Friday, September 30, 2005

You're either with us or against us

One good threat deserves another, or so it seems in world politics these days. One theme of the Bush administration since 9/11 has been "you are either with us or against us" most recently emphasized with respect to India's recent vote condemning Iran's non-compliance with the IAEA's nuclear non-proliferation treaty.

Less than a week later, Iran's new government has decided to cancel the five-million-tonne a year, 25 year, liquefied natural gas (LNG) export deal with India proving that indeed, you are either with us or against us.

I'm going to make a bold prediction, IF the televised news media deigns to report on this development, some cute but vacuous minded talking head will likely mention "playing the oil card" with the same disdain (and almost total disassociation from the real world phenomenon described by the phrase) they recently mouthed the sound bite, "playing the blame game." THEN, at some point in the not too distant future, the same (actually the talking heads are all beginning to look the same to me) person will wonder aloud why oil prices are rising.

Time to stack some wood, I say.

Wednesday, September 28, 2005


Fair warning for those 2-3 intrepid souls in search of financial wisdom (now there's an oxymoron these days) who just might find their way to these pages, it looks to this aging hippie, as Bobbie Zimmerman used to sing, the times, they are a changin'.

This week our Fed Chairman was reported to have told the French Finance Minister that the US had "lost control" of its budget. While this was reasonably apparent to anyone who noted how many items, like the current wars, were excluded from the budget and how little debate over the increasing debt was emanating from Congress, that this has become a public discussion seems notable. Just as the leaks of dissent from the sinking ship of war are becoming ever more prevalent so too are the leaks of dissent from the sinking ship of finance. How ironic that the Fed Chairman just clapped himself on the back for a job sell done in guiding the US to this pass. Yeah, Alan, you were right, it would have been much worse to have a little recession in 1994 than a huge one now. As an aside, just about every time Europe and the US seriously argue about US budget deficits, financial disruption follows (end of Bretton Woods, 1987 stock market crash).

Bringing the budget process back under control will require some heavy lifting. Thus when I read today's news of House Majority Leader, Tom Delay's indictment, and the recent exposure of Senate Majority leader Bill Frist's curious foresight in stock trading, I don't get the sense that these are the guys who can do the job. Meanwhile the Executive branch labors under the Sword of Damocles, or is that Fitzgerald. In the best of times it is difficult to sell a program of sacrifice, such as any massive budget cutting exercise, just ask any of the former leaders of the nations caught in the Asian Crisis. When the leaders are working under clouds of scandal, however accurate the accusations, the difficult becomes nearly impossible.

Under normal conditions these events would be worrisome, at least to me, in the context of the need to rebuild after Hurricanes Rita and Katrina, they are dire. Even the US has a credit limit, when it is hit, the $ will fall, just as any public stock's value falls when credit lines are maxed out and cash flow is insufficient to maintain operations.

Which comes first, Greenspan's departure or a severe financial shock? I favor the latter.

Saudi Oil Reserves

A friend wondered what I thought about this statement from ExxonMobil and Saudi oil ministers that oil reserves in the Kingdom would soon be doubled. So I mixed myself a cocktail, tighened my robe and here's what came out.....

If memory serves, the oil majors all downgraded their proven reserves substantially a few years back, and were forced to pay significant fines for having overstated them so I take any statement from them with a large grain of salt. Besides, once the Saudis publicly state that their oil reserves are in decline, the West will begin to pull its support from the regime and then the ruling family is ....well, toast.

More generally, for a reserve to be "proven" it must be economically viable to be extracted. At $20 crude and current wage and capital equipment rates there are no proven reserves in Canada's oil sands. At $100, assuming wages and capital equipment costs stay the same, there are billions of barrels. At $1000 crude, other things equal, there are many trillions of barrels of proven reserves. That is, as the real price of crude rises, other things equal, proven reserves will grow. To think of it in labor terms, the more man hours spent, the more crude which can be extracted. Whether that change in labor and savings resource allocation is sustainable is another question, man can't live by oil alone. As a corollary, indigenous resistance to oil extraction reduces proven reserves by raising costs. To wit, proven reserves in Iraq are plummeting as the cost of the Iraq War keeps mounting.

I sometimes think the peak oil advocates overstate the case in their zeal to inflame the public mind and thus create a "straw-man" which is easy to refute for the skeptics. The issue isn't so much that the world is running out of oil, but rather that, for reasons which include the exhaustion of many large fields, greater extraction difficulty in the newer fields (including Hurricanes), and disputes over ownership of those remaining, the real costs of extraction are rising, currently quite quickly.

Ultimately, though, we will all have to wait and see in the Saudis have more oil. Of course, real oil prices have been high for years now, which, you might think, would already have spurred extra capital investment in Saudi Arabia. Heck, why spend $250B going to war in Iraq if $20B invested in Saudi's oil infrastructure would get you, according to the boys from Exxon and Saudi, more oil? I'm sure in the years before the turn of the last century there were many whalers on the New England coast who assured everyone that there would always be enough whale oil.

Sunday, September 18, 2005

Following salespeople

Nobody dast blame this man. You don't understand: Willy was a salesman. And for a salesman, there is no rock bottom to the life. He don't put a bolt to a nut, he don't tell you the law or give you medicine. He's a man way out there in the blue, riding on a smile and a shoeshine. And when they start not smiling back-that's an earthquake. And then you get yourself a couple of spots on your hat, and your finished. Nobody dast blame this man. A salesman is got to dream, boy. It comes with the territory. - Arthur Miller, Death of a Salesman

America, according to most press reports, and economic quantifications, is a nation of consumers, not producers. By virtue thereof, it shouldn't be surprising that we are led by salespeople, how else might we come to buy all these goods. Now a good salesman, as the old saw goes, can sell ice to Eskimos, in other words, can make you believe you need things you don't, and don't need things you do. This is all well and good until reality bites, or in this case Katrina strikes. Op-eds in the papers, talking heads on TV and press reports of success are not going to rebuild N.O. and its much needed infrastructure. I reckon Arthur Miller had it about right, salespeople are "out there in the blue, riding on a smile and a shoestring." Unlike farmers, builders and producers of things, salespeople don't know there are limits, they don't have the requisite experience to temper their enthusiasm.

Remember back to your High School days and the election of a class President? While some people took the whole affair quite seriously, many others laughed. In the end, the officers were elected. Imagine, if instead of penning a few letters to the school paper and attending a few meetings about where to place trash receptacles, a real crisis were to hit the school, say an earthquake. Would your elected class President be the person to whom you would look? or would the crisis changed conditions lead you to look elsewhere? I don't mean to single out any official, it is just that there are not, to my knowledge, many class Mayors, Governors or Senators. However, there are, I suspect, a great many officials who are salespeople. As Warren Buffett is wont to say, it is only when the tide goes out that you discover who's been swimming naked. I think we will see who are the salespeople and who are the real leaders in the months ahead.

Friday, September 16, 2005

Infrastructure anecdotes

Yesterday evening I shot some pool and had a few beers with a friend who owns an industrial construction firm, specifically hi-tech plumbing and electrical. He was late to the bar because he'd come across what he cites as an ever more common occurrence, blue prints which don't match the actual construction. While drilling to pour a footing for a protective post his team hit a coolant line which, according to the blue prints was supposed to be buried 7 feet, instead of the 3.5 feet where he found it. Further exploration showed a host of other inconsistencies all of which suggested that the original contractor had skimped on burying the underground pipes. I Having dug my share of fence posts around here I have a good idea why they tried to skimp. The area is more rock than dirt and getting down the required 7 feet would be much more labor. Besides, out of sight, out of mind-who would know they didn't go deep enough, nobody can see it. According to my friend, he'd much rather work on a site which was built 30 years ago than one built in 1995, the chances of error are much smaller. This isn't to universalize this particular observation but in the aftermath of Katrina it seems to me that the lack of emphasis on the importance of well functioning infrastructure over the past 10-15 years is coming home to roost.

Monday, September 12, 2005

The Biggest Pool of Capital in the world

Over the weekend, Junichiro Koizumi's LDP was re-elected in what we Americans would call, a landslide. By virtue thereof, Koizumi-san has decided that he now has a mandate. To do what? you might be asking. To privatize Japan Post, which just happens to be where much of Japan's savings deposits are held. According to the Guardian, the total is 330Tln Yen or $3Tln, a little less than half the entire US national debt.

Now I don't know what Koizumi-san has up his sleeve but it seems to me that taking control of that huge pile of savings from the MoF (Ministry of Finance) and giving it to some of the Japanese banks might lead to changes in international capital flows. Who knows, maybe with the private sector apparently a little less willing to buy up our debt, this shift in control might lead to a shift in demand of US debt instruments, or even (gasp!) outright selling.

Things just look downright ugly for Uncle Buck ($), too bad nobody has the heart to break the news.

Saturday, September 10, 2005

..and The Chip Diller Award goes to ....

Chip Diller, uh..for those who haven't seen Animal, if you didn't see it in context, I won't be able to do it justice, although a picture might give some sense of the guy. Anyway, the nominees for The Chip Diller, Remain Calm, All Is Well Award, for the Katrina Crisis are:

1) The Media, for taking a well qualified assessment from Ben Bernanke and throwing out the qualifier: Headline: Hurricane Katrina to have 'modest' economic impact - White House adviser actual comment, My guess is though that as long as we find that the energy impact is only temporary, and there is no permanent damage to the infrastructure ... the effects in the overall economy will be fairly modest. Score one for Ivory Tower man

2) US Treasury Secretary, John Snow, who opines: While this will elevate spending levels for '06 -- primarily because that's when the major effects will hit -- we're going to stay on track with the president's deficit-reduction program. The Dude wonders just how many people, businesses included, from the Gulf are going to be filing income taxes any time soon.

3) US Commerce Secretary Carlos Gutierrez, after a big swig of the Kool-Aid, avers: There is unparalleled prosperity in this country because the president's agenda has been working. So that should give us a great deal of comfort that the presidents' agenda will continue to drive the economy in the future. "Unparalleled prosperity" is so late 90s, man.

Kidding aside, judging by the financial markets, outside of Gold, the effects of Katrina are just temporary. Call me kooky, but this reminds me, just a bit, of hubris, if not outright denial. Take a read of this more sober assessment, focusing on the crucial energy impact:

  • And offshore, the Coast Guard said 52 oil and gas production platforms sank in the storm and 58 were damaged.
  • Another three drilling rigs sank when Katrina rumbled through the Gulf of Mexico and another 16 rigs were damaged.
  • All together, the Minerals Management Service is reporting that some 900,000 barrels of oil a day and another 3.8 billion cubic feet of natural gas a day remain shut in.
900K barrels of oil a day is just under 5% of US oil demand and just under 18% of domestic production. In terms of running sums 900K/day comes to 6.3M/week and 27M/month, a flow which would empty the Strategic Petroleum Reserve in just over 2 years. Perhaps desirous of keeping oil prices down, the Bush administration in conjunction with other oil consuming nations, expects to release 2 million barrels a day of crude oil and refined gasoline from U.S. and international emergency government reserves to counter supply disruptions caused by Hurricane Katrina. (for a total of 60M barrels according to this)

Meanwhile down at the Port of New Orleans, Port of New Orleans President and CEO Gary LaGrange has set a goal for the Port of New Orleans to work its first commercial cargo ship by Wednesday, Sept. 14, 2005.

As I've said before, It's a complicated case, Maude. Lotta ins. Lotta outs. And a lotta strands to keep in my head, man. Lotta strands in old Duder's--...whoa, boy, almost lost my train of thought there. Anyway, it just seems to this aging Dead head, that the commercial, and by virtue thereof, financial impact of Katrina is more serious than a cursory read of the financial markets might suggest. At best, the Port will miss half a month of commercial traffic and more likely many months before it is fully operational. Going back to the Houston Chronicle article:
  • The company [Chevron] did issue a statement saying four of its Gulf projects will be sidelined into 2006 because of storm fallout.
  • Damage to Mars, Ursa, Mensa, Cognac and West Delta 143 [deep water drilling projects] is still being assessed, but ramping up production from several of those facilities does not look like it will happen before year's end.
It's a good thing there are no other risk factors in the oil market....oops. I read in the UK's Independent, Insurgents open 'southern front' with deadly car-bomb in Basra. Basra is the jewel in US occupied Iraq, exporting some 1.5M bpd. So, at the moment, the west is throwing some 2M bpd on the market, keeping prices down at cost of reducing reserves. Meanwhile India and especially China, awash in $ mind you, and likely aware of the risk of more aggressive insurgent attacks on the oil supply, can also buy at these reduced by intervention prices.

Did I mention that the financial aspect of the SPR release is a "swap" wherein the refiner or distributor promises to return the oil in a set amount of time. What happens is oil is say $80 when the swap comes due? How many of the businesses getting oil would be able to withstand that hit, assuming they didn't hedge? And we got a new Fed Chairman coming along any month now. Oh well, just call me Alfred E. Newman.

What me worry. Remain Calm, All is Well!

For those who just might want to worry a bit- who might be somewhat apprehensive about the financial system's ability to gracefully handle this disruption, here's an excerpt from Stratfor's sober assessment of New Orleans:

New Orleans is not optional for the United States' commercial infrastructure. It is a terrible place for a city to be located, but exactly the place where a city must exist. With that as a given, a city will return there because the alternatives are too devastating. The harvest is coming, and that means that the port will have to be opened soon. As in Iraq, premiums will be paid to people prepared to endure the hardships of working in New Orleans. But in the end, the city will return because it has to.

Thursday, September 08, 2005

Could we ever miss Greenspan?

For those who used to read my more economically specific musings the question might seem absurd...miss him!...he can't go fast enough! Perhaps and perhaps not. Sometimes I wonder, given all the hubbub over who gets to pick the next Supreme Court Justice, why there seems to be so much less concern over who gets to pick the next Fed Chairman. Stacking the Fed seems to me at least as dangerous as stacking the Supreme Court. Worried about the definition of marriage or abortion rights?, to pick 2 contentious issues begging for adjudication, consider what a 10% Fed Funds rate might mean given the new more difficult bankruptcy qualifications, or a quick 100 basis point drop to "shore up" flagging optimism in the economic health of the nation.

What was it Mayer Rothschild was reported to have said? Let me issue and control a nation's money and I care not who writes its laws. While I believe Greenspan was quite sensitive to the political winds in Washington, and obviously Wall St. I don't think of him as a total tool, a qualification that may or may not apply to the next Fed Chairman At a minimum, Greenspan was keenly aware that sharp and sudden moves might not be a good idea, just the kind of wisdom a newbie probably has to learn by experience-by touching the stove, something the state seems to be doing a lot of these days. Ivory Tower employment only Ben Bernanke might find his rise to power quite exhilerating, a feeling which can lead to impaired judgement.

Paul Kasriel's always thought provoking economic commentary touches on a very key point, how will the Fed react to the shock of Katrina? Contemplation of this issue is complicated by a huge unknown, who will be the next Fed Chair? The delicate balancing act of international finance, already on a razor's edge with war and oil price shocks just got a lot more complex and the current Fed Chairman has but a few months left. Who knows, the financial manifestation of Katrina's storm surge may not yet have materialized. Good thing I got my golden bowling ball!

Monday, September 05, 2005

Be careful what you ask for....

As I've watched the images from New Orleans in awe, my mind keeps recalling the sentence from the Neo-Con manifesto, The Project for a New American Century's Rebuilding America's Defenses: Further, the process of transformation, even if it brings revolutionary change, is likely to be a long one, absent some catastrophic and catalyzing event – like a new Pearl Harbor, and the administration's swift response to the attacks of 9/11. I wonder how long it took, that morning in September, before the phones started to ring, decisions were made, and armies began to move? "This is the moment we have been preparing for," they must have thought, and off they went, milking the catalyzing event for all it was worth.

Alas for the Neo-Cons' plans, and hundreds of thousands of residents of the Gulf Coast, Mother Nature just trumped the airborne attackers of 9/11. I wonder what a different administration, say one "champing at the bit" to rebuild American infrastructure with as much vigor as the Neo-Cons wished to project American Military Dominance in the days before 9/11, would have made of Hurricane Katrina? For in sheer human terms, the effects of Katrina will dwarf those of 9/11, the catalytic effect, if you will, will be much more profound.

Another oft recurring thought popped into my head when I began to contemplate the effects of this disaster, monetary quantification, and the relation thereof to GDP, seems such a useless metric for economic considerations. According to the NYTimes, A risk management firm yesterday offered the first estimate of economic losses from Hurricane Katrina - $100 billion - and said that private insurance would probably cover less than a quarter of that. Federal money and charitable contributions may need to do the rest. Ah, the GDP economist might think upon reading this, $100B is not quite 1% of GDP, more than a blip but not by much. Those unfamiliar with (or worse disbelieving) the argument in Bastiat's Broken Window are already looking forward to all the new construction.

Consider the GDP metric in a new framework, perhaps that of the human body. If a doctor tried to console you by saying that the 3 toes you just lost to gangrene from wading in toxic water represented less than 1% of your body weight, would you feel better? Would you feel that he had a handle on the situation? and could make forecasts about your future quality of life going forward? Then again, I guess it depends on the % about which we speak. Many people could easily, and probably happily give up a few percent of body weight from the right spots and equally most would die if that same weight were removed from vital spots.

New Orleans and the surrounding area, seem to me more than just liposuction material, or as one astute observer put it, a place that "could be bulldozed." As the website of the Port of New Orleans puts it,

Ideally located at the mouth of Mississippi River, the Port of New Orleans is America’s gateway to the global market. New Orleans has been a center for international trade since 1718 when it when it was founded by the French.

Today, the Port of New Orleans is at the center of the world's busiest port complex — Louisiana's Lower Mississippi River. Its proximity to the American Midwest via a 14,500-mile inland waterway system makes New Orleans the port of choice for the movement of cargoes such as steel, grain, containers and manufactured goods.

The Port of New Orleans is the only deepwater port in the United States served by six class one railroads. This gives port users direct and economical rail service to or from anywhere in the country.

From the same site, here is an assessment of damage.

“The Port of New Orleans’ riverfront terminals survived Hurricane Katrina in fairly decent shape,” said Port President and CEO Gary LaGrange. “Although they are damaged, they are still workable once electrical power and manpower is available.”

In the next several weeks, almost all of the Port of New Orleans will be dedicated to military relief vessels. In the next week to two weeks, commercial vessels will return once electrical power and manpower arrive,” LaGrange said He added that many repairs will be needed though to bring the Port back to full capacity.

One of the more curious pangloissian arguments I have been reading these past few years avers that the United States is less dependent on oil now than, say 25 years ago, because the cost of oil supplied to the country is a much smaller component of GDP. I think we are going to find out just how dependent on oil specifically, and our physical infrastructure in general, the nation is as the effects of this material bottleneck are experienced. The port, the oil rigs, refineries, chemical plants, offices, homes, jobs and lives have all been profoundly effected. Several weeks worth of shipping is in limbo- shipping which is the direct physical counterpart to millions of $ of financial contracts each day that will compound. Inverting the argument above, I wonder, since so much more of GDP is levered on a similar process now than 25 years ago, if its interruption will have a much more significant financial effect? No matter how you slice it, the map of material exchange which is the financial markets is but a reflection of the material world.

A few years back, Federal Reserve Chairman, Alan Greenspan, argued: Even our most sophisticated analytic techniques have difficulty dealing with the interactions among time preference, risk aversion, and uncertainty and with the implications of these interactions for the risk premiums that are embedded in asset prices. It is our failure to anticipate changes in this discounting process that much of our inability to accurately forecast economic events lies. For example, the dramatic changes in information technology that have enabled businesses to embrace the techniques of just-in-time inventory management appear to have reduced that part of the business cycle that is attributable to inventory fluctuations and, accordingly, may well have been a factor in the apparent decline in equity premiums that has characterized the latter part of the 1990s. Whether the decline in these premiums themselves may foster activities that could result in wider business cycles, as some maintain, is an open question.

I expect those "sophisticated analytic techniques" will, in hindsight, be seen once again to have misread, at least initially, "the interactions among time preference, risk aversion and uncertainty" to which Greenspan refers. Interestingly, Wall St. was, at least initially, equally non-plussed about the effects of the 1973 oil embargo (Embargo was announced on Oct. 19 yet the Dow Jones didn't begin sinking until November) a transformational event noted by Daniel Yergin, of Cambridge Energy Associates, in the Wall St. Journal;

Katrina's shock underscores a transition in the idea of energy security. For three decades, the operating concept was "1973 Vintage": In response to the 1973 embargo and then the Iranian upheaval, it focused on securing the flow of crude, primarily from the Middle East, and coping with any disruption. The SPR was created in the mid-'70s for 1973 Vintage reasons (although the idea of such a reserve had first been bruited by Eisenhower after the Suez Crisis). Its proponents, focused on another Middle Eastern crisis, never thought that its second major use (the first being in the 1990-91 Gulf Crisis) would be for domestic disruption.

But a host of developments -- from terrorism to the California power crisis to the East Coast blackout to Katrina -- have emphasized a return to what might be called the World War II model of energy security, assuring the security and integrity of the whole supply chain and infrastructure, from production to the consumer. (The gravest energy threats during World War II were when Nazi U-boats came close to cutting the tanker pipeline across the Atlantic that supplied U.S. military forces). This more expansive concept of energy security requires broader coordination between government and the private sector; more emphasis on redundancy, alternatives, distributed energy and back-up systems; planning and pre-positioning of vital supplies ("strategic transformer reserves" for electric substations); and methods that can quickly be applied to promote swift market adjustment. As with the August 2003 blackout, this crisis underlines the need for modernization and new investment in the energy infrastructure that supports our $12.4 trillion economy. A strong push in this direction may come from the new energy legislation, rather than from the idea of "energy independence."

The PNAC's vision of American Military Dominance fits quite well with what Mr. Yergin calls the "1973 vintage" operating concept of "energy security." But as seems painfully clear now, is much less useful as driving force behind the WWII, or primacy of the nation-state as operating unit, model. Assuring the security and integrity of the whole supply chain would seem to call for a reversal of recent policy. Instead of just in time inventory management and outsourcing to the cheapest bidder, a.k.a. globalization, which increases dependency on each element of the supply chain, Yergin argues, we will need broader coordination between government and the private sector; more emphasis on redundancy, alternatives, distributed energy and back-up systems; planning and pre-positioning of vital supplies ("strategic transformer reserves" for electric substations).

Growing public discontent with administration policies have, I believe, found their focus in the effects of Hurricane Katrina and the official response. The trade-offs inherent in any policy choice have been brought into stark relief. Many former administration cheerleaders in the media have had their confidence shattered. The Bush administration faces, in my view, its biggest test. The change in national sensibility invoked by the Hurricane and its aftermath, will, I believe, be profound, far more so than after 9/11. If the Bush team rises to the challenge and puts the same intensity into rebuilding the area, helping people get back on their feet and making the nation's transport and energy infrastructure more secure, they could still pull a rabbit out of the hat. If instead, they opt to continue, what in the aftermath of Katrina might come to be seen as tilting after windmills in Iraq, they may yet follow in the footsteps of the Nixon administration.

More to the point for those playing the financial markets, the bet that the Iraq War would make the world a better place for commerce seems to have been exposed. In their wildest dreams, neither Osama nor Saddam could have dealt the US commercial machine a heavier blow than the lack of preparation for a significant hurricane in New Orleans. While it is yet early, I speculate that Federal Reserve efforts to reduce some of the imbalances in the financial system by raising the cost of funds will be terminated. How the nation's creditors respond to that will be key.

As Mr. Yergin made clear above, the Arab Oil Embargo was a transforming event. Rewind the clock back to 1973. Despite years of widespread, by virtue of fear of the draft, anti-war sentiment among the young and rising costs from whose effects the economy was being insulated, the policy of "stopping the spread of communism" was in full swing. Then the Arab oil embargo, the catalyst of 1973 if you will, painfully demonstrated that the nation's military assets had been engaged in the wrong theater. It was seen that the biggest threat to our nation's security was not the spread of communism in SE Asia but the flow of oil from the Middle East. The malinvestment of the Vietnam War was exposed for the world to see.

The men behind the PNAC asked for a catalyzing event and in this case they may have gotten more than they bargained for. Unlike the attacks of 9/11, the media will not need to show images and descriptions of the event to bring the effects home to those not in the immediate vicinity, they will be felt on their own. In one of his final interviews in office, President Clinton wryly noted that "They'll (the Bush team) have the microphone." In the aftermath of 9/11 they also had the story to transmit. I certainly hope they have a new narrative now.