company, are in line for further handouts.
A “Make in India” jamboree in Mumbai earlier this month sought to present an image of openness to foreign investment, eliciting promises of multi-billion-dollar plants from firms keen to cosy up to policymakers. But India is trying to emulate China’s export-led manufacturing growth in a global economy that is now drowning in China’s industrial surpluses. It hopes to fill the vacuum left by its larger neighbour as Chinese wages rise, to double those of Indians, and its economy rebalances from exports to consumption. Yet so far it has struggled to seize that opportunity.
Indian firms grumble, with some justification, about their products being shut out of the Chinese market. Agricultural products, of which India is a net exporter, are largely excluded from China through various phytosanitary rules. Indian pharmaceutical firms complain that China’s growing aid to other developing countries often includes the provision of medicines—Chinese-made ones, of course—which means that the recipient countries buy fewer Indian-made drugs than they used to.
India runs a global surplus in services, mainly by selling them to rich countries. But they are a small component of Indo-Chinese trade. China gets the best of tourist exchanges between the two countries: 181,000 Chinese tourists came to India in 2014, against 730,000 Indians who visited China. All this tortures Indians, for whom China is the biggest source of imports and third-biggest export market, but barely troubles China, for whom India is a second-tier trade partner. Indian policymakers are reflexively sceptical, for example, of China’s plan to build a road linking the countries, worrying it will only widen the trade imbalance.
If China’s consumers won’t buy Indian goods, perhaps its businesses could build factories in India instead? Some big projects have recently been announced, notably a $10 billion industrial park to be developed by Dalian Wanda, a Chinese property group; and a $5 billion plant proposed by Foxconn, a Taiwanese electronics outfit which mainly manufactures in China. Foxconn said last July that it might employ up to 1m Indians in 10-12 plants by 2020, despite suffering labour strife when it closed an existing factory last year. However, foreign investors’ projects often fall quietly by the wayside when bureaucratic obstacles prove insurmountable. Foxconn is already said to be rolling back its ambitions.
After years in the doldrums, India is enjoying its moment as the world’s fastest-growing large economy. That in itself will be enough to pique the interest of multinationals: Apple, for example, thinks a sales push in India can help make up for sluggish Chinese demand. Even so, it will be a while before its devices (whose assembly it outsources to Foxconn) are made in India. Instead, they will further weigh down the ships entering its ports

Tuesday, February 23, 2016

Who Will Be Left Standing At The End Of The Oil War?

This is a financial cold war—nothing more, nothing less.
While there are billions of reasons to cut output, and every major producing country is reeling from the loss of revenues, some are weathering the current bust better than others, but the devil is in the details, and the details contain tons of variables.
Production cost and breakeven figures that analysts enjoy bandying can trap you in bubble of black-and-white mathematics that is a few brush-strokes shy of a full picture.
Breakeven prices are hard to pin down, and harder yet because they fluctuate. OPEC governments downsize their budgets, cut social spending and put big projects on hold to lower the breakeven price. Independent producers likewise cut spending and delay development to get closer to a feasible breakeven. So the breakeven is elusive.
Saudi Arabia and Kuwait enjoy some of the lowest production costs in the world, at about $10 and $8.50, respectively, according to Rystad Energy data. Production in the UAE costs just over $12 per barrel, which is pretty much the same as in Iran, though Iranian officials say they will eventually be able to produce for as low as $1 per barrel from their central fields.
But these are just the costs of lifting oil out of the ground. State-owned oil companies often have many more responsibilities than just producing oil. They underpin generous spending levels by their governments, and thus any estimate of a “breakeven” price should include the cost of those obligations.
It’s hard to come up with a real breakeven point for Saudi oil, for example, because it is responsible for funding the royal palace and indirectly, a large number of social programs that include everything from education to housing and energy subsidies. It’s hard to measure costs when this oil has to pay for all the luxuries of the Saudi royal family.
According to Quartz, if you add in all these costs that U.S. shale producers don’t have, we’re looking at a breakeven point of around $86 per barrel for Saudi oil. That’s just one opinion, but it’s a poignant one. So is the royal family ready to give up its luxuries? Or will they sacrifice things such as healthcare and education first? The fact that the government is considering taking parts of Saudi Aramco public does not bode well.
The Iranian perspective, newly off sanctions, is entirely different. It’s probably more concerned about regaining the market share it lost under sanctions than it is about low prices. In June, Iran will launch a new grade of heavy crude that will compete with Basra crude, and which the Iranians will surely seek to undercut in price in order to win Asian market share from Iraq and the Saudis.
For Nigeria, Libya and Iraq, the breakeven point is the point at which they can fund the fight against Boko Haram, a civil war and the Islamic State, respectively. Right now, they can’t. And that’s with per barrel production costs of around $31/$32 in Nigeria, $23/$24 in Libya, and $10/$11 in Iraq.
Then we have Venezuela, where production costs hover just over $23 per barrel on average, but where disaster is imminent. Debt defaults here are looming, and inflation is soaring, while recent moves to drastically devalue the currency and raise gas prices by over 6,000 percent for the first time in decades are harbingers of highly destabilizing unrest. For Venezuela, the breakeven point is particularly elusive because the country’s oil is very heavy and very dirty—and thus very expensive to extract and refine.
Breaking the back of U.S. shale?
From the Saudi perspective, the end game here is to break the back of U.S. shale.
The average production costs for the U.S. is about $36 per barrel, but Rystad Energy estimates that some the key U.S. shale plays have a $58-per-barrel breakeven point. This, too, varies section by section, and even well by well, so it’s hard to get a concrete picture.
Here is the breakeven picture in more detail, courtesy of Rystad Energy:
Plenty of shale areas are still profitable even with oil below $30, according to Bloomberg Intelligence—just ask Texas, where the Eagle Ford shale play’s Dewitt County patch, for instance, can turn a profit even with crude below $23. Other counties, though, might need $58 to be profitable.
It’s all about hedging right now for U.S. shale producers. The larger percentage of oil output that's protected by hedging, the longer the lifeline.
Last week, Denbury Resources Inc. (NYSE: DNR), for instance, said it had increased its fourth-quarter hedges to cover 30 Mbbl/d at around $38/bbl.
So far, “there is little evidence of production shut-ins for economic reasons,” according to Wood Mackenzie’s vice president of investment research, Robert Plummer. “Given the cost of restarting production, many producers will continue to take the loss in the hope of a rebound in prices.”
The breakeven is quite simply the line in the sand that determines whether extracting a barrel of oil is profitable or not. And this line in the sand is vastly different for private American producers than it is for kingdoms such as Saudi Arabia.
Everyone is hurting, some more than others. Venezuela is already on its knees. But even $30 oil isn’t enough to bring the other bigger players down or to end the cold oil war. Saudi Arabia has some $600 billion in financial reserves; Russia is worried enough only to start talking to OPEC; U.S. producers are holding strong and are fairly calm, closely measuring the pace of desperation most recently indicated in the word game over an output freeze.
The variables of the breakeven game favor U.S. shale. But Saudi Arabia won’t give up the cold war path easily because its ultimate goal is to preserve its market share at all costs.

Friday, February 19, 2016

BlackRock Senior Director Explains the Three Ways That Negative Rates Are a Failed Idea

More and more central bankers have moved into the next frontier of monetary policy by enacting negative interest rates in an attempt to stimulate their economies.
Though the limited data available thus far make it difficult to judge the success or failure of this monetary innovation on an empirical basis, BlackRock Senior Director Peter Fisher turns to theory to point out this policy's inherent limitations.
During an interview on BloombergTV on Thursday, Fisher laid out the reasons why sub-zero interest rates will prove counterproductive by examining the three key channels through which monetary policy supports economic activity:
  • Foreign exchange: a weaker currency helps improve net exports;
  • Credit: lower borrowing costs spur more debt-fueled activity; and
  • Wealth: monetary accommodation supports asset prices, and higher asset prices cause people to feel richer and boost their spending. 

Exchange rate

Fisher acknowledged that in certain cases—for smaller, open economies without especially deep capital markets (like Denmark or Sweden)—negative rates could prove to be a useful tool to deter capital inflows that foster an appreciation in the currency.
But this strategy doesn't work on a grander scale, according to Fisher, and has only helped weaken some exchange rates to a moderate degree thus far, because the U.S. still has a positive policy rate.
"But let's be clear, negative rates for the FX rate is about a race to the bottom of competitive devaluation," he asserted. "The International Monetary Fund was established to try to prevent us from doing that again, what we did in the 1920s and '30s that were such a disaster."

Credit Channel

On the credit side, Fisher argues that policy wonks and central bankers alike have been too focused on just half of the ledger: the demand side.
While lower interest rates make it cheaper and more attractive for consumers to take on debt, net interest margins will determine how attractive it is for the lender to provide these funds.
Negative rates crimp profitability both by the direct charge on deposits and the flattening of the yield curve that has accompanied their adoption, he claimed. Banks have been unwilling to pass along the tax on deposits to their customers, due in part to the money illusion; the general unwillingness of people to accept a negative nominal return.
"How do you feel about lending more when the spread you're earning is compressing?" he said. "It's not about the level of rates, it's about the shape of the yield curve."

Wealth Effect

By lowering interest rates and, more recently, by engaging in large-scale asset purchases, central banks have helped support the value of risk assets. The traditional wealth effect holds that as the price of the assets savers hold rises, these people feel richer and spend more.
Negative rates, Fisher argues, are a perverse way of getting people to boost spending. If the tax on bank deposits is also levied on consumers, they're effectively made poorer by saving.
"If we put through a negative interest rate, and we pass it through to consumers, they'll stop saving and spend money," he said. "This is the opposite of the wealth effect!"
Fisher believes that central bankers' growing penchant for negative policy rates stems from a desire to avoid admitting that they've expended all of their monetary ammunition.

Thursday, February 18, 2016

Core ores

AT THE pinnacle of the mining industry sit two Anglo-Australian companies, BHP Billiton and Rio Tinto, which are to iron ore what Saudi Arabia is to oil: the ones who call the shots. Their mines in Pilbara, Western Australia, are vast cash cows; with all-in costs below $30 a tonne, they still generate substantial profits even though prices have slumped from $192 a tonne in 2011 to about $44. They have increased iron-ore production despite slowing demand from China, driving higher-cost producers to the wall—an echo of the Saudis’ strategy in the oil market.
But whereas Rio Tinto has doubled down on iron ore, BHP also invested in oil and gas—in which it has nothing like the same heft—at the height of the shale boom. Their differing strategies are a good test of the merits of diversification. The China-led commodities supercycle encouraged mission creep. Many companies looked for more ways to play the China boom, and rising prices of all raw materials gave them an excuse to cling on to even those projects that were high-cost and low-quality. Now the industry is plagued with debts and oversupply. 
On February 16th Anglo American, a South African firm that was once the dominant force in mining, said it would sell $3 billion of assets to help pay down debt, eventually exiting the coal and iron-ore businesses that it had spent a fortune developing. That would leave it with a core business of just copper, diamonds and platinum. The day before, Freeport-McMoRan, the world’s largest listed copper producer, was forced to sell a $1 billion stake in an Arizonan copper mine to Sumitomo of Japan, to help cut debts racked up when it expanded into oil and gas. With Carl Icahn, an American activist investor, agitating for a shake-up, analysts say its energy assets could follow—if there are any buyers.
When BHP reports half-yearly results on February 23rd its misadventure in American oil and gas will be of particular concern because it has put the world’s biggest mining firm in the shadow of Rio for the first time. Since BHP merged with Billiton in 2001, its share price has outperformed Rio’s (see chart); it made an unsuccessful bid to merge with its rival in 2007. Yet in the past year its shares have done worse. Analysts expect that next week it will cut its annual dividend for the first time since 2001, thereby breaking a promise to raise the dividend year by year. Though Rio ended a similar “progressive dividend” policy this month, it did not cut the 2015 payout.
BHP’s dividend yield began to soar relative to Rio’s in late 2014 so a payout cut should not be a surprise. But shareholders, especially those in income funds that depend on mining-industry returns, will be kicking themselves. They could have diversified their own portfolios, putting more money into oil majors like Exxon Mobil, whose payout is considered more secure, rather than have BHP expose itself to oil and gas on their behalf.
Paul Gait of Sanford C. Bernstein, a research firm, says that because of BHP’s weak position in oil, it is suffering from the same cost pressures that it is inflicting on its competitors in iron ore. He calls it “nemesis to their hubris. They are in oil what they are attempting to destroy in iron ore.”
BHP argues that its strategy enhanced shareholder returns during the good times, and that no one expected oil and metals prices to collapse with such synchronicity. It says its business mix is no stranger than that of an oil company like Exxon Mobil, which is into the refining and marketing of oil products as well as the exploration and production of crude. Its underperformance against Rio has also been the result of a mining accident in Brazil in November. Rating agencies worry that a big fine could put further strain on its balance-sheet. “We just have to be patient. Cycles are an inherent part of the business,” an executive says.
BHP’s long-held belief is that by strengthening its oil and copper businesses it enjoys a longer cycle than if it were more exposed to iron ore and coal. In China, for example, demand for steel, and thus for iron ore and coking coal, has been central to the country’s building boom. But as it grows richer, it will need more copper for electric cables, and petrol for its growing fleet of cars.
Such arguments were more compelling when Chinese growth seemed unstoppable. But Konrad von Szczepanski of the Boston Consulting Group says the downward leg of the supercycle has eroded the case for diversification, pushing firms to reconsider strategies last used in the 1990s: focusing on single commodities in which they have the cheapest, best-quality ores.
Whatever they do, mining companies will now be required to demonstrate that the assets they have are high quality and capable of generating cash even in hard times. The trouble is that as they attempt to focus, as Anglo American is doing, there is no guarantee they will be able to sell their non-core assets for a high price. Acquirers, as one analyst puts it, only want the family silver, not the dross.