Tuesday, March 31, 2009

On a slippery slope forecasting oil's future

Business Times - 31 Mar 2009

Uncertainty in the energy sector will prevail until a real replacement for oil emerges

RELATIVELY low oil prices provide some cheer even in this rotten global economy. But like the Prague Spring all those years ago, this 'energy spring' will be transient. The massive pump-priming by governments will produce results in a year, perhaps two years, and energy worries will return once economic growth is restored.

We have had our energy lesson in a generation. We were told the chase for returns by pension funds and investment banks drove prices to dizzying heights. As consumers, we remained worried bystanders as prices swiftly crashed through each resistance level.

Now energy prices are down from about US$150 a barrel eight months ago. But the arguments for the price surge remain valid. A lot of people, including those from the Organization of the Petroleum Exporting Countries (Opec), blamed speculators for the spiral. But careful analyses conclusively point in another direction: demand and supply.

Such scenarios make US President Barack Obama's vision of a change from fossil fuels compelling. Green energy will foster a new world one day, where consumers potentially become producers of their fuel. Sunshine and wind are, after all, almost ubiquitous.

But renewable energy use on a global scale has a long way to go. The US Department of Energy still expects fossil fuels to account for 80 per cent of energy needs in 2030, though annual growth in oil and gas production will lag the pace of renewable oil.

Since this forecast was made last year, vast amounts of money for new energy research - US$150 billion in 10 years in the United States alone - have been committed for a technological breakthrough to whittle down fossil fuel shares. That push also reflects concerns about climate change. It is hoped that the nations will produce a charter for action, if not this year, very soon, to control harmful emissions.

It doesn't require much public persuasion when the stark changes in climate are felt worldwide. But the mainstay fuel for transportation primarily lies in Opec countries and Russia as other supplies dwindle. It presupposes continued investment - almost half a trillion dollars to 2030.

But these oil producers face a predicament. These countries are asked to risk billions of dollars on a fuel that the wealthy nations are working to get away from.

Unlike the rich industrialised countries, most Opec members are dependent on that single commodity. And they face population pressures. Already the sharp decline in oil's fortune has slashed their revenues.

They may find comfort in the forecasts for the continued dominance of oil and gas but they are nervous. The International Energy Agency, the adviser to rich countries, expects Opec to contribute 12 million barrels per day from new fields by 2030. But Saudi Oil Minister Ali al-Naimi has sounded a warning: 'We must also be mindful that efforts to rapidly promote alternatives could have a chilling effect on investment in the oil sector.'

Already, three dozen projects have been mothballed in Opec countries. The Cambridge Energy Research Associates warns that reduced investments could deprive the world of eight million barrels of oil a day within five years.

Elsewhere, the story is very much similar. Some expensive proposals such as the Canadian oil sands project have fallen victim to low oil prices. Meanwhile, Royal Dutch Shell says it will rather focus on oil and gas and biofuel but will skip new investment in wind, solar and hydrogen energy.

Adding to the mixed energy signals is the fact that the transport sector seems to be on the cusp of a revolution. It consumes almost 75 per cent of oil pumped. A significant technological breakthrough in fuel or batteries could hasten the shift away from oil.

As part of the US car industry rescue, struggling car companies have to make vehicles more fuel efficient. Every major car producer, as well as the upstarts, plan to produce electric cars by 2011. Mr Obama is aiming at a million plug-in hybrids by 2018 on US roads.

Yet, sales of petrol versions in countries such as India and China will swell global car population. But many of them, like the cheapest car in the world launched by India's Tatas this month, will be fuel-sipping (24km a litre). Some will not need any petrol at all. China is spending US$1.5 billion annually for three years to lift production to 10 million cars a year and at least of 5 per cent of them will be electric vehicles.

As these countries tailor their economic ambitions to the demands of climate change, it would mean more green cars and green power. Thus change will be driven by the competing fuels. Will it be smooth? We have already seen how tectonic shifts alter life, as Internet revolutionised commerce in recent times.

So far the road to the alternative future has run into potholes. The ethanol debacle should be instructive. It sparked a global outcry over using food crops for fuel and is no longer so acceptable. Today, controversy swirls over exploiting tar sands.

US Energy Secretary Steven Chu is, of course, promising transformational research. It would have to mean we need technologies that will create fuel as cheap or cheaper than oil. We are not there yet.

Until a real replacement emerges, uncertainty will prevail. Will we end up in a bind, where oil is short and its replacement not yet ready for prime time, all leading to high prices?

USA: The Bernie Madoff among nations

Business Times - 31 Mar 2009


TEN years ago, the cover of Time magazine featured Robert Rubin, then Treasury secretary; Alan Greenspan, then chairman of the Federal Reserve; and Lawrence Summers, then deputy Treasury secretary.

Time dubbed the three 'the committee to save the world', crediting them with leading the global financial system through a crisis that seemed terrifying at the time, although it was a small blip compared with what we're going through now.

All the men on that cover were Americans, but nobody considered that odd. After all, in 1999 the United States was the unquestioned leader of the global crisis response. That leadership role was only partly based on American wealth; it also, to an important degree, reflected America's stature as a role model. The United States, everyone thought, was the country that knew how to do finance right. How times have changed.

Never mind the fact that two members of the committee have since succumbed to the magazine cover curse, the plunge in reputation that so often follows lionisation in the media. (Summers, now the head of the National Economic Council, is still going strong.) Far more important is the extent to which our claims of financial soundness - claims often invoked as we lectured other countries on the need to change their ways - have proved hollow.

Indeed, these days America is looking like the Bernie Madoff of economies: for many years it was held in respect, even awe, but it turns out to have been a fraud all along.

It's painful now to read a lecture that Summers gave in early 2000, as the economic crisis of the 1990s was winding down. Discussing the causes of that crisis, Summers pointed to things that the crisis countries lacked - and that, by implication, the United States had. These things included 'well-capitalised and supervised banks' and reliable, transparent corporate accounting. Oh well.

One of the analysts Summers cited in that lecture, by the way, was the economist Simon Johnson. In an article in the current issue of The Atlantic, Johnson, who served as the chief economist at the IMF and is now a professor at MIT, declares that America's current difficulties are 'shockingly reminiscent' of crises in places like Russia and Argentina - including the key role played by crony capitalists.

In America as in the third world, he writes, 'Elite business interests - financiers, in the case of the US - played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse; more alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.'

Now, in fairness we have to say that the US was far from being the only nation in which banks ran wild. Many European leaders are still in denial about the continent's economic and financial troubles, which arguably run as deep as our own - although their nations' much stronger social safety nets mean that we're likely to experience far more human suffering. Still, it's a fact that the crisis has cost America much of its credibility, and with it, much of its ability to lead. And that's a very bad thing.

Like many other economists, I've been revisiting the Great Depression, looking for lessons that might help us avoid a repeat performance. And one thing that stands out from the history of the early 1930s is the extent to which the world's response to crisis was crippled by the inability of the world's major economies to cooperate.

The details of our current crisis are very different, but the need for cooperation is no less. Mr Obama got it exactly right last week when he declared: 'All of us are going to have to take steps in order to lift the economy. We don't want a situation in which some countries are making extraordinary efforts and other countries aren't.'

Yet that is exactly the situation we're in. I don't believe that even America's economic efforts are adequate, but they're far more than most other wealthy countries have been willing to undertake. And by rights this week's G-20 summit ought to be an occasion for Mr Obama to chide and chivy European leaders, in particular, into pulling their weight.

But these days foreign leaders are in no mood to be lectured by American officials, even when - as in this case - the Americans are right. The financial crisis has had many costs. And one of those costs is the damage to America's reputation, an asset we've lost just when we, and the world, need it most. -- NYT

The writer is a Princeton University professor of economics and international affairs and last year's winner of the Nobel Prize in economics

Saturday, March 14, 2009

Triple-A Rated Companies

The AAA credit rating, the gold standard in corporate finance, isn't just an endangered species. It's almost extinct at this point in Corporate America.
On Mar. 12, Standard & Poor's took the prized triple-A rating away from General Electric (GE). The move, from AAA to AA+ - still at the upper echelon of corporate credit quality - was widely expected by fixed-income investors, who fretted for months over GE's exposure to bad debt through its GE Capital arm.

GE still holds its top Aaa rating from S&P's rival, Moody's Investors Service. But Moody's already put GE's rating under review for possible downgrade—a stance the ratings agency reiterated Feb. 27 even after GE cut its dividend to save the conglomerate $9 billion per year.

Just Five AAA Holders

The downgrade leaves just five U.S. non-financial companies with the top credit rating from S&P. The triple-A rating seems secure at ExxonMobil, Johnson & Johnson, Automatic Data Processing and Microsoft. Pharmaceutical giant Pfizer also holds a triple-A rating, but on Jan. 26 S&P put the rating on watch for a possible downgrade, after Pfizer said it would borrow $22.5 billion to buy rival Wyeth.
Difficult Criterion
Companies enter the triple-A elite only when ratings agencies determine they have, in Riccio's words, "extremely little risk of default" on their debt. Thus, investors feel comfortable lending to Microsoft or Johnson & Johnson at lower interest rates. That lowers the companies' financing costs.

Thursday, March 5, 2009

GE stock hits fresh low despite CEO reassurances

Business Times - 05 Mar 2009

(WASHINGTON) General Electric (GE) is trying to convince shareholders it can weather the economic storm, but investors keep running for cover.

In a letter to shareholders on Tuesday, chief executive Jeffrey Immelt reminded them that one of the world's largest industrial conglomerates has taken strong steps to protect itself from a recession that is rapidly spreading around the globe and threatening its wide range of businesses, from jet engines to lending.

'GE has enormous and enduring strengths that are underestimated right now,' he wrote.

Shareholders apparently aren't convinced. GE, based in Fairfield, Connecticut, has shrunk its troubled finance unit, lowered its reliance on risky debt and moved to preserve cash by slashing its dividend. Yet the selling continues.

GE shares fell 59 US cents, or 7.7 per cent, to close at US$7.01 on Tuesday after touching a new 52-week low of US$6.85. They have dropped 80 per cent over the past year, trading at levels last seen in 1992.

By contrast, the Dow Jones Industrial Average, of which GE is a component, has fallen about 45 per cent the past year, while the S&P 500 index has shed 47 per cent.

And more problems are likely ahead. Many analysts believe that GE will lose its top 'AAA' credit rating this year because of the woes of its lending arm, GE Capital.

Some shareholders argue there is still too much uncertainty around GE Capital, which makes loans for credit cards, overseas mortgages and commercial projects.

GE is shrinking the unit from about 50 per cent of overall earnings to 30 per cent. But it remains difficult to value the business as the financial crisis rages on, said Peter Sorrentino, senior portfolio manager of Huntington Asset Advisors, which owns 6.4 million GE shares.

'I don't think there is anything GE can do to reverse the psychology on the stock,' he said. 'Investors looking at the stock still don't know where the bottom is for GE Capital.'

'Did we end up with too much exposure in certain areas during the credit bubble?' Mr Immelt asked in the shareholder letter.

'Maybe, a few. Today, I wish we had less exposure to commercial real estate and UK mortgages.'
Analyst Nicholas Heymann of Sterne Agee also cautioned investors to be wary of the long-term health of GE's industrial businesses - which include wind turbines, locomotives, refrigerators, aircraft engines and light bulbs - areas that could be hurt by the sharp deterioration of the global economy.

'The ability to sustain the performance of GE's industrial operations, and limit further erosion of their long-term competitiveness, will also become an increasingly critical component of investors' analysis of GE's future prospects,' he wrote in an investor note on Tuesday.

GE also owns NBC Universal, which includes the NBC television network and a chain of theme parks. That unit is expected to notch lower profits this year.

In Mr Immelt's letter, released with the company's annual report, Mr Immelt accepted responsibility for GE's 'tarnished' reputation as a 'safe and reliable' growth company.

But he wrote that he believes GE's industrial businesses should grow this year - GE has said it expects earnings growth of up to 5 per cent for the segments.

He noted that the 130- year-old company has survived nine recessions and the Great Depression.

And some divisions could thrive in a down market, especially those that may benefit from President Barack Obama's US$787 billion stimulus package. That includes GE's US$7 billion renewable energy unit, which makes solar and wind power equipment.

Still, Mr Immelt said GE is preparing for a difficult economy in 2009.

Recent moves to save cash include last week's dividend cut, deeper than most analysts expected and the first reduction since 1938. The lower payout to investors should save GE about US$9 billion annually.

Sunday, March 1, 2009

TED Spread

The TED spread is the difference between the interest rates on interbank loans and short-term U.S. government debt ("T-bills").
Initially, the TED spread was the difference between the interest rates for three-month U.S. Treasuries contracts and the three-month Eurodollars contract as represented by the London Interbank Offered Rate (LIBOR). However, since the Chicago Mercantile Exchange dropped T-bill futures, the TED spread is now calculated as the difference between the three-month T-bill interest rate and three-month LIBOR.

TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract. The size of the spread is usually denominated in basis points (bps). For example, if the T-bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40 bps. The TED spread fluctuates over time, but historically has often remained within the range of 10 and 50 bps (0.1% and 0.5%), until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.


The TED spread is an indicator of perceived credit risk in the general economy.[1] This is because T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. When the TED spread increases, that is a sign that lenders believe the risk of default on interbank loans (also known as counterparty risk) is increasing. Interbank lenders therefore demand a higher rate of interest, or accept lower returns on safe investments such as T-bills. When the risk of bank defaults is considered to be decreasing, the TED spread decreases.


The long term average of the TED has been 30 basis points with a maximum of 50 bps.

During 2007, the subprime mortgage crisis ballooned the TED spread to a region of 150-200 bps. On September 17, 2008, the record set after the Black Monday crash of 1987 was broken as the TED spread exceeded 300 bps. Some higher readings for the spread were due to inability to obtain accurate LIBOR rates in the absence of a liquid unsecured lending market. On October 10, 2008, the TED spread reached another new high of 465 basis points.