Kent on Current Events

The Toyota Weigh

2010-02-11T21:05:00.000-07:00

http://www.flickr.com/photos/kenjonbro/ / CC BY-NC 2.0

For years Toyota has been the darling of capitalism. The "Lean Manufacturing" philosophy and "Toyota Way" became the model to emulate for manufacturing corporations around the globe. As people are quick to stand behind a winner, they tend to be even quicker to dissociate themselves if and when they fall from grace a la Tiger Woods.

To be fair to Toyota, the latest estimate is that their vehicles were responsible for 19 deaths in the past decade.^[1] While that's 19 deaths too many, it pales in comparison to over 420,000 motor vehicle related deaths that occurred in the United States alone over the same decade.^[2] It will take months to determine if Toyota executives acted with negligence or were slow to respond to the reports of problems; but given the statistics, even if Toyota admits 'mea maxima culpa', driving a Toyota remains safer than driving any given vehicle while texting, programing a GPS, speeding, or under the influence of alcohol among other driving hazards. It just happens that a large, financially successful corporation can be held accountable for those nineteen, while most of the 419,981 others lack such a powerful scapegoat.

That's not to acquit Toyota--especially if they knew about the design flaws and opted not to correct them for economic reasons. Ford allegedly did this with the Pinto in the early seventies. According to sources, the company knew about a design flaw that could cause a gas tank explosion in the event of a rear-end collision but determined that the ensuing lawsuits could be settled for less than the cost of fixing the design (since it was already well into production)^[3].

While the Pinto put a large gash in Ford's reputation, it has obviously recovered and is now all but forgotten. Given the scope of Toyota's recent recalls, this could have a much bigger impact on the company's reputation and future sales than the Pinto miscalculation did on Ford.

Some analysts have gone so far as to predict bankruptcy for the auto giant. This possibility may actually not be too far fetched given the debunking of the "too big to fail" myth in the past couple years. This, in addition to the fact that Toyota is still expecting a loss for the 2010 fiscal year (ending March 31) even before the impact of the recent recalls^[4]. Even so, it's also in the best interest of many economies, including the United States and Canada, to continue to support Toyota since the company produces so many local jobs.

At the end of the day, I wouldn’t feel too concerned about the statistics of driving a Toyota; but I do think it’s time for business to recall the cliche of the Toyota Way. Many of the principles will remain of course, but their association with Toyota will irreversibly fade. Now there may be a new business model for business to emulate: The Google Way.

The Future of Reading

2010-02-02T19:41:00.005-07:00

Imagine reading the morning paper without getting out of bed. Imagine going to school without needing a single textbook. Imagine going into a meeting where all you need is a clipboard sized device that has access to all the documents you need at the touch of a button. The electronic digital paper revolution is here. I know it's been said before, but now it really is only a matter of time before 8.5 x 11" paper really begins to go the way of the dinosaur. According to the EPA, the average US worker uses 10,000 sheets of paper each year^*. That number won't fall to zero any time soon, but players in the pulp and paper and the printing industries need to start looking forward and adapting to avoid becoming extinct, because the future of paper is here.

/The future/

2010 has brought on an array of new devices to the market. The Amazon Kindle has an early lead with 60% of the market share, but with a market that is poised to grow exponentially in the coming years, there are no clear winners yet. All of the 'contenders' below, except for the LCD-based iPad, use E Ink Corporation's patented Electronic Ink technology, which actually uses a fairly straightforward concepts in chemistry and physics to produce a static image that doesn't require continuous power or back-lighting. Ultra-thin devices that can be rolled up and perhaps even folded could become commercial in a matter of years. The file size of an ebook can vary, but considering the cost and size of memory (an 8GB micro SD card can be purchased for $20 or less), it's not hard to imagine having all of the encyclopedia sets ever produced and much more on a device the size of a sheet of paper and only slightly heavier. Not to mention mobile wireless capability, which makes access to text virtually unlimited (3G wireless capability is already standard on many of the first-generation e-readers below).

/The contenders/

Amazon Kindle (Photo: Jon 'ShakataGaNai' Davis under CC license)

The Kindle was one of the first devices to enter the market, and because of it's online store, and focus on title availability. The device itself currently comes in two models: a 6" version and a 10" DX version (priced at US$259 and US$489 respectively). Both are capable of displaying multiple formats including PDF and have limited 3G wireless access (mainly for book downloads).

Proprietary format: AZW (with Digital Rights Management).

Sony e-reader (Photo: Gdolck)

Until the end of 2009, Sony's e-reader had been the primary competitor to Amazon's Kindle. The device itself comes in multiple versions and prices, including a touchscreen option and 3G wireless. The downside is that the Sony store does not contain as many titles as the Amazon store and some of the top bestsellers are conspicuously absent. The upside is that its ability to read Adobe's EPUB format means that unlike with the Kindle, you have access to the growing list of ebooks available to 'borrow' for free at most major libraries (with a valid library card).

Proprietary format: BBeB (encrypted or unencrypted).

Barnes & Noble Nook (Photo: Ajai Khattri under CC license)

The Nook is Barnes & Noble's jump into the market of e-readers. The device itself is well-designed and features a six-inch screen with a smaller, 3.5" LCD touchscreen for navigation. The Nook entered the market in the 2009 Christmas shopping season, and although the software has drawn complaints, the hardware is considered robust. Barnes & Noble also features a competitive collection of e-books on its online store. Along with the Kindle and Sony Reader, the Nook rounds out the list of static-image e-readers that dominate the recreational reading market (other devices do exist).

Proprietary format: none, but supports PDB, EPUB and PDF.

Plastic Logic QUE

The QUE, by Plastic Logic primarily being marketed towards business users for digital documents rather than recreational book readers. It has been in development for over ten years and is likely to have the most advanced display capabilities of any device. It is currently available for pre-ordering and expected to begin shipping in April, 2010. There will be a 4 GB WiFi only version and an 8 GB WiFI + 3G version (retails for US $649 and $799 respectively). Both units are 8.5 x 11" and 1/3" thick with touchscreen controls. The device is also lighter than other e-readers because the screen is made of scratch-resistant plastic rather than glass. It's sure to make its way into quite a few executive boardrooms.

Proprietary format: none, but compatible with PDF, ePUB as well as most image and text formats.

Apple iPad

The iPad isn't really an e-ink device but it can still serve the purpose of an electronic reader. Frequent book readers will complain about shorter battery life and eye-strain due to the backlit LCD that refreshes over 60 times a second. Claims about eye strain in modern LCD devices aren't necessarily proven, however, and the ability to place the screen in a comfortable position certainly make reading easier than on a fixed position monitor. The iPad wasn't designed exclusively for reading but rather as a multi-purpose device including web browsing, video and music capability. While it looks to be a convenient little device, I don't see it as an instant success; at least not when marketed to the recreational reader. It's basically a big-screen iPod touch with 3G capability which probably isn't the same market for readaholics. An organic LED (OLED) display may hold the greatest commercial promise for a future generation of iPads when it comes to reading.

/The issues/

Price

While the prices of these devices will come down over time, most entry-level e-readers start at over $200 for a relatively small screen (about a five inch diagonal). Readers wanting something to read larger than a pocket Bible will need to spend up to $800 or more. Then will likely still need to pay even more for content, which typically include books as well as magazine and newspaper subscriptions. This is where a smart marketing model could really help the publishers and resellers. Readers should have the option to get a subscription that includes something like 3 books per month for a monthly fee that equates to 30% off the list price of individual purchases. Not all ebooks cost money though, many of the 'classics' have been released into the public domain (usually a period after the author dies or after the work was created depending on the country). In the past, publishers had still made money printing them, but in digital form they can typically be distributed for free. Google has made many of these works available for free download (PDF or EPUB) on its Google Books website. Many works of classical music are available the the public domain and available for free in the form of digital sheet music.

Copyright

This is a huge issue that could turn out to be disastrous to publishers and authors if it isn't handled properly. Publishers have privately been sparring over the selling price of their content with these device distributes. One of such instances became public when Amazon announced it was removing Macmillan e-books from its store. The issue was resolved with Amazon caving in to a price increase but publishers need to be extremely careful with their financial/pricing models. My advice would be for them to apply a really high multiplier or exponent to the cost policy variable to model the impact of illegal copying. Consumers aren't happy to pay the same price for an e-book as for a hardcover or paperback, and it could only be a matter of time before they revolt if the prices are too high. If illegal copying and distribution of digital books did become widespread, it would be virtually impossible to stop, given that the file size of text is much smaller than music and videos.

It's been just under a year since I posted E-Papyrus: Reinventing Paper, and since that time it's clear that this 'new reality' is here and exciting.

Umbilical Oil - Part 2 (demand)

2009-11-03T22:31:00.001-07:00

'Organic' Demand

It should come as no surprise that oil is the most valuable widespread global commodity in Western civilization. In relative value terms, oil has surpassed gold. A broad range of uses including energy, transportation and non-energy/material uses are, in large part, the reason for this. Industry uses just under ten percent of the refined crude oil in order to manufacture goods and services. Commercial, residential and agricultural sectors use just under thirteen percent--much of that for heating and electricity. Non-energy uses of hydrocarbons include plastics, synthetic clothing (eg. polyester), cleaning and lubricating agents, as well as binders like asphalt. Eighty percent of the asphalt refine is used for building roads. Which leads to the sector that consumes the largest volume of crude oil--transportation. Only a few modes of widespread transportation don't consume any oil; walking, cycling and electric trains are among the few examples of these. I don't have statistics on this, but the percentage of motorized vehicles that don't consume refined oil products is probably less than 1% (hybrid-electric vehicles are still powered by oil). Between cars, trucks, boats and planes, the world consumes about sixteen billion barrels of oil each year.

Industrial consumption is already at it's lows. Heating and electricity loads are unlikely to change much in the near term (alternative energy and efficieny improvements could chip away at this in the long term). Non-energy sources are also pretty static as far as demand goes; there is an obvious reluctance to return to cotton diapers and no one likes driving on gravel roads. That pretty much leaves transportation sector to the task of reducing demand.

There are essentially two ways to reduce organic demand in the transportation sector (1) improve efficiency and (2) reduce volume. Improving efficiency implies activities like purchasing new, fuel efficient airline fleets and passenger vehicles. This requires significant capital investments and thus time before it can become a reality--even if it makes economic sense to do so. Industry leaders such as GM and Tesla Motors estimate it will take ten years and lots of government subsidies before hydrocarbon-free transportation vehicles start to become competitive in the mass markets. It will take even longer (30-40 years)^* before significant market share is acquired by alternatively powered vehicles. On the volume side, while per-capita car ownership in the United States has probably peaked, passenger car ownership in emerging economies continues to skyrocket. This is part of the reason why the transport sector only amounted to 45% of total oil consumption in 1973 and is now over 61%. China and India alone would need 2 billion cars to approach the rate of car ownership that the United States has.

Given that any major initiatives to reduce dependency on oil will take time, there is really only one way to reduce near-term organic demand for oil--higher prices.

That being said, there is a level above which the price of oil will not only be self-limiting but potentially even catastrophic in contributing to a recession. In early 2008, when oil prices pushed well past $100, the transportation sector began to collapse along with the eventual low at the end of that year. This was made worse by other issues such as the subprime housing crisis, but the bottom line was that people could no longer afford to fill up their gas tanks and thus prices necessarily fell.

Given the continued weakness of the U.S. economy, along with rising unemployment expected to peak in 2010, a high enough price could contribute to another recession and result in another price collapse. This instability price point is probably above $80 and not as high as $150. Filtering out price corrections, the trend for oil prices would appear quite bullish based on supply and demand alone.

There is however, one final part to this story: the measuring stick (the dollar).

Umbilical Oil - Part 1 (supply)

2009-10-19T23:31:00.000-06:00

Crude oil, unlike natural gas, is a commodity in much shorter supply at current prices. While a vast amount of total reserves still exist, the marginal cost of production of these reserves continues to increase. Impressive technological improvements have only partially offset the increase in finding, development and operating costs of these deeper, tighter and less permeable hydrocarbon reservoirs.

Worldwide, average recoverable oil reserves have historically been around 30-40%. In other words, for every 100 barrels of oil we find, we can only economically produce 30-40 of those. Natural gas recoveries, by comparison, have historically been in the 70-90% range. Of course, if market prices are higher, economic recovery rates also go up as energy companies can spend more capital and energy to improve efficiency. Physics and thermodynamics however, ensure that this relationship is typically a logarithmic one--doubling the oil price could, for example, only lead to 5% more recovery. On the gas side, it's much easier to move the relatively small independent methane molecule across the reservoir rock and to the wellbore than a large viscous molecule of crude oil. Two of the largest undeveloped reserves of oil in the world are deep offshore oil and unconventional resources like the oilsands. Both have the potential to produce a vast amount of oil, but it will take a lot more to fill up the gas tank if we are to rely exclusively on fuel derived from these sources.

Offshore Oil
For comparison's sake, I will compare BP's recent 'huge' Tiber oilfield find to Ghawar. Ghawar, the world's largest and most prolific developed oilfield, has produced 48% of the 131 billion barrels it's operator, Saudi Aramco, expects to recover. It has a very favorable set of geological preconditions that we have yet to find anywhere else in the world. The number of large oil discoveries is dwindling and those that have been made also have more fragile economics because of the engineering (and political) complexities involved. BP's recent Tiber oil sits 10.6 km below the ocean floor--that's more than the height of Mount Everest. It also sits in 1.2 kilometer deep water--deeper than the crush depth of the most advanced military submarines. Some submersibles and special unmanned vehicles can get this deep, but it speaks to the challenges involved. Challenges that will ensure the oil does not come out of the ground cheaply. Even when the infrastructure is in place and capital expenditures have been made, early recoverable estimates for Tiber of up to 1 billion barrels would only sustain current global oil consumption for 12 days (a thousand barrels a second is about how much the world currently consumes).

Oilsands
Unlike offshore oil, oilsands are typically very shallow and geographically accessible. It is the quality and flowability of the hydrocarbons that present challenges--the oil is too viscous to be produced using a conventional oil well scheme. The oil is typically either mined and extracted from the sands using steam, or it is produced 'in-situ' using a steam-assisted gravity drainage (SAGD) technique where high-energy steam is injected to lower the viscosity of the oil enough that it can be produced in a horizontal well. Both techniques use vast amounts of steam, which itself requires lots of energy to produce (currently most of the steam generation is produced by burning natural gas). Unlike conventional crude oil, the resulting hydrocarbon slurry then needs to be either upgraded or mixed with lighter hydrocarbons before it can be pipelined to a refinery. These processes often involve several steps such as distillation, cracking the large molecules into smaller ones, removing sulphur and heavy metals and in some cases dilution with lighter hydrocarbons (i.e. condensates). One of my textbooks from elementary school said that the oilsands would never be commercially viable. The authors were wrong--but producing the heavy oil isn't cheap by any means. Not to mention the potential of added costs due to environmental regulations and CO₂ reduction or sequestration.

"Currently oil at about $60 to $70 per bbl we think is not enough to justify some of the significant projects we are contemplating, especially on the mining side," says Jean-Michel Gires, CEO of Total E&P Canada. The energy company CEO went on to predict a sustained price of at least $85 was needed to make many these projects commercially viable.

From the supply side, it appears as though the fundamentals might support an oil price of around $80/barrel, with a continued ascent upward as the elephants* mature and decline. But that's just the supply side--stay tuned for the demand side (part 2).

*the term 'elephant' refers to a very large oil field, typically one that contains at least 100 million barrels of recoverable oil.

Swamp Gas

2009-08-24T20:49:00.018-06:00

Swamp
-noun
5. to overwhelm, esp. to overwhelm with an excess of something: He swamped us with work. [Dictionary.com]

Swamp Gas
-noun
An organic decomposition product gas which is mostly methane, the primary component of Natural Gas.

The Natural Gas Story
As crude oil prices continue to rise to pre-recession levels, prices for natural gas, the other base hydrocarbon commodity, continue to flounder. Last week NYMEX Natural Gas futures for September fell to a seven-year low below US $3/mmBTU.

The spikes are indicative of the vast reserves of natural gas, which unlike peak oil, can come on stream relatively quickly and cheaply. Liquefied natural gas technologies have also created a 'pipeline' for inexpensive natural gas reserves that were previously stranded. Worse yet is the high price of oil, which has in recent years, been in lockstep with the Canadian dollar, meaning Canadian gas producers will get even less for molecules produced north and sold south of the border. Storage levels are near all-time highs and hundreds of cubic feet per day have been shut in awaiting higher prices. The U.S. economy remains slow to return to growth compared to emerging economies despite all the stimulus. Some analysts believe a number of small and mid-cap producers will simply need to go out of business before prices for the commodity fall back in to balance. North American workers in the Oil & Gas industry have been relying increasingly on drilling natural gas wells as oil production on the continent continues to decline from it's peak (with the exception of the oilsands and other unconvnetional reserve plays). A cool summer will likely mean a tame hurricane season and forecasts of a mild autumn will keep heating demand low. All of this has been fueling rumours that the North American Exploration and Production companies will need to begin layoffs in the fall while M&A activity will increase.

Not quite apocalypse...yet
Despite all the bearish news, it's not quite time to predict an apocalypse yet for North American producers. This could still happen, if the U.S. economy were to fall into a second recession in the next 18-24 months from a economic stimulus hangover, prices could fall towards $1/mmBTU or less. For now though, contract futures beyond December 2009 continue to be sold above $5/mmBTU, a level at which most producers can be marginally profitable. Most of the hedging contracts made in 2008 when prices peaked are now expiring, leaving buyers free to spend more on new contracts and push prices higher. A U.S. government bailout could also come in the form of tax incentives for natural gas powered vehicles, furnaces or power generation, which would also push prices upwards. We're probably near the bottom, but I wouldn't hold out on $15/mmBTU gas prices anytime soon.

Coming next is the Crude Oil story.

Tax Time

2009-05-30T20:27:00.008-06:00

Many Canadians and Americans are wondering if taxes will go up, when they'll go up, and how they will will go up. The answer to the first (if) is quite easy, the second (when) a little more difficult and the third (how) is still on the drawing board. Nonetheless, the scribbles are happening...

If?
With unsustainable debt and deficits in Canada and the U.S., every political insider knows that taxes are going up. They just won't talk about it because it's unpopular. Furthermore, they'll try and use clever names to try and avoid the word 'tax', which has always had negative connotations. A quick look at the projected numbers (table below) makes it pretty obvious that without an unfathomable decrease in government spending, taxes are going up. An additional problem is the large projected increases in entitlement costs (pensions and health care) over the next several decades.

Fiscal Year	US Deficit^*	Canada Deficit^**
2008/2009	$459 billion	$9.1 billion
2009/2010	$1.7 trillion	>$50 billion (up from $33.7 billion)
2010/2011	$1.1 trillion	$13 billion (not revised)
2011/2012	$693 billion	$7.3 billion (not revised)

*Congressional Budget Office
**Canada's Economic Action Plan

When?
The economy is showing signs of reflation with commodity prices increasing. Rising Treasury yields are a clear sign that cost of borrowing cannot be held artificially low for much longer. The foreign apetite for holding U.S. debt is falling. It is "time to sell" treasuries, said Kim Heeseok. Heeseok is the head of South Korea's National Pension Service, the country's largest investor in U.S. treasuries. All of this is an indication that the answer to the question of 'when', is likely sooner rather than later.

How?
There are three general classes of options for increasing taxes:

Sales Taxes (Value-Added-Tax, Sales Tax, Point-of-Purchase Tax, etc.)
This class of tax is added whenever a 'taxable' good or service is purchased. Everyone in Canada is familiar with the GST. It was the Mulroney version of a "tax shift". The next government (Chretien) promised to eliminate it and failed to deliver. Ultimately, the GST was reduced by two percentage points. While it was a popular political move, the annual government revenues were reduced by an estimated $10 billion, nearly the same amount as the current account deficit. A federal sales tax is now the leading candidate for a universal tax increase in the United States, according to sources.

Income Taxes
Income taxes are levied on all legitimate forms of compensation for services rendered. The structure of these taxes is often complicated as they are often 'marginal' to allow for higher tax rates for higher income earners. Capital gains and dividends are also typically taxed, albeit at different rates than 'standard' income. There is usually little room to maneuver upwards on income tax because these rates need to be competitive in order to keep people and businesses from migrating to other regions with more favorable income tax rates. They can also be evaded in instances where stringent records of income is not kept--as is the case with many small businesses.

Duties, Royalties, Excises and Levies
These are miscellaneous taxes charged towards specific items. Politicians like this type of tax because they don't necessarily have the word 'tax' in it and the amount of the tax can usually be hidden inside the cost of the item itself. For example, most people have no idea how much excise taxes are on alcohol and cigarettes. California is now considering monetizing its underground marijuana industry by legalizing and taxing the substance. The resulting potential revenues for California would be massive in this case, but this example is the exception, not the rule for this class of taxes.

Savings and Property Taxes
This type of tax is the most controversial as it is a direct raid on the savings of the citizens. One common example is an estate tax--when some of the savings of a deceased person are transfered to the government instead of to their designated beneficiaries. Properties are often subject to annual taxation indefinitely despite the perceived ownership by the landowner.

Phantom Taxes
This is an indirect tax that tends to be the easiest for politicians to implement without creating public backlash. That's because citizens don't even realize that their savings are being raided. It occurs when the government decides that instead of borrowing money to finance deficits, they will print it to make up the shortfall. This leads to inflation and devaluation of the currency. The effective reserves (savings accounts) of the currency holders will fall. Many people attempt to use gold and other precious metals as an inflation hedge to hold value during this decline in the purchasing power of the dollar. The only trouble with using this inflation hedge strategy is that any 'appreciation' is subject to another type of tax--a capital gains tax.

No matter what you word it, the tax man is coming. Politicians will try and evade the question because any hint of an increase is unpopular; but the question still stands.

Getting Back To Prosperity

2009-05-10T13:32:00.004-06:00

The pace of job losses in is slowing. This is apparent looking at the 16-month payroll chart for the United States, which shows that although the economy lost jobs for the fifteenth straight month, the pace of those losses is up off it's lows. The picture in Canada is similar, although the data is reported slightly differently. There will probably be at least another 3-4 months of negative job growth but there are other signs of "green shoots". That being said much of the appreciation in equity values that we have seen this past month is due to inflation as I mentioned in the previous post. The same is true for commodity prices, which are also up sharply off their lows earlier in the year. This trend is likely to continue, and without cheap oil, the extent to which the United States economy can recover is really quite dim. While the emerging economies still have a long way to go in terms of manufacturing quality, the productive capacity and thus growth potential of these regions far exceeds that of the 'developed' nations and at a much lower labour cost.

One of the biggest delusions I've heard is that the health services sector (drug research, health care, stem cell research, and so on) will lead us out of recession. While it's true that everyone is willing to pay more for their health, the reality is that they can still only pay what they can afford. The aforementioned speculation seems to be largely based on the premise that people will pay anything for good medical treatment when practical realities dictate otherwise. Further to this, the government will need to spend less, not more, on health care costs. Even with the health care sector outperforming other sectors, it alone cannot single-handedly sustain any economy of scale.

"Well, first of all, it's our money. We paid the taxes. We're just asking for some of our money back." - Buzz Hargrove, former Canadian Auto Workers Union president on why the union should be bailed out (April 26, 2009)

The attitude of Buzz Hargrove and thousands others needs to change. Hargrove did not finish high school and yet he feels that compared to international workers, he is entitled to better pay for equal work, simply because he was born in Canada. This is an indication, unfortunately, that the 'correction' is not quite finished yet, and we'll need to see a subsidence of the corporate welfare state, reduction in entitlement expectations and a notable improvement in workforce value generation. This means better service and quality for globally competitive prices. This is where America has diverged so far away from it's founding principles in recent years. In a free economy, jobs can, and should be outsourced unless the domestic workforce provides greater competitive value. Not only is this a critical component of a free economy, but it is also critical in a free society and any protectionist government measures to artificially maintain jobs domestically will only hurt the economy in the long term. There are no shortcuts on the road back to prosperity.

The Inflation Tease

2009-05-10T12:22:00.007-06:00

The principle of inflation in economics is actually not much different than the principle of inflation in physics. When a balloon is inflated with hot air, for example, we see a very large increase in volume without any appreciable increase in mass. Similarly, in economics, inflation represents an increase in monetary supply without the corresponding increase in the value of that money. It looks like growth at first, but like a Ponzi scheme, it’s only a matter of time before the bubble pops and a correction occurs and everyone sees what’s really there; thin air.

There is no perfect way to measure inflation, but many different indicators exist. The most commonly accepted indicator is the Consumer Price Index (CPI); a sampling of the prices of the most commonly is purchased consumable goods. Using this indicator of inflation, the CPI chart indicates a step change in slope around 1971, the year the gold-based Bretton Woods system was officially abandoned because it was preventing government from running large deficits. The average annual increase in CPI jumped to a 4.6% average annual rate of increase from a more stable 2.5%.

The cause of inflation is a significant increase in money supply. Imagine playing a game of Monopoly where the bank decides to add a zero to the end of every new note it issues. Pretty soon, the old money becomes useless and each player would be forced to raise the selling price of his or her properties to reflect this new reality. It wouldn’t be so bad if we just added a zero to the end of every note, but the way it happens usually benefits some people quite a bit more than others. The first person to pass ‘Go’, for example, would find themselves flush with cash, and would likely go out on a spending spree. By the time the player in ‘Jail’ realizes what’s going on, he will probably have sold off all of this properties for what he thought was a great price, when in fact he got ripped off. This is exactly what happens in the real world, the first people to get the increase in money supply—the large financial institutions, hedge funds, very wealthy and so on, get to spend the new money at old prices. By the time this money gets into the pockets of the middle class and the poor, prices have already increased and they simply find that their savings have been rendered worthless. This is exactly what we are seeing today—wage depreciation occurring at the same time that consumer prices are either increasing or staying flat.

It’s no surprise that central banks such as the United States Federal Reserve, a pseudo-private, pseudo-public entity which is essentially run by banks and backed by government, makes their policy that creates the biggest benefit to their friends at large financial institutions. Government, which essentially owns (but does not directly operate) the central bank, is usually complacent to this policy because inflated economies look good—at least until the bubble bursts. And yet no president including Regan has been able to successfully balance recessionary and inflationary forces since the idea of having a naturally stable currency was abandoned in 1971. This is the main argument for why central banks should be abandoned—government has proven itself incapable of maintaining a stable currency in nearly four decades since it decided it could do a better job of this than free markets could.

"I'll bet you a lot more than a penny" - Peter Schiff predicting the credit crisis and collapse of the purchasing power of the USD (2006).

This reality is often underreported by the mainstream American media. Some claim this is because the media, including many so-called experts and economists, are mislead by the way the government reports on it's monetary policy. For example, the U.S. Federal Reserve decided to stop reporting M3, the total money supply in March of 2006, claiming the data was too difficult to accurately compile. It still reports M2, which is part of the money supply, but the M3 wedge has grown from less than 5% in 1971 to over 30% of the total in February 2006 when this figure was last reported (see chart). Not everyone is fooled though. The video below shows economist Peter Schiff on major U.S. television networks predicting the subprime and credit crises in 2006 and 2007 despite being ridiculed by his naive counterparts at the time. It is also worth noting that these counterparts recommended buying equity stake in firms like Bear Sterns, Merrill Lynch and Washington Mutual, all of which became insolvent and were forced into distressed mergers with more solvent financial institutions. Each of these transactions was facilitated by either the Federal Reserve or the Treasury with some kind of taxpayer-backed debt guarantee or subsidy. Hopefully these guys stay low-key for awhile until people forget how bad their recommendations really were. Enjoy watching the video.

Swineophobia

2009-05-03T20:24:00.005-06:00

Let me first assert that infection from the active strain of the H1N1 virus does indeed cause serious illness which does have the potential to cause death--this is indisputable. However, it is important that any and all responses by the public, health officals and government remain both appropriate and contextual rather than hasty and irrational. This particular strain is not necessarily any more virulent than that of the 'human' influenza virus. For example, with the swine flu 'epidemic' of 1976, more people died from the recklessly synthesized vaccine than from the virus itself--one of the reasons many people still fear the influenza vaccine today. It is now reported that only 19 of the deaths in Mexico to date can actually be attributed to the virus rather than the hundreds they initially thought. Preliminary research suggests the current strain has a cleavage site that may reduce it's virulence. The 'mild' virus would need to mutate further in order to cause more serious danger to the general public.^[1]

Outbreak: A disease outbreak is the occurrence of cases of disease in excess of what would normally be expected. A single case of a communicable disease [may] constitute an outbreak.

Pandemic: The emergence of a disease new to a population involving infectious agents. The disease is spread across a large geographical region and can be transmitted easily and sustainably among humans and cause serious illness.

While the Swine Flu or H1N1 virus may meet the technical World Health Organization definition for both an outbreak and a pandemic, this classification is misleading as the disease is far from widespread. Confirmed cases in Canada affect 0.00027% of the population. Mexico's confirmed infection rate is 0.00036%, while the United States has 176 confirmed cases out it's 300,000,000 people. The actual number of cases is undoubtedly greater, but even if it is one hundred times greater, the risk of infection to the general population remains insignificant at this point in time (less than one tenth of a percent). This begs the question of whether the additional $1.5 billion president Obama has asked congress for to fight this virus could be more effectively deployed for other public health issues. There's a good chance the money won't even provide any assistance to the cause before the pandemic subsides. We won't know the answer for a while yet, but few people, including government, will hesitate to ask for more money when an opportunity arises.

The 'cartoon' model of a molecular protein. The label H1N1 is derived from the two proteins found on the surface of the Swine flu virus: Hemagglutinin subtype 1 (H1) and Neuraminidase subtype 1 (N1).

This does not mean preventative measures by health authorities do not need to be taken. It can certainly make sense for large businesses, for example, to encourage employees to take paid sick leave if indeed there are reasonable grounds to suspect they are sick with any respiratory infectious agent that has a high rate of transmissibility. From a company-wide perspective, this is not just a matter of ensuring the health of it's employees, but it's also a matter of maximizing the productive capacity of the workforce. If a single employee takes two weeks off, this outcome is much less disabling to the company than if he or she returned to work and infected tens or hundreds of other employees.

The standard preventative measures to reduce the risk of infection should always be taken, whenever possible. These include handwashing and personal hygene, as well as measures to maximize your body's immune system such as adequate sleep and good nutrition. I wouldn't plan a vacation to Mexico for next week, but if you already have a trip booked and can't get a refund, deciding to proceed won't exactly mean you're facing "certain death".

My next post will deal with Human Physiology--the impressive amount of knowledge we've accumulated on the subject and how much we still don't really know.

USA: Success or Secession?

2009-04-21T18:07:00.012-06:00

It's pretty hard to imagine why anyone would be willing to pay a 90% income tax rate without any improvement in public services. Especially if it's to repay debt incurred by somebody else. Anyone that has the means would simply pick up and move somewhere else. Investor Jim Rogers already relocated to Singapore for this very reason; many others will follow. Naturally, it will be impossible for 300 million people to do the same. The alternative therefore, will be secession. Canada had it's own debates about secession with Quebec trying to withdraw from the country. Americans will have similar heated discussions about the legal right of American States to secede from the Union. Nonetheless it is the most probable and perhaps even inevitable outcome, particularly if economic recovery does not happen sooner rather than later. As I've said before, I think crude oil prices of no more than $20 a barrel will be necessary for sustained economic growth to occur in the United States.

The bad news is that when a country splits up, the breakup is nearly always preceded and/or succeeded by some form of civil war. Debt holders could be wiped out or suffer significant losses. The good news is that the Soviet Union, the only nuclear power to secede, was able to keep it's inventory of nuclear weapons secure and unused during the process.

The Precarious Peace

2009-04-05T20:42:00.007-06:00

In times of abundant resources and economic wealth, living in harmony, peace and civility is a relatively simple thing to do. In times of economic hardship and resource scarcity, the instinct of survival takes over. I suppose this is why the Obama administration wants to reduce the number of active nuclear weapons in the world as futile as the effort may be. Here's a brief look at the science and the politics of nuclear armament.

The Science
Several years ago, I read a book called E=mc²: A History of The World's Most Famous Equation. In Chapter 13, author David Bodanis provides an explanation of the events that occurred, from micro to macro at 8:16am in Japan when the first nuclear weapon was used against man. It is a visceral, awesome and terrifying account of the ultimate weapon of mass destruction.

Virtually every state possessing nuclear weapons developed them as martial insurance against a potential nuclear attack from another antagonistic nation with such capabilities...

The death and destruction caused in Nagasaki and Hiroshima makes the attacks of September 11th seem rather insignificant in terms of civilian death toll, injury toll and infrastructure destruction and long-term effects such as radioactive contamination. Yet these were only fission-based weapons delivering 15-20 kilotons of TNT equivalent. Since then, thermonuclear (fusion-based) weapons have been developed which will theoretically deliver over 100 megatons of TNT-equivalent energy. Tests of high-yield bombs are typically done below theoretical maximum yield to minimize both environmental destruction and for secrecy purposes; the mushroom cloud can be seen by anyone as far as 1000 kilometers of the blast and if below-ground tests are done, the seismic signatures can be detected. Russia's Tsar Bomba, the most powerful device ever built by man was tested at about 50 megatons or 2.1×10¹⁷ Joules. It's a bit hard to grasp what a megaton of TNT means, but the image of the mushroom clouds produced below may help put it into perspective.

Fat Man (1) is the 22.5 kiloton fission bomb that was detonated in Nagasaki, Japan while Castle Bravo (2) was the 15 megaton thermonuclear fusion device tested by the U.S. in the Marshall Islands. (Image: U.S. Federal Government)

The peak temperature is about 350,000,000 degrees Celsius--a temperature for which all matter exists in a state called plasma. Steel near the blast epicenter would be instantly vapourized and there would be no forensic trace of any humans unfortunate enough to be nearby. Those far enough to survive instantaneous death would receive severe third degree burns to any soft tissue with a line of sight to the bomb. Depending on wind directions, radioactive fallout could cause hair loss for people hundreds of kilometers from the blast site. My guess is that a single high-yield thermonuclear device could eradicate 20 million people if it were detonated in the right place.

The Politics
Since Hiroshima and Nagasaki were bombed, the world has made well over 65,000 nuclear warheads of which over 10,000 are currently active (the weapons have 'expiry' dates). Ninety percent of these are held by the U.S. and Russia, with the balance in the U.K., France, China, India, Pakistan. Israel never signed the nuclear non-proliferation treaty and thus does not report on its nuclear weapons program, but is believed to possess a significant stockpile of nuclear warheads. North Korea withdrew from the treaty and is believed to have successfully conducted a nuclear weapons test. Iran and Syria are following a similar path to that of North Korea, but are not believed to possess viable nuclear warheads at this time.

Virtually every state possessing nuclear weapons developed them as martial insurance against a potential nuclear attack from another antagonistic nation with such capabilities: The USSR as a deterrent to the U.S.; the U.K. and France in response to the USSR; China to counter the U.S.; North Korea to oppose U.S. nuke stockpiles in South Korea; Pakistan to retaliate against India's tests; and Iran and Syria to retort Israel.

Hopefully each and every person with the authority to deploy these weapons will hold them as a nothing more than a deterrent and never use them. Otherwise the world will find a new peace without too many humans, if any left in it.

Copying right? The Digital Age of Consumer Media

2009-03-30T20:43:00.007-06:00

High-speed internet, CD and DVD burners, personal video recorders, high-capacity hard drive, iPods, mp3 players, satellites and receivers made it effortless to transfer, reproduce and store trillions of bits of data at the touch of a button. Few groups, with the exception of the consumer have kept up with the technologies in their rapid state of flux.

Is 'file sharing' really stealing?!?
The entertainment industry put out an advertisement condemning the pirating of intellectual property. Their assertion is that stealing a television is the same as stealing a satellite signal. The list price of the service could be the same as a television, yet there is an important philosophical distinction. While intellectual property has apparent value, it does not have any tangible value. A person stealing a satellite signal only causes lost revenues for the provider if the thief would otherwise have paid for it. This does not make such a theft ethical; by law the violator could face penalties as if he/she stole a tangible good of equal value. It is still stealing, but it does require the distinction from someone who steals a material thing effectively removing a salable product from inventory, thus causing more apparent harm to the rightful owner. Many people continue to have little sympathy for entertainment executives and pop artists and movie stars that continue to earn millions despite the fact that it is the smaller artists that rely the most on record sales for their revenues.

The Law
The legal process is far too slow to keep up with the latest technologies and proved ineffective. By the time Napster was closed by the courts, peer-to-peer networks like Kazaa and BitTorrent were already set to take their place. The industry then went after the individuals that 'shared' the most content. This strategy had minimal success and created a PR mess in the process. Some of the violators were children using their grandparents internet account to do all their illegal downloading. People sympathize with ninety year old grandmothers accused of copyright infringement who don't even know how to write an email. The approach failed to dissuade large masses of people from downloading illegally.

The Lawmakers
The lawmakers (politicians) are part of an older generation that generally does not use or understand the technologies being used in potential copyright infringements. In 1998, President Clinton signed the Digital Millennium Copyright Act into law. Despite a modern-sounding name, the act did not provide the protections the record industry had hoped for. Less than a year later, Shawn Fanning released the original Napster that popularized 'file sharing'. Canada has yet to pass it's own version of copyright reform for the new millennium, but proposals have been tabled. A version of Bill C-61 will likely get re-introduced since the bill did not get passed before the 39th session of parliament was dissolved. The law will likely not have no more success at curbing illegal and/or unethical copying than it's American counterpart did.

While Canadian copyright laws have yet to be overhauled, the Canadian Private Copying Collective (CPCC) was created by the Federal Government in 1998 to collect and distribute royalties on blank media on behalf of music rights holders hurt by illegal copying. The tariff amounts are based on statistical data of music downloads. The table below shows current levy rates being charged to all blank CD's purchased in Canada. The proposed tax on music-based digital storage media and devices (such as iPods) was struck down by the Canadian Federal Court of Appeal on the basis that the CPCC does not have the legal authority to impose such a tariff (link). Others argue that it's unconstitutional because it is based on the presumption that consumers are not paying for the media on their digital devices. Some even argue the tariff encourages 'file sharing' because it compensates artists. It's certainly hard to believe that someone buying a digital camera should have to pay up to $10 to the record industry for their flash memory card.

	Tariff
Audio cassettes of 40 minutes or more	29¢
CD-R or CD-RW	29¢
CD-R Audio, CD-RW Audio or MiniDisc	29¢
Removable electronic memory cards over 256 MB (MMC, SD, Compact Flash, etc.)
no more than 1 GB	$2
more than 1 GB and no more than 4 GB	$5
more than 4 GB	$10
Digital Audio Recorders (iPods, mp3 players)
No more than 1 GB	$5
more than 1 GB and no more than 10 GB	$25
more than 10 GB and no more than 30 GB	$50
more than 30 GB	$75

Source: CPCC Tariff Backgrounder

The Enforcers
Without entering into the offices and living rooms of millions of private citizens, it's very difficult and in some cases impossible to monitor the massive amounts of data that gets transferred between electronic devices. In some cases, it's virtually impossible to determine who downloaded or uploaded something using an unsecured wireless network from a laptop that leaves little to no trace of itself. Recently, several police agencies complained that Blackberry's (made in Canada by RIM) are too secure--they can't intercept and monitor drug dealers who are using them. The trouble is that if security holes are deliberately built in to the devices, they become more susceptible to hackers. This extremely reliable security of the device was likely the only reason President Obama was allowed by the secret service to be the only standing president with a mobile communications device.

Asleep At The Switch
The CRTC is the "Independent public authority in charge of regulating and supervising Canadian broadcasting and telecommunications." Radio waves and satellite communications typically prove to be a very difficult thing to regulate since they pass through Canadian airspace whether the CRTC wants them to or not. Broadcast radio was not too difficult to control in urban settings because U.S. broadcast frequencies could simply be overpowered by stronger signals on the Canadian side of the border. Satellite radio did not have the same overwriting capability. During the first three years of the service, satellite radio was not officially available in Canada. Still, many Canadians were using the American service 'illegally' by registering 90210 as their zip code since the signal could be picked up even in northern parts of the country.

Another example is Pandora internet radio. The US-based service provides 'radio' stations customized to the users individual tastes. The CRTC forced the Music Genome Project (Pandora) to block its content for Canadian IP addresses in 2007. This did not stop some Canadian internet users from circumventing the block. In other cases, the blocking algorithms on the site simply do not work allowing Canadian IP addresses to access Pandora content freely (albeit violating the terms of use of the site).

It seems clear to me that everyone from lawmakers to enforcers, record industry execs to artists have a long way to go when it comes to adapting and bringing themselves into the twenty first century. The neo-luddites will lose the war against the Digital Revolution just as their counterparts lost their fight against the Industrial Revolution.

1.3 Billion Pounds of Thrust

2009-03-26T19:16:00.017-06:00

It flies more than twice the speed of sound. Radar absorbing materials (RAM) in conjunction with fan blade design making it virtually invisible to direct radar. It's the F-22 'Raptor'. Most men marvel at one exuding 70,000 pounds of thrust let alone one fully loaded with eighty thousand pounds of bombs, missiles and cannons. An engineer gets excited like a kid in a toy store at the sight of one of the beasts you don't even hear coming, provided they're on your side. My office wall has a picture of two of them flying next to the F-15 'Eagle' they were built to replace.

On Wednesday March 25, an F-22 Raptor crashed in California killing the test pilot. The cause of the crash was not immediately known but obviously the smallest oversight becomes catastrophic at 2,500 km/h. This was by no means the most expensive crash at $140 million dollars either. About 13 months ago, a B-2 Spirit crashed in Guam just after takeoff. The two pilots ejected safely but the hull was completely destroyed at an estimated cost of $1.4 billion.

I don't think the 1.3 billion Chinese from the People's Republic realize just how powerful they are yet.

When you add up all the numbers, the United States military budget totals about $500 billion a year. While it's obvious that president Obama doesn't have much of an appetite for military spending, the United States' creditors, rather than it's citizens will effectively decide how much capital it can sustain on the military. As we've already seen China flexing it's economic muscle in the past several days just by mentioning concern about the inherent risk of their treasury holdings. The USD's universality is currently the only thing holding the United States economy back from hyperinflation in the medium term. I don't think the 1.3 billion Chinese from the People's Republic realize just how powerful they are yet. The use of military force against Iran will hinge upon China's agreement. China would likely take exception since Iran provides discounted oil in exchange for economic protection. I talked about this 'nuclear option' in previous posts (see America In Recession). Now I think this may take years instead of decades to happen. The world may need to get used to five yellow stars on red rather than fifty white stars on blue.

White Out

2009-03-04T21:38:00.010-07:00

The White House, Wealth and the Economy

Larry Kudlow of CNBC always talks about mustard seeds in relation to the economy. The trouble is that his optimism, while refreshing, had been unrealistic over the past year. As I've said before, there is a difference between optimism, pessimism and reality. It's now becoming clear that some of those who were previously labeled pessimists are actually perpetual optimistic realists. Today however, it looks like the mustard seed is finally in the ground. It will need plenty of water, nutrients and time to grow, but the seed has been sown nonetheless. I've penned some Q&A-style perspectives below..

Isn't the market supposed to be forward-looking?!?
Many people have said the markets are forward looking and that the next 6 months are already factored in to the stock market. Obviously they were wrong if they said this three months ago. The reason they were wrong is that the stock market is not some kind of oracle but merely an indicator of economic sentiment and perception. The perception was wrong as CEO's and analysts were continually making downward revisions to their guidance leading to a negative feedback loop in the economy. The popular perception is now much closer to reality now, in my opinion, which means we are at, or near a bottom in the stock market.

What did the Obama administration have to do with the economy?
Thus far they haven't done anything measurable. The market correction paused to determine if the smart guys in the administration had a magic bullet that would stop the declines. They didn't, and when this fact became apparent, the declines resumed their course. Sporatic reactions to announcements and press releases are never a reflection of long term equity value with the very rare exception of events that act as a catalyst for catastrophic events (the Lehman Brothers failure for example).

So the Obama administration actually knows what it's doing?
Not really. In his testimony yesterday Treasury Secretary Timothy Geithner admitted that if the administration's GDP growth projections for the next decade are off, the public debt may no longer be serviceable. He emphasized that he didn't see any better alternative to the current direction given their inheritance. He's probably right and certainly transparent; but this does not inspire much confidence in their ability to fix the economic problems.

Is now the time to buy stocks?
Yes and no. One certainty is that anyone predicting a bottom will be wrong. However, my outlook several months ago was that the Dow Jones Industrial average would bottom out in the 4000-6000 range. My outlook has not changed (as it sometimes does), and the stimulus packages could help push this bottom higher than my estimate. I'd be ready to diligently put long-term investment capital to work. Traders beware of expecting large returns and high long-term growth rates. Profit taking will ensure that volatility remains in the markets for the next 3 months as the economy moves towards a rebalanced state. A structural debt problem that still exists in the United States economy should be considered very carefully.

Does this mean the economy is turning?
Yes and no. More job losses are on their way. House prices still likely have further to fall to eliminate the excess in homes. There is still more downside. When growth does resume it will not be a sudden dilation back to 2007 activity levels. On the other hand, the light at the end of the tunnel is becoming visible. Just realize that the path to get there will be a difficult one.

Every obstacle forges fortitude, every hurdle appraises fitness and every challenge tenders opportunity.

-You're smarter than you think.

Economic Stimuloids

2009-03-02T18:34:00.016-07:00

"Suplement Me" by SMmeaLLuM [cc]

"The biggest problem with steroids is that you can only inject so much before the patient goes into cardiac arrest."
-Anonymous

Many of the smart people on Wall Street continue to call for more stimulus in response to falling investor confidence. Major executives like billionaire Mortimer Zuckerman continue to call for more stimulus. They say the current stimulus package is way too small and that Washington will need to ask the Chinese if they can borrow more money on behalf of the unborn American taxpayer before the end of the year.

The U.S. debt levels as a percentage of GDP has now has not been seen since the 1940's. The main difference between then and now is that the debt holders then were mostly domestic; it was considered patriotic to be a bond-holder of national debt. The trouble is that now the U.S. is relying on foreign creditors to buy up public debt. Should these purchasers decide they don't like something the United States is doing or consider their credit risk too high, they may simply stop buying their debt. This leaves two basic options, (1) print more money (inflate and devalue the currency), and (2) raise taxes, and several other more complex but less effective ones, such as raising interest rates.

The most likely response would include an array of the aforementioned strategies, none of which are desirable.

"It's going to take World War III to get us out of this."
- Don Luskin on the state of the economy

E-Papyrus: Reinventing Paper

2009-02-28T20:05:00.019-07:00

The Heracles Papyrus

One of the first transportable media to carry information in the form of written language was Papyrus, which dates all the way back to the First dynasty circa 3000 B.C.E (over 5000 years ago). Modern (wood pulp-based) paper is believed to have been invented in China during the Han dynasty circa 200 C.E. We are now on the dawn of a new type of paper, plastic paper.

The idea of digital or plastic paper is not a new one, and has been hypothesized and researched for years. The problem has been figuring out how to produce something with the following four criteria:

Portability - If it weighs more than about 500g you may as well just carry textbooks.
Durability - It needs to stand up to moisture, mild G-forces and variable temperatures.
Cost - Few people will want to carry around a device worth thousands of dollars when they can just buy a newspaper for a dollar.
Ease of reading - standard screens (LCD, plasma, etc.) are not comfortable on the eyes for reading lengthy documents. That's because they have non-ideal text contrast, back-lighting and/or screen refresh rates that lead to eye strain.

With advances in material science, manufacturing and miniaturization, it looks like we are finally approaching the electronic paper era that many people erroneously thought would come with the invention of computers. The Plastic Logic eReader, Sony Reader, iRex iLiad and Amazon Kindle are just some examples of the first generation of electronic readers. It may not be long before high school and university students can carry all their textbooks on a single device.

Plastic Logic's e-Reader is to be piloted in mid-2009.

This exciting new reality won't be a boon for everyone. The forestry sector will see their demand dwindle, as will the pulp and paper mills and the printing businesses over time. The aforementioned should have time to restructure since demand for paper won't drop overnight. The intellectual property holders will need to adapt much more quickly. Within seconds, a NY-Times bestseller can make its way to thousands of internet users without proper compensation. Digital Rights Management (DRM) will likely continue to prove ineffective as it is too easy to circumvent. They will need to discover new ways to generate revenues going forward or technology will simply leave them behind. Which leads me into my next topic: intellectual property and copyright reform.

You're smarter than you think.

The TARP, optimistically..

2009-01-15T22:27:00.022-07:00

Some philosophical context

I think it's both timely and important to note the distinction between optimism, pessimism and reality. Most people think that forgetting reality is the way to remain optimistic. This is the wrong way to approach reality. The truth is that understanding reality is the only way to manage expectations and remain optimistic. Expectations are usually met for someone who has a tangible grasp on reality. The optimist also understands that they can mold their own reality but they can't choose the clay. On the other hand, the person who does not have a tangible grasp on reality finds themselves is always disappointed by unrealistic expectations. This psychological house of cards is sometimes made even worse as they create more undue optimism to fill their void in troubled times, which can only lead to a terrible downward spiral in the end.

TARP (tar⋅pau⋅lin) - [tahr-paw-lin, tahr-puh-lin]

-noun

a protective covering of canvas or other material waterproofed with tar, paint, or wax.

When it comes to the economy, it's clear that many people still misplace optimism with optimistic realism, despite a notable improvement in this regard in recent days and weeks. Many people still believe the purpose of the TARP (Troubled Asset Relief Program) was to increase lending and stop foreclosures. It wasn't. The purpose was simply to stabilize financial markets and stall the market correction following the failure of Lehman Brothers collapse. Major banks were failing by the week at the time, with no clear end in sight. The system was collapsing and the fall had spread to the broader market. The economists that saw the current problems of the market predicted the fair (unadulterated) value level of Dow Jones Industrial Average was (and still is) about 4,000 (Thursday's close was 8,212). The program eventually passed congress and equity markets stabilized. The .DJI has been flat since October 10, 2008, about the time it became clear that the bailout would pass in some form or another. When the Obama and Bush economic advisers realized is that the correction was about to resume it's course, with more defaults coming from the retail sector in addition to continuing subprime loan defaults, they called for the release of the second $350B bale of the TARP.

The real objective of the TARP was to diffuse the full extent of a free market correction. Without the TARP funds, the mark-to-market net worth of nearly everyone with equity would fall by about half (this includes RRSP's, 401k's, home equity, etc.). Foreclosure rates would have accelerated in the opposite direction of equity. Citibank, Bank of America, Fannie Mae, Freddie Mac, Chrysler, GM, AIG would all obviously have failed with catastrophic consequences, along with many others. The economy would need a combination of pay cuts and job cuts; if fewer people willingly took pay cuts, more people would be forced into job cuts (this still holds true despite the TARP). It's no surprise that no acting government, republican or democrat, would be willing to face such a reality and opted instead for inflationary market interference instead.

I'm not personally in favour of these bailouts unsustainable tax cuts, debt loads, deficit spending and stimulus handouts. They will ultimately just prolong and extend the natural correction as well as stagnate longer-term growth for years, perhaps even decades. Political stability will become rather precarious as it becomes clear that debts cannot and will not be repaid. The greenback will have questionable value as the dollar becomes mortgaged (also see America's Fundamentals). Nonetheless, it's important to be onside with reality. This is the only way to see the glass as being half full.

You're ~~Richer~~ Smarter Than You Think.
Kent Carter

America In Recession

2009-01-11T20:38:00.008-07:00

The United States has already conceded it's title as the world's most powerful nation. Of course, it still has the World's most technically advanced military, most martial firepower and the largest and most capable nuclear arsenal. It still has the World's reigning currency, highest volume of wealthy people in the world and largest GDP (excluding the European Union).^{[1], [2], [3]}

Waning Superiority
The military superiority is a bit misleading because it hinges on America's ability to both finance and fuel the technologies. The massive energy and cost requirements of the U.S. military are becoming increasingly reliant on foreign oil and foreign debt. Even economic superiority is decreasing because of huge deficits and debt. Economic debt is, in principle, no different from social debt: an obligation requiring future reparation (usually with interest). In the decades immediately following the first two World wars, the United States was the lender, mostly to European countries in ruin, giving it unprecedented power as a recipient of Europe's future financial obligations. The United States did had large debts of its own at the time, but the debt holders were largely domestic, leaving its own citizens in control of its own destiny. In 1988, about 13% of the government debt was foreign-owned.^[4]. Currently, about half of the public U.S. debt load is owned by foreign investors. This percentage is certain to rise social security, health care and other entitlements on the rise while the GDP shrinks. The president elect forecasts trillion dollar deficits "for years to come."^[5]

Iran Example (image)
China has formed a strategic alliance with Iran. The arrangement allows China to receive Iranian oil at a discount in exchange for economic support that allows Iran to circumvent UN sanctions. In the spring of 2008, China and Russia blocked a UN Security Council resolution to increase sanctions on Iran in response to Iran's defiance of calls to abandon its uranium enrichment program. ^[6]

The 'Nuclear Option'
Knowing it cannot count on United Nations support, were the United States to decide to attack Iran unilaterally, Iran could plead with China to use its economic nuclear option in order to prevent such an attack. The economic nuclear option is the scenario where a large foreign owner of another nations public debt threatens to stop lending thus crashing the currency value of the indebted country and plunging it into economic ruin. The United States used this approach to help end the Suez Crisis in 1956. In short, president Eisenhower threatened to sell the U.S. reserves of British Pounds and Sterling Bonds and collapse the British Pound if they did not withdraw troops from the region. This tactic coupled with other pressures forced Britain to withdraw it's troops from the region and is regarded by historians as an egregious point in the decline of the British Empire.

Precarious Positions
Tactics such as the 'nuclear option' are not without significant economic risk to the powers considering it's use however. An estimated 70% of China's currency reserves are held in the U.S. dollar (the administration does not make these figures public).^[7] Trying to convert (sell) large amounts of these holdings will inevitably cause the U.S. dollar to fall, leading to a write-down of their remaining domestic currency reserves. Instead, they will likely try to divest these holdings over a period of years or decades, leading to a gradual decline in the value of the greenback rather than a violent plunge. China, India and other emerging economies are also in the rather undesirable position of having large populations but limited domestic resources. The world simply does not have enough natural resources to bring the average standard of living up to the same average level of the wealthy western nations. One of the reasons America was able to become so prosperous was that the country was awash in natural resources: coal, oil, water, minerals and fertile agricultural land. Now that those resources have mostly been exploited domestically, America has tried to create a knowledge-based economy without conceding any reduction in annual economic growth. I think the current economic environment is a reflection of the reality that the global economy was supersaturated with overpaid knowledge-based employees and thus became reliant on inflation and artificial Madoff money to provide illusory growth. Is there really nowhere to go but down? America and the rest of the world certainly face the challenge of finding real and significant growth in a globe that appears increasingly finite. What the world needs is some good ideas on how to succeed in this feat.

You're Smarter Than You Think.
-Kent Carter

International Monetary Fund Report
CIA World Factbook
World Bank Statistics (2007).
Final Monthly Treasury Statement, U.S. Treasury (September 30, 2008).
Obama Predicts Years of Deficits Over $1 Trillion, Washington Post (January 7, 2009).
Russia, China block UN resolution on Iran; MSNBC (March 4, 2008).
China Losing Taste for Debt From U.S., New York Times (January 7, 2009).

The Perfect Gift

2008-12-24T00:00:00.006-07:00

I'm a Boxing Day baby. In my youth, some of my peers were jealous that my birthday landed on the only concurrent pair of statutory holidays. It was definitely great, but not because I get double the gifts. In fact, I'd usually get one combined gift for Christmas and my birthday. Some people assumed it was a bigger agglomerate gift (so to speak) to combine the two events. That assumption often proved wrong--my brother would get the exact same gift even though his birthday is in the spring. The only difference between my present and his was that his card didn't have the 'Happy Birthday' appendage written on it. For a brief time, I felt like I got shafted every single year...

photo by Kasia [cc license]

Now that I'm older, I realize that what I thought I wanted was often an illusion. The bubble was created by the people trying to convince me I needed stuff I probably never autonomously wanted. Unfortunately for Detroit, even the most brilliant advertisers can't persuade people they need a Hummer right now. If you ask me what I want now, I may still mull over the usual suspects. I'm a Toronto Raptors fan; but watching their games is painful enough as it is. I don't think I'd enjoy seeing a Chris Bosh Fathead on my dining room wall every day. I don't need something to provide me with 10 seconds of entertainment like a Tickle-Me-Elmo doll. It would just end up feeding the black hole some people call 'the basement' anyway (anyone who's ever seen my Mississauga basement knows what I'm talking about). I do have a small wish-list of course, but I prefer to keep that one to myself. That's because if Santa Claus, a genie, government or anyone else decides to grant all my wishes, then I'll have no motivation left to work for anything.

Alas, here is my guidance for finding me the perfect gift this holiday season. It's tailored specifically to me, but I suspect it can apply generally to quite a few other adults as well.

If you find the perfect gift and it fits within your budget, I will very much appreciate your bestowal.

On the other hand, if you have no idea what I want and need to ask me what I want, chances are I don't need it and will get by fine without it. Do not feel the need to get me something for the sake of gift giving.

If you feel the exigency to give me something material, get me a cheap card and write something in it. If you're really frugal, you can make your own card out of paper and I'll appreciate it just as much, if not more. The best gifts always have intangible value.

If you feel absolutely compelled to spend money, and you have no idea what I may want, here's the fail safe: ask me to send you a list of charities. As a follow up, I'll send you a list of about five charitable organizations that I consider to be well managed, deserving, underfunded and serving a cause that I feel connected to. You can choose one (or several) from the list I provide, and donate your earmarked gift budget to it. Just let me know to whom and how much you donated and I'll have the peace of mind in knowing that no Wal-Mart employees were harmed in giving such a gift. As an added bonus, you'll get a kickback from the tax guys.

Happy Holidays and Happy New Year.

And don't forget, You're Smarter Than You Think. Kent Carter.

You're Smarter Than You Think: Part 4

2008-11-30T19:01:00.002-07:00

Unlocking Your Potential

I've tried to reinforce that you are likely more intellectually capable than you may think. Unfortunately, I can't offer too many answers to the question of how to maximize these intellectual capabilities (if I could, I think I'd be rich). Instead, I've compiled an brief list based on multiple robust studies and what has historically been effective for many people. I'm sure the list will continually grow as we build better bridges to ply the gap between intangible psychology and pseudo-tangible cognitive neuroscience. In the meantime, here is my rudimentary list:

A wide variety of balanced activities help expand the mind. This includes activities like sports, music and other extra-curricular activities. I already talked about TV and video games as they relate to children, but even in adults their use for entertainment purposes should be minimized. There are many educational TV programs and video games, but on average even the most academic ones tend to be more of a hindrance to learning compared with other activities. That said, there was a recent contestant on Jeopardy who said that she learns her facts from television documentaries and almost never reads books.

In mathematics, repetition has proved very effective when it comes to improving performance. This is the basis of programs like the Kumon method. I do not generally endorse Kumon as as I think it's math fixation lacks cognitive balance. In principle though, these types of mind exercises (crosswords, puzzles, brain teasers, etc.) are all very effective.

Adequate sleep improves short term memory and concentration. That could mean that, pulling an all-nighter to study doesn't necessarily improve performance in the exam that follows. That said, this is only a rule of thumb as adrenaline can reverse some of the effects of sleep deprivation on a temporary basis (i.e. prior to a major exam). Caffeine helps prevent drowsiness but does very little for memory and concentration. Generally speaking, recreational drugs are bad for the intellect and some even cause permanent and irreversible brain damage.

Opening Your Mind

Albert Einstein has acquired the reputation of being one of the smartest minds of the 20^th century. He rejected the assumption that time and space are absolute, and postulated the special theory of relativity. Not surprisingly, even the most respected scientists initially thought the idea that time was relative rather than absolute was nonsense. It was not until several years later when Einstein's abstract theory was considered proven by a celestial event that it became openly accepted by the scientific community. Among other things, Einstein's work produced the world's most famous equation, E=mc², and eventually gave us the ability to recreate the energy of the sun (nuclear fusion/fission). Later in life, Einstein, like many of us, allowed age and experience to become a barrier to openness of thought. Although he was one of the scientists that helped develop quantum mechanical theory, he had notable difficulty accepting one of the philosophical consequences of it (a probabilistic universe rather than a deterministic one). Einstein was better than most in that he gave this consequence due consideration before saying he was "convinced that [God] does not play dice" with the universe.

Quite often people dismiss an idea as being stupid before giving it any real consideration. Unfortunately, this approach deprives them of a potential learning opportunity. That doesn't mean all ideas are good ones; it simply means all ideas need due consideration before they are dismissed. Even the least capable people can have great ideas and the brightest of people can come up with stupid ones. In response to a question, one of my old teachers once joked, "You're ask a really stupid question for such a smart student. [comedic pause] I'm just kidding... you're not that smart." On the other hand, let me end te final installment with an idea that will always be sincere:

You're smarter than you think.

You're Smarter Than You Think: Part 3

2008-11-23T21:00:00.022-07:00

Learning How To Be 'Smart'
Up until this point, I haven't defined what I mean by the word smart. First, I will define intelligence: it is both the ability and capability to learn, comprehend, retain and process information via cognitive function. Note that there is a subtle but important difference between ability and capability. Ability relates to a current skill. Capability has an emphasis on potential and is future-oriented; a young person, for example, can still be considered intelligent even if his adult counterpart currently holds more wisdom and knowledge. This is analogous to how a young sports professional in his rookie year compares his veteran counterpart. We tend to associate the word 'smart' with current intellectual ability rather than capability; with current knowledge rather than potential. I suspect this is because while ability is quantifiable, capability can be very difficult to measure. IQ tests are designed to measure intellectual ability and not capability, which is why they require age adjustments. Even in this capacity IQ tests remain imperfect as they are good at measuring some types of brain functions and not very good at measuring others. Just because a toddler can't solve a complex differential equation now, it doesn't mean he or she can't in the future.

Some people use the analogy of the brain being like a muscle. The brain is of course physiologically very distinct from a muscle, but the key similarity is that both can adapt and grow to meet the demands of external stimuli. This is why the sports professional does weight training: to optimize muscle tone, strength and response. When the analogous response happens in the brain, cognitive psychologists call the process learning.

Neuron Gila interaction by Khazaei(cc)

It's quite astonishing how often people can lose sight of the fact that humans have the prodigious capability to learn. I had a grade three teacher who told my mom on parent's night that she could tell I was "not very smart." She was categorically right; and because she was right, she had a job as an educator to facilitate learning and help make myself and my peers smarter. Recently, The Lens (CBC) aired a documentary on the Arrowsmith School called "Fixing My Brain". The school's curriculum is designed to help students overcome learning disabilities by focusing on cerebral learning and pattern recognition exercises rather than traditional academic fact-based learning. Skeptics of the Arrowsmith program voiced their opinion of the program in this documentary as being unpractical with few demonstrable results. The the efficiencies of the program's methods undoubtedly need to be subjected to scrutiny. At the same time, traditional north American schools can also be criticized in the way they deal with learning disabilities. Currently, students diagnosed with a learning disability are given very lenient time-frames to complete assignments, tests and exams. This is conceptually unpractical at best and excessively magnanimous at worst. On the other hand, the objective of the Arrowsmith program is to resolve the student disability rather than providing the students with a crutch for the rest of their lives (whether it meets this objective or not is not for me to say). In either case, constructive criticism of the existing methods is both necessary and productive, but to question the ability of the children to learn and improve their intellectual ability is fundamentally wrong.

People with learning disabilities (LD) are sometimes misunderstood for people low intellectual capability, yet the two are considered mutually exclusive. Instead they are people who have trouble accessing the traditional learning pathways. Dyslexia (trouble reading and writing), dyspraxia (neural motor skill dysfunction) and ADHD (a nonstandard LD that interferes with learning nonetheless) are some examples of neurological disabilities and disorders, which are considered by neurologists to be independent of intelligence. As I said in my last post, television and video games can increase the probability of a child developing severe learning disabilities, and this increased risk is proportional to the amount of the child spends doing these activities.

It is also important not to become unduly fixated on the idea of learning disabilities or to use them as an exonerating excuse for everything. Many conditions can lead to a medical diagnosis of multiple cognitive incapacities. Improper nutrition, insufficient sleep, psychological depression, drugs and alcohol, emotional stress among many other things can lead to creating an atmosphere where learning is effectively disabled. In poor neighbourhoods, where children go to school hungry, virtually every child effectively has a learning disability although they are rarely diagnosed. Parents and educators alike need to shine the spotlight on how to harness capability rather than find reasons to excuse disability.

In part 4, I will talk about the world of intelletual possibilities that can be opened if we are able to optimize our intellectual capability to learn.

"Fixing my Brain" will be re-aired on Tuesday December 30 at 10pm EST on CBC Newsworld.

Video Promo: "Fixing My Brain" [1:02 min]

The Arrowsmith School will also be looked at in another CBC documentary called "The Brain That Changes Itself", which will air at 8pm on Thursday November 27.

You're Smarter Than You Think: Part 2

2008-11-16T22:22:00.022-07:00

In The Beginning
The first conspicuous opportunity for us to learn starts at birth. Never again does learning happen at such an accelerated pace than in the first few months when a newborn begins to uncover the world through the perceptive stimuli of his or her environment. While developing the senses of sight, taste, smell, hearing and touch, the newborn begins to learn how to consciously interact with this environment beyond the subconscious brilliance inherited through the parental genetic fingerprint.

Baby in Hand by Aldo Risolvo

According to Dr. Robert Titzer, a California-based infant researcher "[t]he natural window of opportunity to learn opens at birth and begins to close at the age of four." In an article written by Matthew Coutts, Dr. Titzer recommends to parents that they should be reading to their babies by the time they are 3 months old (article).

Unfortunately, the National Post article overshoots the purpose of the early-reading recommendation. It's not meant to mold the baby into a child prodigy; it's to give the child a good start to life the same way that a parent focuses on good post-natal nutrition. A newborn is a sponge for the knowledge that their surroundings offer and they will learn considerably more from a used children's book than they will from a Baby Einstein DVD. Unlike the DVD, the book allows the child to interact directly with the learning tool at his or her own pace. Furthermore, the action of reading helps strengthen the communication bond between parent and child in a way that the unilateral television-based visual tool will not do. An increasing number of studies directly link television to decreased learning ability in addition to attention deficit hyperactivity disorder (ADHD) and other learning disabilities. The challenge for most parents is finding the time to read because television is a very effective distractor for babies thus freeing up time in a busy parent's life. This also implies that the parent needs to significantly reduce and ideally eliminate the hours he or she spends watching television, which is by no means an easy lifestyle change to make. There are some who believe that television is exploited by the elite and wealthy as a means to keep people from moving up into higher socioeconomic classes in a globalized world where the opportunity to learn and gain knowledge is so widely accessible. Proponents of this theory note that many highly educated parents do not let their children watch any television at all. Literacy rate is a strong indicator of economic wealth and while even the poorest neighbourhoods in the United States now have television, they also have alarmingly low functional literacy rates. This digression to the connection between television, literacy and socioeconomic wealth is another topic in itself.

Taking a step back to when a newborn first opens his or her eyes, this moment is the only time in a person's life when intellectual capacity exists in a way that is effectively unaltered by the external environment. Psychologist Cyril Burt termed this intellectual capacity 'innate general cognitive ability'. It is essentially the genetically inherited capacity to gain intelligence. Unfortunately, we have no way to measure this quantity and thus there is no way to determine how smart one can realistically become. What really matters though, is that babies are nurtured to make optimum use of the available learning channels.

Coming up in my next post, I will define the 'smart' adjective in 'You're Smarter Than You Think.'

You're Smarter Than You Think: Part 1

2008-11-11T20:23:00.003-07:00

In my June post, I predicted why Barack Obama would be the 44th president of the United States, and at the end of that post, I said that I would discuss his flaws and strengths in detail in a later post. In the spirit of political rhetoric, I will 'refine' this promise: such a posting will be indefinitely suspended due to the over saturation of media coverage on the subject of Barack Obama.

The McCain 'straight-talk express' translation: I don't think anyone needs or wants to hear any more about Barack Obama right now. Anyone wanting to know more about him, his ideals or his policies can (and will) consult the multitude of media on the subject including--but not limited to--the two books he has authored.

photo by allie^TM

Introduction

So instead of talking about Obama, I will use the former Vice Presidential candidates as an introduction to my next topic, a series of posts I call "You're Smarter Than You Think".

Contrary to popular belief, Sarah Palin is not unintelligent. Clearly she has not spent an inordinate amount of time studying political science. For example, she could not name any supreme court decisions other than Roe versus Wade (nor can I, but both of us could learn). Lack of political knowledge could make a legitimate case that Palin was not quite ready to assume the role of vice president, but it says little about her raw intelligence. Her former counterpart, Vice President-elect Joe Biden, has become an expert at giving the public the illusion of political knowledge. He certainly does have political knowledge, but the number of times he misspeaks is quite worrisome if one assumes he makes policy decisions based on this flawed knowledge. In some university and college multiple choice tests, the examinee is penalized marks for incorrect answers. In such a test, I'm not sure Joeseph Biden would score any higher than Sarah Palin on the political science front. It's really quite amazing how many of these smart-sounding people get themselves into positions of responsibility. They make themselves sound smart to create the illusion that the are smart. They often find themselves saying that they are smart, perhaps because they are compensating for their fear that they are not smart enough. The "You're Smarter Than You Think" series is not intended for these types of people who think they are smarter than they are. It is intended for those who underestimate their capability and never reach their full potential as a result.

I was able to predict the winner of the election because of the poor fundamentals of the economy in addition to the low voter confidence in the incumbent party and not because I'm smarter than anyone else. Most people that know me are aware that I'm terrible at remembering names and birthdays, I can't solve a Rubik's cube, I'm not even 'smarter than a 5th grader', let alone a Jeopardy contestant. These facts should not limit myself (or anyone else) from doing anything I want to do in order to be successful. Knowledge is often misunderstood for intellectual capacity. The next series of posts will build on the story of why you very well could be smarter than you think.

The Perfect (Financial) Storm

2008-10-19T20:30:00.008-06:00

Perfect Storm: a critical or disastrous situation created by a powerful concurrence of factors. [Mirriam-Webster's Online Dictionary]

Storm Clouds by CoreBurn / © Some rights reserved.
Licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives license

Many people had given dire warnings about the serious problems the economy would be facing. Some even knew it would extend far beyond the United States. But few predicted the severity, scope and timing simultaneously, because of the complex commingling of the events. With hindsight, things become that much clearer.

Three factors--all of which were major contributions--were the reason why the world economy is now facing a global economic downturn of this level of severity. Any of the three occurring on their own would not have caused as much damage as we will now see in the coming months. All three are of course interconnected, but few specialists knew enough about one, let alone three to accurately predict the damage that this storm would cause.

The Road: Questionable Lending Practices
There was of course, Fannie, Freddie and the irresponsible lending practices promoted by government coalitions with free markets. This built a road that led to the edge of a cliff had been construction for decades only to be completed by about 2005. Warren Buffet who is often lauded as the World's best value-oriented investor, divested his entire position in both Fannie and Freddie all the way back in 2000. Buffet said he felt "uncomfortable with certain aspects of the business." It's also clear that many Washington insiders knew a problem was brewing here. In 2006, several Republicans (including John McCain) sent a letter to the majority leader which warned that "if regulatory reform for housing-finance government sponsored enterprises (GSEs) is not enacted this year, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole." The list doesn't end there, many others knew about fundamental flaws and an inappropriate risk profile for these quasi-government enterprises.

The Vehicle: Energy Price Shocks
Then there was the lack of a stable and sufficient energy supply (particularly oil), which served as the vehicle that had also been assembled over the course of several decades. Peter Tertzakian had some very impressive and accurate foresight with regards to oil 'breaking' the economy. In his 2005 book, he says that the world economy would stop, "'firing on all cylinders' in 2007," and in 2008, "a confluence of events [would force] the public and our nations' leaders to finally realize how vulnerable [the economy] had become [to oil prices]." He goes on to predict a plunge in SUV sales and automaker mergers, acquisitions and consolidations we are now seeing (his forecast calls for Toyota partnering with or buying GM). What he didn't foresee is how high gas prices would catalyze a collapse in suburban home values. With this, the assumption which was held by so many now troubled financial institutions--that home prices always go up--also failed.

The Fuel: Monetary Policy
Lastly, there was the fuel: credit money. Because markets are based on a fiat currency (based on a perceived value) rather than the gold standard (based on intrinsic value), the system is subject to bubbles, sometimes resulting very large corrections (the gold standard has its own drawbacks of course, which is why the two standards have been swapped many times throughout history).

Instead of going into too much into detail about how the world moved from the gold standard to a system of credit, I'll give a brief synopsis here (google it if you want to know more). Following the World Wars, the United States was in a very strong economic position (much like China today), as it was spared widespread damage on its own shores while Europe's infrastructure had been devastated. The country was extremely productive relative to other countries and awash in natural resources. Because they were in a position to lend money for the rebuilding of Europe, they formed the Bretton Woods Agreements (1944/1945). Essentially, the U.S. pledged to maintain a stable dollar by pegging its currency to gold, and all other currencies were in turn pegged to the United States Dollar. Several decades later, when the U.S. started to become a borrower rather than a lender as well as overextending itself with several wars, the hybrid gold standard to become incredibly unstable. It was officially abolished in 1971 and all major currencies were subsequently unpegged from the USD by 1976. No politicians in any of the major economic power had the political leverage to go back to the gold standard because fiat money allows for inflation and inflation makes the economy look good. Instead, national banks pledged to control inflation using imperfect price inflationary indicators, such as CPI and later core inflation.

It's not hard to see from the chart that soon after the gold standard was abandoned, the bubble era had begun. Deflation is considered political suicide and therefore the market corrections are always artificially stopped by government (meaning the problems simply build upon themselves). Former 2008 Republican presidential candidate Congressman Ron Paul can offer more on this subject, but the point is it hasn't worked.

It was not oil that was in a bubble at $147; it was the entire economy that was overvalued (homes, cars, equities, etc.). It was not price manipulators, speculators pushing oil prices upward but merely investors moving money from U.S. dollars into commodities to hedge against global inflation. This is why neither gas prices nor equities rooted in these commodities increased by nearly the same amount. Ironically, we now call this a "credit crisis".

In The End: A Terrible Concoction
As I've said, any one on its own, the flawed road, the vehicle or the fuel, doesn't really present instantaneous systemic danger. Had gas prices stayed low, consumer sentiment may have stayed high and home prices may not have plunged with Americans reconsidering the value of homes situated in very distant suburbs. Had monetary policy been better managed, oil prices would have increased more linearly rather than exponential volatility shocking markets (unlike the oil shocks of the 1970's, 2008 had no major supply squeeze). All three would still have presented a very serious threat individually of course, but the "perfect storm" as Bernanke puts it, is why the economy has weakened far more than many of the partitionary experts had predicted. I would caution that conditions are likely to continue to get worse even if global financial markets can be stabilized. Political instability has become one of the spillover effects and history has shown it is very difficult to maintain peace in the case of poor countries (or bankrupt ones). And yet I remain optimistic for the future, because after the storm, nature always rights itself. Always.

The Black Gold Sands

2008-10-12T21:01:00.020-06:00

Image: Terry Bain [cc]

Barring a complete catastrophic collapse of the global economy and credit markets (which happens not to be overly improbable), the Canadian oilsands will remain in a relatively strong position despite correcting oil prices.

In the absence of a breakthrough scientific discovery like cold fusion, there exists neither a viable alternative fuel source for oil, nor a likely prospective one in the near future. It certainly isn't impossible, but a cold-fusion type of discovery is highly improbable. The Manhattan programme and Apollo project are often cited as major scientific investments yielding results; but neither one required the kind of infrastructure overhaul that would be required to reduce demand for fossil fuels. With rising energy costs, nuclear, wind, solar and the other alternatives to fossil fuels will all become more competitive with oil. In fact, from a price-energy perspective, $100/bbl crude oil is already fiscally disadvantaged compared to its alternatives. One joule of oil priced at $100/bbl is even more expensive than the same amount of energy produced from wind energy. Residents of Hawaii paid 24 cents per kilowatt hour for their electricity because oil is the primary fuel used for electricity generation in the state (the cost of electricity produced from wind is on the order of 14 cents/kWh). The only reason oil remains so prominent is that it happens to be convenient (batteries are not well-suited to power cars) and current infrastructure, which will take decades to update, necessitates it.

A common mistake people make is to think that the rate of change of the consumer electronics industry can be replicated in the energy industry. The reason consumer electronics can evolve so quickly is mass (or lack thereof). Replacing a 20 ounce cell phone requires considerably less work than replacing a quarter-ton vehicle. This is because a cell phone has relatively little total intrinsic value in the materials used, which is in part why many electronics become cheaper as the become smaller (for example, a 1 GB flash card now costs less to make than a 1 GB magnetic hard drive).

How Long Will It Take?
In terms of energy substitutions, the change from wood to coal took 75 years. The change from coal to oil took 100 years. Natural gas took even longer because of the extensive pipeline infrastructure that was needed to accommodate it--in fact, over 28 trillion cubic feet of natural gas associated with oil wells has been discarded in the U.S. alone since 1936 (U.S. Department of Energy). The gas is simply burned at the wellhead or vented to atmosphere without capturing its useful energy because the pipeline infrastructure would cost more than the potential revenues from selling the gas. This does not happen much anymore in North America, but continues in places that have no market for natural gas such as deep offshore production and some middle eastern oil producing nations. Liquification of natural gas (LNG) and gas hydrates are emerging alternatives to pipelines, but both are expensive because of the energy inputs involved.

Transportation Industry
The transportation industry uses about 50% of the world's oil. The United States has about 250 million automobiles. Even if automobiles that didn't use fossil fuels were available today at a competitive price, it would take 9 years to replace most of them (9 years is the mean age of these vehicles, according to the Bureau of Transportation Statistics.

Electric vehicles can't be competitively priced today without making significant infrastructure changes. Batteries that meet the range requirements for American automobiles are simply too expensive. Also, too many steps in the electrical conversion process make it an intrinsically inefficient way to turn wheels. The figure above shows potential paths to turning the wheels of motorized land-based transportation. Each step loses energy due to thermodynamic constraints (the fewest number of steps are often the best route). Ethanol and other biofuels have a lower energy density than hydrocarbons as well as other significant challenges (discussed below). Heavy trucks are nowhere close to using alternative fuel sources and the aviation industry does not even know of a potential alternative to jet fuel.

1970's Lessons Learned?

Those who are old enough to remember the oil shocks of the 1970's and early 1980's can recall long lineups at gas stations and the economic chaos it caused. It prompted everyone to rethink the dependency of crude oil because of the economic impacts it had on oil importing economies around the globe. The first crisis occurred in 1973 when the Arabic members of OPEC imposed an oil embargo aimed at countries that gave military and political support to Israel. A resolution was reached between OPEC members and the United States in early 1974, but the shortages it created would leave prices elevated for several years. In 1979 another crisis occurred the Shah of Iran was exiled. Oil production from Iran would fall 75% in the next two years as a result of political instability and the resultant war with Iraq. Over the next several years however, other countries were able to fill the supply gap as a result of higher prices. Virtually every oil consuming nation devised an energy strategy in light of these price shocks. It would be left up to the policymakers to see these strategies through to completion as an oil glut ensued and very cheap energy prices left the general public unconcerned about energy independence for the rest of the 20th century.

United States Strategy
Project Independence was a vision of President Nixon which never got much traction because of extensive costs. Another reason American politicians did not to want to reduce oil consumption was that at that time, the United States was the largest producer of crude oil in the world, meaning that oil production was a very large part of the domestic economy (U.S. oil production peaked just a couple years earlier in 1970). Instead, strategic political measures were favoured such as a strategic alliance with the Saudi's as well as military efforts to ensure unimpeded flow of oil from the producer nations.

France's Strategy
In response to the same crisis, France decided to invest heavily in nuclear energy over a period of 15 years. Today, France leads the world in Nuclear Energy production, and even exports electricity from its nuclear plants to surrounding nations such as Germany. This now leaves them in an economically advantaged position compared to its European counterparts; however, oil consumption per capita only decreased by about 35%. This is because the substitution was only made for electrical power generation and they did not attempt to replace oil the transportation industry (this would have taken much longer and have been much costlier).

Brazil's Strategy
Brazil actually did decide substitute foreign oil in its transportation industry following the oil shocks of the seventies. They used sugarcane ethanol to do it and this conversion took them 30 years to reach a degree of energy autonomy. Flex fuel vehicles are mandated to use the E25 blend of 25% ethanol, 75% gasoline; some can even use E100 (almost pure ethanol). The United States tried recently to model Brazil's strategy, but it is failing for two reasons:

Brazil is a developing nation and its average citizen consumes 1/5^th of the liquid fuel that the average American does. It can't be scaled up in an overpopulated world without creating serious food shortages, as we've already started to see.

Brazil intersects the equator, meaning considerably more energy is available for the process photosynthesis that ultimately creates the energy used in the biofuels. This is why sugarcane ethanol yields about 8 times the energy required to produce it, while corn ethanol in the continental U.S. hovers around breaking even (optimistic scientists say 1.5 while pessimistic ones say 0.7). This means that for every gallon of diesel a farmer uses to cultivate corn, the amount of ethanol can be processed from the crop contains no more energy than a gallon of diesel--but the farmer can still make money provided subsidies are paid by the government.

Where Prices Will Go From Here
Now it's quite possible (but not probable) that oil could return to $40 a barrel depending on the depth of the global recession (some have even forecasted $10 oil). Even if prices did fall below $40 a barrel, such low prices will not stick once the recession has ended. Sector-specific inflation has increased the cost of production quite dramatically. Production and labour costs are out of control and the cost of production for new oilsands projects now sits between $80 and $120 a barrel. This is far too high for receding demand, and it may need to deflate and correct itself along with the rest of the global economy. This will present short-term challenges and if oil did fall to $10 or $20/bbl, this unlikely scenario would certainly mean layoffs; but even so, long-term supply will remain under pressure. The other supply issue surrounds peaking production in the worlds largest oil fields as I discussed in the past. Saudi Arabia's spare capacity (oil it can produce during shortages) is now limited to sour heavy crude, which only a few refineries in the world can handle.

One problem with projections about the Canadian oilsands ultimate recoverable oil estimates is that they often assume demand for this commodity will remain unchanged through 60 years. Instead, its likely that the oil which is hypothetically recoverable at today's prices will simply be left in the ground. This is analogous to the way many coal reserves remain in the ground from when coal was partially substituted for oil. My best guess is that it will take at least 25-30 years to significantly reduce global dependency on oil. The change is happening though, and Fort McMurray could easily end up being Detroit north if city planners aren't smart about economic development of the future. In the transition period from this now disadvantaged fuel, the oilsands should remain profitable. If not by a windfall, then at least by a small margin.

The White House of Cards

2008-10-07T20:55:00.021-06:00

The problem with foreclosures is that often times the pledgor is not cognizant of the severity of the problem until it's too late. It happened with millions of Americans who lost their homes. It happened with large institutions like Bear, Fannie, Freddie, Lehman and Wachovia. Now it is happening with the U.S. government.

Many financial advisers continue their rhetoric about a pending recovery of the U.S. economy, as it 'always does'. As mentioned in earlier posts, the U.S. economy is structured on cheap oil, which despite the crisis, still does not exist right now. In USD terms, oil is still more expensive than it was a year ago. Either the financial advisers don't get it, or they are lying the way Enron executives lied to their shareholders while funnelling their money out the back door. I suspect it is the former. Following weeks of market turmoil, record low auto sales and continuing record high oil prices, Citigroup finally began recommending to investors to sell shares in GM and Ford this week after their shares fell 82% and 67% in the last year. At least they made their statement sound eloquent:

"[W]e believe the risk-reward balance [on automaker stocks] has tilted decidedly negative on both absolute value and relative value versus underperforming suppliers," -Citigroup investment note.

Thanks Citi for the timely advice. Neither Ford nor GM has had a profitable automotive division in over 6 years. Better late than never I suppose.

Many had hoped that swift approval of the bailout plan would restore confidence in the U.S economy. Such an effect has yet to be seen as even the hopeful are growing skeptical. Hank Paulson said it will not prevent all bank failures--which are likely to resume their course now that the short selling ban has ended. Violent and sometimes even more damaging aftershocks continue to ripple worldwide as the USD is still the most widely held currency. The only stable asset right now is gold (it appears moderately unstable because of the gyrations of the currencies in which it is valued). Few signs of a bottom can be seen yet and confidence continues to slide.

Anyone who has been overseas recently knows that the once universal US dollar began to fall out of favour by merchants for other currencies over a decade ago. Unfortunately most Americans have never been overseas and don't even understand what is happening with their 401k's. Even the presidential candidates appear naive (or perhaps it is merely election rhetoric). They appear to think that they can solve the 'crisis' by investing in the economy (cutting taxes, fixing health care, energy independence spending, gas tax holidays, and so on). Unfortunately, it's probably too late for that, as they don't have any more pre-approved credit to invest. They would have to borrow it from foreign investors (or print it and make the USD worthless). The flaw that proved fatal for many of the failed institutions was the assumption that they could always raise more capital, if required.

House prices will always go up, storied institutions can always raise debt, and foreign investors will always buy up U.S. treasuries. The first two cards have already fallen. With foreign investors fleeing, the U.S. government needs to prove to its lenders that it will not default and is serious about paying back its debt rather than running deficits indefinitely. Serious action could take the form of pulling out of Iraq as quickly as humanly possible--this would likely split the country in three and destabilize the region, but the U.S. economy is pretty unstable itself if anyone hasn't already noticed; furthermore, as Alan Greenspan notes, Iraqi oil production has only now recovered to pre-war levels, so staying longer is unlikely to result in significant cheap oil supply anytime soon. It would also be wise to pull out of Afghanistan as soon as possible and negotiate a deal with the Taliban--this may not be in line with offical public policy; but as John McCain said, unofficial policy is often quite different from public policy. Most importantly, they need to sit down with the leaders of economic powerhouses and negotiate a set of terms to repay their debt and stabalize confidence. The first two cards have already fallen, if the third were to fall, it would get ugly. Barack Obama talks about hope and change. Let's all hope someone understands the severity of the problem and is willing to make the change required to avert a catastrophe.

America's Fundamentals

2008-09-20T19:33:00.001-06:00

A Fundamental Subprimer:

1938 - Fannie Mae was created under President Roosevelt as a government entity to provide liquidity to the housing market in the wake of the Great Depression.

1968 - Fannie Mae was pseudo-privatized by President Johnson to remove it from the federal budget. To make this privatization feasible, the company was made exempt from taxation and oversight. To ensure competitive market, Freddie Mac was created in 1970 to perform essentially the same role. Critics say they had no incentive to pay down debt because (1) they were exempt from reporting financial difficulties to the public, (2) they were backed by government as GSE's, and (3) house prices always go up. The effects of President Johnson's overall policy were swift and disastrous (link).

1970 - President Nixon continued tradition by signing the Emergency Bill on Housing, a bill designed to inject "as much as $10 billion a year into the sagging home construction industry." White house construction quotas were still not being met, so interest rates continued to be artificially subsidized. (St. Petersburg Times - July 25, 1970)

2002 - President Bush releases the Home Ownership Policy Book.

The stated mandates of this policy include

home ownership targets, with a focus on minority home-ownership,
a $440 billion increase in the financial commitment made by Fannie Mae and Freddie Mac to fund mortgages,
incentives for other mortgage lenders and
tax credits and down-payment assistance for new and prospective homeowners

2005 to 2008 - The growing American housing bubble bursts. Financial markets around the globe suffer as a result, especially in late 2007 and the first three quarters of 2008. Fannie Mae and Freddie Mac are put under conservatorship in September, 2008.

September 19, 2008 - In response to market turmoil, Treasury Secretary Henry Paulson announces a plan to buy the toxic assets that were plaguing markets. Critics say it emulates the tradition of creative accounting--moving garbage around in the hopes that it won't start to stink until it becomes somebody else's problem. They say Henry Paulson has just named himself CEO of a new enterprise called Hermie Max. Supporters say they have finally taken the first step in accepting responsibility for these problems.

Obviously, last week's developments in the mortgage crisis have been developing for some time. But it is by no means the only problem the U.S. Economy is facing. In fact, many of the problems have been exacerbated by others which are not mutually independent from the credit crisis.

=====================================================

John McCain has refined his position that the U.S. economy is fundamentally strong to saying that American workers are the fundamental strength of the economy. Many take issue with both claims. The following is a disquisition as to why.

The Myth of The Hardworking American
As a generalization, the hardest working Americans are actually the landed immigrants. They believe in working hard to obtain 'The American Dream'. Although they are often unable to reach this dream, because of either lack of education or lack of credential recognition, they continue to work hard to ensure their children can live out their dreams. Unfortunately though, n^th generation immigrants (children of landed immigrants and their children) often lose this value of hard work. They tend to feel they are entitled to the American Dream rather than believing it is something they have to work for. They believe the living in America is a birthright rather than a privilege. In a lot of ways, they are technically correct--but that doesn't help labour productivity.

How hard Americans work in absolute terms is not really all that important with respect to the fundamental economy. What really matters is how hard the American citizen works relative to citizens other countries around the world. There is no question that labour unions have done very great things for the working class. However, in well-established societies, unions have basically become an extension of government and their value at present is now rather questionable. In American society today, government already mandates minimum wages as well as reasonable and safe labour conditions. The only purpose left for unions is to squeeze every bit of corporate profits out of the corporation for more benefits and higher pay. Competitive compensation is good, but union practices now make western business uncompetitive in increasingly globalized markets. They have actually caused job loss rather than increased employment. Meanwhile, developing nations were able to produce goods and services without the excessive labour costs exasperated by entitlements and labour unions. There was a very lengthy period of time when this labour cost discrepancy did not matter much for the western world. That's because the west held something more valuable than work ethic: knowledge. The concentration of literacy, education and knowledge in the western world meant that while Dollar Store items were 'Made In Taiwan', expensive technological items like cars and computers were still 'Made In America'. With globalization, the Internet, and other technologies, knowledge is more widely accessible than ever before. Computer science jobs are now being outsourced to India. Japan has taken over the automobile manufacturing industry. In China, the automobile industry is rapidly gaining ground although it is currently still in the 'pathetic' phase at this point. Critics who think they will never be able to make cars suitable for the western world should note that the same thing was said of Japanese automobiles when they first entered the industry. Relative to the American worker, productivity of the developing nation labourer is closing in fast. This is part of the reason why U.S. GDP growth has been declining over the years, while it has been increasing rapidly in developing nations like China and India.

History Does Not Side With US
Many advisers are saying now is the time to make long-term investments in the U.S. economy because markets are undervalued. This is likely true, and markets are indeed likely to be higher in 12 months than they are today. These advisers are saying to look at history as proof that the markets will recover; that markets have always recovered from downturns in the long run. This idea that history is a key to the present is very important--but they are using a panoramic lens instead of taking the 360 degree view. The panoramic lens goes back to the start of the twentieth century; the 360 degree view goes back to the first dominant human civilizations. Dominant superpowers have always overextended themselves to the point that their decline of power becomes an inevitable conclusion. This doesn't necessarily mean the American Empire^* will go the way of the Roman or Ottoman Empires; but it may go the way of the diffused and diluted British Empire. Some historians think this happens because the intrinsic rigid nature of empires leaves them incapable of adapting to change.

: *Many Americans are reluctant to call the America an empire, and prefer the term 'superpower'. I suspect this is because of stigma surrounding the fact that no empire in history has ever maintained its hegemony status for more than several centuries. Ultimately though, it will be up to historians to decide on an appropriate title for America's global influence.

The Swinging Pendulum
Turning the focus back to the economy at present, most analysts estimate there is still another 6-18 months before the fundamentals of the United States housing market hit bottom. The reason, they say, is an excess inventory of homes and historically low federal lending rates poised to rise in the coming months when the economic outlook improves. Confidence in U.S. markets has been shattered and it will take some time to repair. Money is on the sidelines and everyone is blaming it on the regulators, greed, and white-collar criminals. By 'everyone', I include those who would normally call themselves libertarians and 'ultra-free-market-capitalists'. They concede that Freddie Mac, Fannie Mae and AIG were too big to fail and in need of a government bailout. They will give very serious consideration to Paulson's plan for two reasons:

By not moving toxic assets to the taxpayer balance sheet, it could cause a depression. All but the most idealist free-marketeers will accept government intervention if this scenario proves realistic.

The credit rating of the U.S. is being eroded. If the government doesn't bail out China and the other creditors that hold the bad debt, then the foreign creditors will stop lending the U.S. money. It would be like trying to refinance a mortgage after declaring bankruptcy--creditors don't lend to clients who don't repay prior debts.

This is a sign that the ideological pendulum is swinging from right to left, and it is now poised to swing too far to the left. Regulation is a necessary part of markets; but only to provide stability and sustainability in an otherwise chaotic 'free-market'.

Under-regulated markets lead to volatility and unpredictability, while over-regulated markets lead to predictability and stagnation. Growth is good, and so is predictability; it's just a matter of finding the desired balance of the two. The swinging pendulum should be stopped somewhere closer to the center rather than the extremes where it was, and where it is now headed. When the Republican presidential nominee says "the regulators were asleep" and wants to dismiss the SEC commissioner for not regulating markets more, this is rather disturbing for the growth side of the equation.

Debt and Deficits
In defence of George W. Bush--the 9/11 hero that has now fallen out of favour with the American public--his policies are now, like those of most presidents at the end of their terms--more responsible since he doesn't have to worry as much about political backlash. He has threatened or tried to veto virtually all of the fiscally irresponsible bills put forth by a democratically-controlled congress (mostly to no avail). None of the recent bailouts were part of the budget.

Bail Out Recipient	Guaranteed (Public) Debt
Bear Sterns	$30 billion
Freddie, Fannie	$200 billion¹
AIG	$85 billion²
'Toxic' Mortgage Nationalization	$700 billion
Big 3 (GM, Ford, Chrysler)	$25 billion³
Total	$1.04 trillion

Notes:

Freddie Mac and Fannie Mae could cost taxpayers much more or less, no one really knows yet as this depends on how many more defaults there are.
AIG was made to sound like a great deal for taxpayers. The balance sheets of AIG aren't public but there is an unlikely scenario that taxpayers could profit and actually get a good deal. Note that free market enterprises would not capitalize on this potential 'bargain' given the high degree of risk. $27 billion of the 'loan' was reportedly used within a day of the takeover.
The big 3 deal is currently being lobbied to U.S. congress. GM is most desperately in need of these funds and some think the figure could be as much as $50 billion.

The U.S. Government Accountability Office states in a 2007 fiscal report that "The government is on an unsustainable fiscal path." It is their job to be alarmist, as this department is meant to hold congress accountable. But even if the debt projections are reduced by an order of magnitude, the picture still doesn't look pretty. This is on top of government deficits that are expected to be US $500 billion (excluding bailouts) for 2008 and only slightly less in 2009.
Neither presidential candidate has a realistic policy platform. Both tax increases and spending cuts are required just to stop the deficit, let alone reduce the $10 trillion federal debt. This figure excludes health care and social security entitlements that are expected to increase in the coming years.

In Canada the health care entitlements are an even bigger problem because of a public health care system. The baby boomers will begin reaching the standard retirement age of 65 in 2011. Health care costs will continue to rise as they have been in recent years and perhaps this rise will become exponential with the aging population blip. At some point in the very near future, Canadians will need to decide between privatizing health care and raising taxes. As the fiscal surplus is gone, there is simply no alternative; but at least in Canada the problem is not compounded by an increasing trade deficit as it is in the United States.

GDP Against Black Gold
America is addicted to oil. Furthermore, it's domestic supply continues to decline meaning it needs to export an increasing amount of wealth to feed it's addiction (see 500 billion dollar problem). As this happens, the U.S. GDP begins to work like the mirror image of oil prices. There aren't too many people left that believe the price of crude oil will go back to $40 a barrel. Given the current level of energy dependence, a sustained price of $40/bbl or less is the only likely way for the American GDP to grow at the same average annualized percentage this century that it has over the last century. This doesn't mean I think the economy can't still grow, but the higher the oil price, the more stagnant it will become. And right now at least, oil prices and the economy are in lock-step--as the economic outlook of the largest oil consumer appears strong, oil prices rise; when economic outlook is weak, prices fall. I can't see how the United States economy can be considered fundamentally strong with oil priced over $100 for each barrel.

It is for this reason of course, that energy independence (or more accurately reduced foreign oil dependence) is now such a hot topic. From this perspective, offshore drilling will help. Though as parties debate how much it will help, oil from this source won't hit markets for at least another ten years. Contrary to popular belief, there is no technological fix to America's energy dependence problem. Any realistic political fix to this problem would need to focus on facilitating revolutionary social change. Most of this required change relates to an incredibly powerful and convenient device called the automobile. There are 250 million registered passenger vehicles in the U.S., more than 8 for every 10 people. The transportation industry consumes half of America's oil, yet no feasible fuel exists to replace gasoline as oil prices rise. The much-hyped alternatives have some potential, but none will result in a seamless transition from oil.

: Natural gas
If a T. Boone Pickens-type plan were implemented, NYMEX natural gas prices on the continent would double to approach or exceed prices in Europe. Driving range between refuelling of natural gas-powered vehicles is considerably reduced. While the U.S. has more recoverable reserves of natural gas, they are not that much more, and it would also turn Russia into the new Saudi Arabia.
: Ethanol
Brazil's sugarcane-based biofuel model can't be scaled up to meet the transportation requirements of the United States, especially using corn-based ethanol. This fact only became apparent to some legislators when corn and grain prices began to skyrocket to unprecedented levels due to artificial biofuel subsidies.
: Hydrogen
This fuel is not an abundant natural resource as it does not exist in its elemental form anywhere on Earth. Currently, most industrial-use hydrogen is generated from steam reforming of natural gas (CH₄ + 2H₂O → CO₂ + 4H₂). Hydrogen can also be split from water using electricity but the process is thermodynamically inefficient--it requires considerably more energy input than a fuel cell will ultimately output. This is why hydrogen fuel cell development has been slow.
: Conservation and Fuel Efficiency
Gains here are limited, and the more significant gains come at a price--automobiles that are more expensive and unaffordable. First-generation hybrids (those that don't plug in), are a good example of this.
: Electricity
The electric car in its current form can't replace the automobile. They simply don't have the speed or range to meet the current social requisites of America. Batteries just aren't amenable to energy storage the way liquid fuels are. No one had to kill the electric car in the conspirator sense some have suggested. The Chevy Volt is a plug-in hybrid that will to come close to meeting social requirements with an optimistic 2010 production date, but at an estimated cost of $30-40 thousand apiece. GM's Vice Chairman Robert Lutz says that hybrids will never be as cheap as gas-powered vehicles for one simple reason: they require two power-trains instead of one. Instead of trying to meet the social requisites, the auto industry should focus their efforts on creating and marketing electric cars as 'urban utility vehicles' rather than as standard cars.

Given that technology will not provide a seamless transition from oil to other fuels in the transportation industry, Americans will be required to undertake social change. In terms of social lifestyles, what energy independence means is not that air travel, trucks and gasoline-powered cars will disappear completely. However, it does mean that the "soccer mom" who drives three kids to extra-curricular activities in different corners of the city in an H3 Hummer will cease to exist. She will find different activities closer to home without compromising the developmental opportunities of her children. Many people, including policymakers, find this new reduced dependency on the automobile very difficult to visualize because it requires a change in the way we think about transportation. This is why it will likely take 40-50 years before any significant degree of U.S. energy independence is reached, perhaps a decade or two less with political facilitation. And yet, the wheels for this have already been set in motion with the collapse in the sales of gas guzzlers and material reductions in air travel (the gas guzzlers of the skies). High gas prices also served as a catalyst in the collapsed assumption that 'house prices always go up', particularly in distant suburbs requiring excessive commute times. In time, the white picket fence will fall out of the American Dream. Unless the world can continue to produce oil at well over a thousand barrels a second, these changes will continue. Unfortunately for the United States, it continues to lose its grip on oil production, which means the change must be financed from within, and this will hurt GDP and growth as a result.

In Brief
As the western countries continue to lose their monopoly on knowledge, the higher work ethic will allow developing nations to continue to steal market share in terms of productivity for goods and services. As America's domestic supply of natural resources continue to decline, and the overpopulated world continues to consume them at an unsustainable rate. An incredible amount of energy will need to go into a structural change in the American way of life. As this happens, the U.S. will continue to lose its grip on control of strategic resources in countries like Venezuela, Iraq and Nigeria. Even domestically, resistance exists to the exploitation of coal and offshore oil reserves because of concerns about the environment. All of this means America's public and private debt is likely to continue increasing to the point where America will not own itself anymore, its foreign creditors will. Government will become incapable of acting on behalf of its citizens as it will become forced to appease its creditors. Useful work will go towards change, and repaying debt, and it is this that will circumvent growth. This is why the fundamentals of the U.S. economy are not all that good.

Fed buys AIG (courtesy: the American Taxpayer)

2008-09-16T19:59:00.029-06:00

I was watching the news today. A headline topic was the proven link between elevated levels of Biphenol A (BPA) in the urine of the adults studied, and an elevated risk of heart disease and type-2 diabetes (full story). An expert on the show noted that the link was not a chemical one and the exact source of BPA in those tested was not determined by the study. It basically proves that we should avoid ingesting BPA (which we already knew). He recommended consumers minimize drinking from polycarbonate bottles and eating from PC-lined food cans. PC is the very hard plastic used in Naglene bottles. As a rule of thumb, if it isn't hard, it probably isn't PC (look for the number 7 or the label 'PC' in the recycling triangle).

Now for the funny part:
As he said this, images of margarine containers, disposable plastic water bottles and other soft plastic food containers were shown. None of the containers shown were BPA-bearing plastics. In plastics, BPA is only used to manufacture polycarbonate (PC) and as an antioxidant in polyvinylchloride (PVC). The products that were shown are made from polyethylene terephthalate, low/high-density polyethylene, polypropylene and polystyrene (PETE, LDPE, HDPE, PP and PS respectively). Other than PVC, which is not generally used in food/drink items, and PC, none of the other plastics are manufactured using BPA!

In other news..

[Image courtesy of Clarke]

In exchange for up to $85 million in federal loans, the U.S. government will receive a 79.9 percent equity stake in the company.

According to the press release,

"The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance."

Instead of a disorderly failure, this announcement ensures and orderly failure as the company's assets are slowly liquidated until the loan is repaid. Extremely large free market equities have now received full or partial bailouts from the U.S. Treasury (Freddie Mac and Fannie Mae's saviour), The U.S. Federal Reserve (AIG's saviour), and soon U.S. Congress (General Motors' saviour).

To be precise, Freddie and Fannie were not explicitly free market enterprises. Instead, they were implicitly guaranteed companies otherwise known as GSE's (Government Sponsored Enterprises). This was their fundamental flaw. Investors said they were taught in 'investing school' (whatever that is) that theoretically speaking, the entities had the risk of treasuries but the reward of equities. If that sounds too good to be true, that's because it is and always was. While others share the blame, this structural flaw took the lead in granting so many irresponsible sub-prime loans and now results in a cascading effect we are seeing in financial markets around the world.

All this is meant as a primer for my next topic: The Swinging Pendulum--and while change is good, the swinging pendulum is decidedly not a good thing.

Captain Planet (aka T. Boone Pickens)

2008-09-06T21:50:00.032-06:00

Note: This post relates to the "Pickens Plan". If you are not too familiar with the plan, please go to PickensPlan.com to read about it first.

When T. Boone Pickens unveiled his energy independence crusade for America, some people were a little skeptical. After all, he's an oilman, and oilmen are reputed to be selfish capitalists. Many people claim his motives are not pure. He refutes the claim that his plan stands to benefit himself more than the American public with the assertion that he's made enough money. At 80 years old, with a estimated net worth of US $3 billion, his claim seems reasonable. He has also donated millions to philanthropic causes in the last 3 years. Yet it's unclear why George W. Bush wouldn't listen to his causes after he donated millions to Bush's 2004 presidential campaign and its affiliates. It's also hard to ignore the fact that he has a pretty big monetary stake in the companies that stand to benefit most the plan.

The Big Stakes...

Clean Energy (NASDAQ: CLNE)
It's no secret that Pickens is the "largest shareholder" in the "largest provider of natural gas for transportation in North America.." Obviously, this company stands to benefit from his plan more than any other, and positive news coverage has driven the stock skywards. Since the 'Pickens Plan' first made news in July, shares in Clean Energy are up about 70%. It outperformed its peer companies by a very large margin. The United States Natural Gas Fund (AMEX: UNG), was down 45% over the same period. The TV spots for the Pickens Plan double as advertising for this company and have probably already paid for themselves on the basis of stock valuation. It likely helped land a big contract in the State of California this month (link). Fantastic!

Mesa Power, LLP
This private energy company owned by T. Boone Pickens has already invested US$2 billion in building a wind farm along the Texas Panhandle near Pampa, Texas. The next U.S. president could make public funding available for alternative energy sources. Pickens will do his best to put Mesa Power on the receiving end of these funds as wind power isn't yet competitive on the free market.

Mesa Water Inc.
Mesa Water is a group that represents"Texas Panhandle landowners, led by Boone Pickens". The company recognizes that many areas in the United States face very serious water shortages, meaning clean water will become an increasingly valuable commodity like oil. It hopes to drill for water from the Ogallala Aquifer (an aquifer is akin to a really big underground lake) and pipeline it to markets in Texas as early as 2021. The part of the aquifer that Mesa Water wants to exploit is located underneath the Texas Panhandle, where a wind farm is being built by another company (Mesa Power, LLP). There is one problem however,
[The Ogallala source water] is "stranded" because without production facilities and a delivery infrastructure to other parts of the state there is no market for it.
Pickens has a duel-use plan to use land obtained in the wind corridor via Mesa Power and also to install water pipelines via Mesa Water. Speculators say he was unable to buy all the land he needs to build a pipeline (landowners can be a pretty big headache) and will need the government to arbitrate (i.e. force) these land sales.

Pickens is lobbying the U.S. government for subsidies and allowances on all three fronts (wind power, vehicular natural gas and water). He's killing 3 birds with one stone. Right now, Pickens' greatest exploit is the American people for their irrational exuberance in the idea of U.S. energy independence. While motives may not be all that pure, his flair for innovation is something to be admired.

Why the quirky title you ask? Does anyone remember the show "Captain Planet"? "Earth! Fire! Wind! Water! Heart!" All Mr. Pickens needs is an ignition source for his natural gas, and he has it all...

Move over Al Gore, "I am Captain Planet!"

Hurricane Update

2008-08-31T19:35:00.021-06:00

There have been many predictions about what the price of crude oil will do as a result of Hurricane Gustav, which is expected to make landfall very close to where hurricane Katrina did. Gustav is also expected to make landfall as a category 3 storm (Katrina had been a category 5 but weakened to Category 3 before making landfall).

Idle Production
Currently, nearly all oil production in the area is shut in, with all personnel evacuated. According to Bloomberg, "96 percent of offshore oil output and 82 percent of gas production" is currently idle. The Gulf region produces a quarter of U.S. domestic oil production and 14 percent of natural gas production. Nearly all operations personnel have been evauated while many refineries and piplines in the area have also been closed.

A couple of days of reduced supply isn't enough to raise prices significantly. The large price spikes in 2005 were due to the damage in the aftermath of Hurricane Katrina that took months to fix, rather than these temporary shut-ins. It's also quite likely that this increased idling simply means oil producers are better prepared and less damage will ensue from the hurricane season this time around. Any production lost due to downtime and minor damages can easily be replaced with oil from the strategic petroleum reserve, which was intended for--and only capable of--replacing temporary and unforeseeable supply disruptions like Hurricanes (rather than to stabilize normal market price volatility, a purpose some people thought of it earlier this year).

Up Or Down?
Sixteen economists polled last week were split almost evenly three ways (I don't recall which poll). About one third said prices would simply fall after the hurricane passes. Another group said prices would remain about the same. The last third of these economic experts said prices could rise significantly. Prevalent Canadian economist Jeff Rubin of CIBC's World Markets thinks gas prices could hit $1.75-a-litre if this year sees "[a]ny replays of the 2005 hurricane season". Ultimately though, what happens will depend on Mother Nature (or global warming for those who speculate that this is the case). Many others think this scenario is unlikely.

Inflation Outlook
If the most active part of the hurricane season does create major disruptions to energy supply in the Gulf, the resulting increase in energy prices could kill the plans of the U.S. Federal Reserve Bank to hold rates steady this year. Ben Bernanke expects to see inflation moderate from an annual pace of 5.6% in July if oil prices remain relatively low compared to their all-time highs of $147-a-barrel. The Fed does not want to raise interest rates until some parts of the "financial storm" passes, which include the housing crisis and credit crunch, high commodity prices and a low greenback.

My Prediction
I'd say there are several indicators that show the markets are comfortable with a crude oil price in the $110-$120-a-barrel range for the next couple months, with some spikes possible. Even with a spike, a repeat of Katrina is unlikely and therefore the odds are that the price won't stray too far outside this range, up or down. It also seems like a stable and sustainable range as an OPEC official has said his organization will cut production if oil falls below $85-a-barrel (Iran has less clout but their oil minister wants OPEC to set this floor at $100); on the high end, airlines and car manufacturers start failing if oil goes above $150-a-barrel (Zoom airlines failed last week with oil below $120). My prediction also translates into gas prices in the range of $1.15 to $1.35 for the fall, depending on what the loonie does relative to the greenback.

Meteorologists are about as good as predicting the weather tomorrow as energy analysts are at predicting crude oil prices next week, even without a hurricane. It seems we'll just have to wait and see how these factors come together. At least the one certainty is that the loss of human life this time around won't be anywhere near as bad, assuming that lessons were learned from Hurricane Katrina.

Some News and Anecdotes

2008-08-19T21:01:00.008-06:00

A Thousand Barrels A Second

"Beginning [in 2006], and over the course of the next 5 to 10 years, increasingly volatile energy prices are going to affect how you live and what you drive, not to mention the economy, the environment, and the complexity of the geopolitical chess match being played out for the world's precious energy resources... we are in the midst of volatility, right on the cusp of a break point that will change the way governments, corporations, and individuals exploit and consume primary energy resources, especially crude oil."

This an excerpt from Peter Tertzakian's book A Thousand Barrels A Second. I strongly recommend this book as you only need to get through the first page to see that the former oil industry "foot soldier" and energy analyst knows what he's talking about.

Anecdote: The New York Times followed up on my news tip with Jad Mouawad's lead business story, As Oil Giants Lose Influence, Supply Drops. I sent in the tip following my post "Big Oil: 2nd Quarter In Brief".

The Olympic Spirit

Usain Bolt raised eyebrows with his come-from-nowhere gander into the title of "world's fastest man". Three months ago, he raced in his first adult international competitive 100m event. The morning of the Olympics he woke up at 11, ate some chicken nuggets, watched TV, ate lunch, more chicken nuggets, then jogged his way into a new world record and gold medal in the 100m. He could have run faster were it not for his pre-finish celebration and an untied shoelace. This may seem suspicious, but even if he had used performance enhancers a good pharmacist knows how to circumvent drug testing; we may never know whether or not he really did wake up one day realizing he's the worlds fastest person. If he ran clean, it would be nothing short of impressive. Or maybe he wanted to run clean but someone slipped something in his Chicken McNuggets. Either way, the Olympic spirit and excellence more than offsets the less desirable sides of the games. 'Communist' China has thus far hosted the games without anywhere near the level of controversy many of the alarmists and human rights extremists had predicted. Canada topped its Athens podium count with 13 medals.

Anecdote: Simon Whitfield made an impressive come-from-behind sprint in triathlon, nearly clinching gold but finishing with silver. I could feel his pain in the closing kilometers of the run. "It hurt, it really hurt..." said Whitfield. But with 300m to go and 40m behind the leading pack of three, he threw away his cap, summoned some energy from deep within, and commenced his sprint to the podium. He even took the lead before Germany's Jan Frodeno stormed back to rain on the party, leaving Whitfield with the silver.

Freddie and Fannie Fall Off The Tricycle

Mortgage guarantor Freddie Mac had mixed success with a high-yield debt sale today. Freddie Mac was able to raise over $3 billion in capital. Shares fell another 6% in addition to yesterday's 25% plunge. The likelihood that the mortgage GSE's will require explicit taxpayer backing is a bit of a psychological self-fulfilling prophecy--as investors are told by analysts not to invest in these companies, it makes it very difficult for them to raise capital. As a result, they must do so by offering a very high yield incentive (as was the case in today's sale). The premium will keep them afloat for longer, but it also hurts longer term profitability, which is why equity shareholders continued their sell off. Inflation data from the past week did not help, as it raises speculation that the Fed may need to raise rates sooner rather than later--a move that would likely force Freddie and Fannie to seek public funding if a rate increase were factored in this year.

Anecdote: Last week, I tried to warn a handful of naive investors on the Google Finance discussion board who thought they were getting a bargain on the shares of Fannie Mae (NYSE:FNM). I pleaded with them to cut their losses and move on. Unfortunately they thought I was a hedge fund manager trying to use psychology to maliciously drive down prices. In retrospect, I should have tried to explain that I did not hold any short positions (my investment knowledge is not advanced enough to take short positions). I have no financial stake in Fannie or Freddie whatsoever--I was simply trying to advise them to donate their money elsewhere. Instead the poor souls lost 30% already since then.

photo credits:
Oil Barrel byblizzy73
Birds Nest by Theo W L Jones
Tricycle by iMorpheus

$80 Oil In 2008???

2008-08-03T18:55:00.021-06:00

Well, I promised some good news in the next post so here it is: It has recently come to my attention that energy market funds have become all the rage in light of all the attention energy prices have been getting. These investment vehicles are engineered to follow the price of crude more closely than any oil company or trust does. They are essentially hedge funds, which are designed for companies that genuinely need to minimize risk exposure to ensure predictable profits. The airline industry is a good example of an industry that needs to hedge itself against the price of oil. Were it not for hedging, many airlines would be in much worse financial shape.

Fund	Symbol	Launch Date
US Oil Fund LP (ETF)	USO	April, 2006
US Natural Gas Fund LP (AMEX)	UNG	April, 2007
12 Month Oil Fund LP (AMEX)	USL	December, 2007
US Gasoline Fund LP (AMEX)	UGA	February, 2008
US Heating Oil Fund LP (AMEX)	UHN	April, 2008

The problem is, that these funds (and I suspect many others around the globe) are available to everyday investors. NYMEX crude oil contracts require minimum trade increments of 1,000 barrels at a price of $13,000 each. Not too many small investors would want that kind of exposure in such a volatile market. These energy funds allow investors to effectively buy oil in much smaller basket increments (on the order of one barrel or even less). Since the funds I've listed (and I suspect many others) only originated recently (end of 2007 to early 2008), it's quite possible that they have added considerably to a speculation bubble that has yet to really burst.

While I do not in favour of excessive government interference in free markets on the grounds that they do not and can not lower long-term prices, I do believe that it can help moderate short term prices as well as stabilize volatility. Yet the commodity exchanges are already heavily regulated and there is little indication that more price controls are the answer. Price volatility has been very high with massive ups and downs in the past year, which is certainly an indicator that speculation is trumping fundamentals. As I said and continue to say, market bubbles will eventually always burst, but unfortunately they can often leave deep scars in the process. I think there is a very real possibility that the price of oil could continue to correct itself downwards by as much as 30-40% in the coming months.

Ed. Note: I just checked oil prices this morning (Monday, August 4) and they have tumbled below $120 (down $4) in intraday trading.

Big Oil: 2nd Quarter In Brief

2008-08-02T12:00:00.015-06:00

Two-thousand eight second quarter corporate results were released in the past two weeks. I reviewed the numbers for the oil supermajors (with market capitaliation above $100B US): Exxon Mobil, BP, Royal Dutch Shell, Chevron, Total S.A. and Conoco Phillips.

Average Second Quarter production Rates (mboe/d)*

Major	2008	2007	2006	2005
Exxon Mobil	2,393	2,668	2,701	2,468
Royal Dutch Shell	3,126	3,178	3,253	3,526
Chevron	2,540	2,630	2,669	2,421
Total S.A.	2,353	2,323	2,290	2,506
BP	3,830	3,804	4,018	4,112
ConocoPhillips	1,750	1,910	2,130	1,540
*Totals*	*15,992*	*16,513*	*17,061*	*16,573*
*Year-over-year change*	*-3.16%*	*-3.21%*	*+2.94%*

The highlights are as follows.

Profits were robust (as expected) due to high oil prices.

Production rates fell (not quite as expected) despite record capital expenditures.

All but two saw production decreases from the same quarter last year despite the fact that oil prices doubled in the same period.

The average year-over-year production drop was over 3% in each of the last two second quarters.

These are the unadulterated numbers. The production drops are under-reported because the companies only highlight production within their control and downplay production drops from the 'Chávez-factors'. For example, in Exxon Mobil's 2008 Q2 press release:

On an oil-equivalent basis, production decreased 7% from last year. Excluding impacts related to the Venezuela expropriation, the Nigeria labor strike and lower entitlement volumes, production was down 2%.

Also downplayed is the effect of asset sales; the reality is that most of such sales are mature fields that already in decline and are no longer material to the company. It seems that while global reserves have edged upwards, our ability to get them out of the ground under free-market conditions is quickly deteriorating, even with oil at record prices. Expropriation of reserves by state-governments is likely why oil prices have increased so rapidly: free-markets are losing control of production to countries like Venezuela, Russia and China. This is very bad for free-market pricing. So far at least, demand destruction has not appeared to offset the bullish market forces including resource nationalization, geopolitical instability and exponential production declines. The entire independent oil & gas industry tells the same story. I'm not predicting $300/bbl oil yet, but I wouldn't fault anyone for holding on to crude oil futures in light of this data.

There is one more recurring theme. Nearly all the refinery and gasoline distribution divisions were the least profitable and in some cases lost money. Exxon Mobil now plans to exit the gasoline distribution market citing very weakening margins. This is bad news for gas prices which have yet to increase by the same percentage as crude oil.

*mboe/d = Thousand barrels of oil equivalent per day. Natural gas volumes are converted to an oil-equivalent basis at a ratio of about 6 mcf:1 boe.

Some light on the Canadian economy

2008-07-29T19:30:00.002-06:00

I keep hearing comments that the weakness in Canada's economy is being masked by high commodity prices.

So last night, I got on Excel and using data from Yahoo! Finance, I charted up over thirty of the World's major exchange indices. The result is the year-to-date percentage increase (or decrease!) of each index.

For clarity, the chart I uploaded only includes the representative indices (let me know if you're interested in the spreadsheet).

As the chart shows, the S&P/TSX Composite Index is the best performer of 2008 (as of July 25, 2008) out of all the headline market indices around the globe. It has lost 2% since January because Canada's economy was dragged down by the American economy. Relative to the world though, it outperformed. If commodity prices continue to fall, so too will the Canadian dollar against other global currencies. This increase export profits will hedge itself against falling commodity prices. The Canadian GDP may have fallen the most out of all the G8 countries, but if the fundamentals for future growth outlook are good then who cares? In the United States, I don't expect much growth through 2009, and our neighbour to the south is our biggest trading partner.

So yes, I do expect growth to be weak (at best) for the next 12-16 months. It may sputter, but when Canada's economy is placed in the relative context of it's global counterparts, I don't understand what all the fuss is about.

External Links

The worriers:

The realists:

The Big (Oily) Crunch

2008-07-13T18:10:00.028-06:00

No, this isn't a public service announcement about the dangers of eating KFC. This is about the credit crunch, inflation, and how it all relates to the price of oil. First of all, I must congratulate the McCain camp by dissociating themselves from former economic advisor Phil Gramm, who believes the U.S. is a "nation of whiners" in a "mental recession". I agree that it's not very productive to whine about losing your home to floods and foreclosures, losing your job and paying twice as much to fill up the gas tank compared to last year--but the recession part is not exactly mental. I stumbled across a stunning correlation the other day--that oil prices are actually linked to inflation. Please excuse my facetiousness, but this is why the U.S. is in a recession, even if the numbers do not show it by definition yet. To be honest I did not realize how close the historical link between oil prices and interest rates has been until I charted it up myself.

The Correlation
Everyone knows when gas prices go higher, so too does the cost of everything since so many of the things we use are either made from fossil fuel and its derivatives, or transported by them. Everything from clothes (polyester) to electronics (plastics) to groceries (diesel for production & transport) is heavily dependent on hydrocarbons. There is usually a price-lag of months to even years because it takes time before these costs reach the consumer in many of these products, particularly when companies use price contracts and hedging to ensure delivery of their commodities and parts at a predictable price for as much as 6-12 months in the future. Employees are given higher wages to compensate for the increasing price of pretty much everything, and thus the cycle of inflation continues.

(click for large detailed view)

It looks to me like the mortgage crisis and subsequent Fed rate cuts in late 2007 and early 2008 played a very significant role in the exponential oil price increase since. The big question is whether the oil price/interest rate link is causal, effectual or casual. It is obviously not effectual because interest rates were low since 2000 when oil prices started to rise. So high oil prices either cause high interest rates or the link is simply casual (i.e. inflation and interest rates tend upwards with high oil prices but not necessarily with any definitive proportionality). I dearly hope it is the latter because otherwise one would expect the cost of borrowing to increase beyond the 20% seen in the oil price shocks of the seventies (which seems unlikely). In either case, it certainly does appear that the cost of borrowing is increasing despite the Federal Banks' decision to keep their interbank lending rate at historic lows. The analysts' consensus is that the Fed will raise rates in late 2008 or early 2009 although the central bank likes to appear apolitical by avoiding rate changes that affect the economy near an election. Banks are not waiting that long to tighten their wallets though--mortgage rates in the United States have increased 10% from January to June 2008 even though the U.S. prime rate has decreased 23% year to date. Fernie, Freddie and IndyMac are more bad news on that front. With the amount of mortgages going delinquent, the banks that backed them going broke, and investors deciding to move their money to the home mattress 'bank' (or at least outside of U.S. markets), higher interest rates would mean we haven't seen the bottom of the crisis just yet.

Who Takes The Blame?
I've already discussed the potential reasons for the increase in oil prices (market speculation, rate cuts and the declining USD, lack of supply, increasing demand from developing countries and re-valuation of the commodity)--there is still no consensus on which of these factors are most important.

There is more agreement on the credit crunch side to this coin:

In the early 2000's, interest rates were at 35-year lows in the face of the dot-com bubble burst of March 2000 and the events of September 11th, 2001.
In June of 2002 the Bush administration unveiled a seemingly well-intending policy to "close the home ownership gap between minorities and non-minorities". It encouraged mortgage brokers to make the lending process easier with "less paperwork" and provided both tax credits and down payment assistance (read full policy).
Some white-collar criminals saw these factors as an opportunity to make money through the regulatory loopholes and predatory lending practices.

I don't think I need to explain what happened next although I will share a very accurate satirical depiction that many of you will have seen via email:

The Subprime Primer (credit unknown).

As far as the Fed goes, it is true that they failed to keep a close enough eye on lending practices and left too many regulatory loopholes open. Many have called on Ben Bernanke to raise interest rates to stem inflation and bring back the value of the U.S. dollar, both of which will lower oil prices. However, it seems clear that even at the current low interest rates, big banks have begun failing. As I've said, this really does seem to be the stagflation dilemma.

What Next?
For U.S. policymakers, they need to find a way to bring down oil prices without raising the interbank lending rate--and quickly. I have no idea how it can be done but they need solutions at this point rather than passing around nonconstructive blame.

For investors, market volatility is likely to continue assuming the policymakers fail to find an answer to the oil price and credit crunch problems. Investing in turbulent times can still be profitable, even though it becomes much more difficult for the average person. Basic goods and services that are based on need rather than luxury items are always good investments in a bear market. Wal Mart's shares are up 20% YTD as consumers move towards discount retail items. Gold and silver are always good hedges against high inflation, although I'm not sure if they are overbought at this point. Shorting positions are obviously good in a bear market--but this is only for experienced investors due to added complexities. And most importantly--minimize debt at a time when the cost of raising capital is likely to increase.

Of course the Canadian economy is in much better shape fundamentally than our neighbours to the south, although our economy is certainly not isolated from that of our biggest trading partner. I would be very interested to hear any comments and opinions of the state of the Canadian and/or U.S. and/or global economies from any readers. My next post will speak specifically to Alberta's economy--which currently holds the economic engine of Canada fueled by the oilsands.

Further Reading

Indymac: here come bank failures (National Post)
Fannie Mae Ugly (Wall Street Journal Online)
Gramm Remark... (Washington Post)

The Presumptive President

2008-06-24T18:41:00.092-06:00

Image courtesy of Charis Tsevis

I know it's early, but I'm ready to project a winner for the U.S. Presidential Election long before CNN does. I am projecting that Barack Obama will be the forty-fourth president of the United States.

They say success is 90% effort and 10% luck (or 10% effort, 90% luck depending on who you talk to)--Either way, Obama definitely has the pocket aces at this point. When Obama was first elected to the senate, he and his advisers devised a plan to make a bid for the White House in 2012. His camp realized that George W. Bush left a really big window open; actually, I'm not sure if it was an open window or if they forgot to erect walls altogether.

Bush's approval rating was 28% in April according to a USA TODAY/Gallop Poll. His disapproval rating is the highest for any president since Franklin Roosevelt. This is quite a sharp fall after his approval rating spiked to 90% in the days following September 11^th, 2001.

Obviously, polls like any other indicator have their limitations. Another indicator is consumer confidence, which hit 16-year lows in June. The last low was in 1992, right before Bush (Sr.) lost his lease on the White House to the democrats.

That doesn't mean the U.S. economic woes are fully to blame on Republican policy, or even President Bush for that matter. In fact, many political scientists agree that the framework of U.S. politics imposes very strict constraints on the President's power, even though he (or she) is sometimes termed the most powerful person in the World. Additionally, the U.S. Congress is currently controlled by the Democrats. In reality, policy failures are some combination of circumstance (i.e. luck) and failed policy by all parties involved. I don't pretend to know the ratios of those two factors.

Iraq Example
Any sufficiently balanced policy will maintain America's prosperity so long as it recognizes and adapts to the challenges current times rather than simply using the strategies that worked in the past. With hindsight, it is now hard to find many people who still strongly believe the 'Operation Iraqi Freedom' was a good policy decision. The war appears to have been justified on the basis that brute force military action was sufficient for victory. That worked quite well for the invasion phase following which President Bush stepped out on an aircraft carrier declaring "Mission Accomplished!". Post-invasion though, brute-force military tactics have proven mostly unsuccessful against the guerrilla tactics used by insurgents that include suicide bombers, IED's and sabotage of oil infrastructure. I'm no historian but I was told France started digging trenches on the eve of WWII. The Germans rolled over them with tanks--this is what I mean by relying on strategies that worked well in the past. Lawrence Lindsey, Bush's former chief economic advisor, speaks to his assessment of the cost of the war when he says, "I misjudged an important factor: how long we would be involved [in Iraq]." Current estimates are now between 5 to 10 times higher than what was circulating in Washington before the war ($30 billion up to $200 billion). The casualty count for U.S. soldiers is currently confirmed at 4,102 deaths*.

The Candidates
Clearly, the name George W. Bush is not going to be on the U.S. election ballot. John McCain could certainly be a worthy candidate, yet he probably won't be able to distance himself enough from Bush to win. He does has some significant policy differences, but the single biggest election issue is and will remain the economy. His economic policy is considered 'status quo' with the Bush administration. McCain has the additional challenge of backtracking on numerous past admissions that he is "not an expert on some of this stuff.." ('this stuff' referring to economics). How much this should matter is debatable given that there is no shortage of qualified economists in Washington, but in the eyes of most voters it will matter. It also won't help that there is no shortage of videos on YouTube depicting his shortfalls when it comes to understanding the economy.

There is definitely no guarantee that Obama will be able to fix the economy of course. Some even argue that he will be worse for the economy. His social values and principles are very liberal. On the other hand, his social and economic policies appear to encompass a more pragmatic compromise than his ideals. Whichever the case, if the economy continues to struggle through November, the Republicans will be blamed, leaving the door open for the Democrats.

While Shelby Steele makes some compelling arguments (in his book A Bound Man) as to why Obama can't win the election, I must disagree. Steele's arguments center around race and character, while the focus of the election will be the economy. When Bill Clinton first took office in 1992, voters leaving the polls said the economy was the biggest issue for them, with character being a trailing issue. The Reverend Wright issue appears to be spent while U.S. economic concerns gain momentum. The mortgage crisis fallout continues; house-equity is dramatically falling as are housing starts, the U.S. dollar and equity markets; sovereign and domestic U.S. debt continues to rise; the bulls on commodities...

Economic Outlook
I won't deny that it's possible that the economy could look more positive toward the November election, but the signs don't seem to show that at the moment. The U.S. Federal Reserve continues to resist calls to raise interest rates to bring back the value of the USD (and help stop the rise of oil prices). Some have blamed Fed Chairman Ben Bernake, but unlike John McCain who "wish[es] interest rates were zero", Bernake has some very impressive academic credentials in economics. Hence there are only two logical reasons to delay raising interest rates until late 2008 or in 2009--that more write downs are expected from sub prime mortgages going bad, or that they believe raising interest rates now would result in a catastrophic market collapse. It seems like the Fed's hands are tied with the stagflation dilemma.

All Senator Obama needs to do now is follow the advice President Bush gave him when the two first met at the White House:

"When you get a lot of attention like you've been getting, people start gunnin' for ya. And it won't necessarily be coming from my side, you understand. From yours, too. Everybody'll be waiting for you to slip, you know what I mean? So watch yourself."
[excerpt from The Audacity of Hope]

It will be smooth sailing for Barack H. Obama from now until November. And he has George W. Bush to thank for rolling out the red Carpet. It will still be a close race, but if I had to bet, I'd put my money on Obama.

Complimentary Reading:

Luck - A president's best jobs plan (by Chris Isidore, CNNMoney.com senior writer)

The 44th President's $4 Trillion Headache
(by Jeanne Sahadi, CNNMoney.com senior writer)

Broad Says Economy in Worst Slump Since World War II (Anthony Massucci and Erik Holm, Bloomberg.com)

Please feel free to comment on my prediction, but hold back on your comments regarding Obama's suitability for U.S. President--I will get to his flaws, strengths, etc. in an upcoming post. But first, I will examine why Alberta is very well-positioned relative to the global economy despite "growing concerns" around the globe about climate change.

Green Shift or Red Shaft?

2008-06-20T00:27:00.043-06:00

You've all heard the basic principles of the plan. Here are some Q and A's about the Liberals new climate change policy and election platform..

Is the policy it tried and tested?
No. There is no example of a similar and successful policy for a country analogous to Canada. It's neither tried nor tested and the complexities will ensure many challenges will be encountered if it even manages to proceed. The flaws of the Kyoto policy was a good example of serious issues that will be encountered in trying to implement untested climate change policies.

What complexities?
Let's say for example that you are renting your residence and your landlord pays the heating and electricity bills (they are included in the rent). If and when a "carbon shift" is applied, then you will get income tax refunds and your landlord will get the higher bill. This doesn't make any sense, so obviously complicated provisions will need to be made for for these scenarios, including for people who are currently under a rental contract. This is but one example of the many complexities that will arise with an untested plan of this scale.

Will it reduce greenhouse gases?
Most likely. But even the liberals admit they don't know exactly how much. On a global scale, Canadians produce an estimated 2-3% of the world's greenhouse gases. That means even a significant reduction in CO₂ emissions for Canada would be fairly modest on a global scale. At best, it represents a symbolic 'first step' more than anything else.

Will it be bad for the economy?
The jury is still out--but it would certainly result in a shift of the economy. Ultimately though, there will be no net flow of Canadian dollars outside the Canadian economy unlike some of the international Cap and Trade policies. It is certain that some industries could be put at a competitive disadvantage while others will flourish under the plan. Economists are split on whether or not it would be good, bad or neutral for the Canadian economy overall.

Can it pass with the Conservatives in power?
No. Even if the liberals garnered the support of all the other opposition parties, the government is not required to follow any policy that includes significant budgetary spending measures. Dion's release of the plan marks an unofficial but irreversible start of an election campaign.

Is it really revenue-neutral?
Sort of. There will be significant administrative costs, particularly with the complexities of this plan. Ultimately though, all of the revenues should be returned to Canadians. That's a bit of a moot point though, because all government revenues are always returned if not at least owned by Canadians--It's really a question of how revenues are distributed and to whom. It's unrealistic to think that everyone will get back exactly what they paid. Some will get more, others less. For example, farmers that require the use diesel will be hit much harder than someone living in a small condo with electric heating (energy sourced from hydroelectricity or nuclear). To compensate, they have added a provision to give more revenues to rural area residents and northern residents. Very complex systems are needed to help even out the imbalances and even then it will still create some winners and losers.

Who are the biggest winners?
Most likely Canadians living below the poverty line. While Dion claims revenue-neutrality, he doesn't claim revenue-equality.

"The Green Shift will be especially targeted to decrease poverty with further emphasis on helping children in poverty."
-Dion at the 'Green Shift' kickoff speech

Clearly the Conservatives claim that it is a masked tax has some legitimacy.

Who are the biggest losers?
Probably Albertans and Saskatchewanians. Alberta's electricity grid relies on coal for nearly 50% of its power and natural gas for almost 40%. Saskatchewan is similar but with more hydroelectric and less natural gas generators. Ontario is basically the next closest electricity carbon-emitter with 20% of its electricity generated from coal. Electricity costs would go up in those provinces--by a lot. It would add over $600 million to Alberta's total electricity cost in year one, and over $2 billion by year four. I'm not sure how much would be returned to Albertans in personal and corporate income taxes but I doubt the figure is proportional to what Quebecers receive. Quebec uses over 97% hydroelectric power. The plan was "adopted wholesale" from Jack Mintz, a tax-policy specialist and chair of Policy Studies at the University of Calgary. Ironically, Mintz hails from Alberta, and received his first degree in economics at the University of Alberta.

Will it harm oil sands development?
Possibly, but not as much as one might think. The taxes are point-of-sale, which means oil sands producers can continue to release CO₂ and as long as the oil is sold to the United States (as most already is), the massive carbon emissions produced will bypass the plan. This is another strange irony because the oil sands are Canada's largest industrial CO₂ emitter. But no plan that destroys Canada's economic towboat would be supported by any economists. However, industry lobbyists will exercise their right to complain because it sets a pretty bad precedent for the future. Still, a precedent has already been set by the United States which banned the purchase of 'dirty' fuels by the Feds. Some say Alberta's oilsands are exempt under the U.S. bill. Either way, I don't believe precedent is a concern in the face of such high prices of an essential commodity.

What about Airlines?
Aviation fuel is not taxed in year one of the plan but 6.2 cents per litre would be tacked on by year four of the plan. Flight prices are already up 30-40% since last year and are likely to continue rising. High oil prices have hit this industry hardest. Airplanes are among the biggest CO₂ emitters, and there are some indications that CO₂ released at higher altitudes could have more impact on the environment compared to ground-level emissions. All this is to say that the aviation fuel tax is very unlikely to be removed from the plan. Truckers will have a similar grievance. Admittedly though, to put it in perspective, the cost of diesel and aviation fuel is on the order of $2 per litre, so it would add somewhere from 1-3% to the cost of flying/trucking.

And other Industries?
Because it is point-of-sale, it is a tax on consumers on the basis of estimated carbon emissions from fuel sources rather than on carbon dioxide emitters directly. Of course, industries can be large consumers as well as individuals. The steel industry, for example, might be hit hard because they use lots of coke (which is essentially coal) in the refining process. As I've said, coal-fired power plants will also be hit hard and ultimately coal miners that sell domestically.

Do all liberal MP's support it?
No. If it comes down to a vote they will all stand up of course. However, there are certainly many liberals that are concerned about their constituents kicking them out of office in the next election. Saskatchewan MP Ralph Goodale's place in the House of Commons could be collateral damage for example. On the other hand, this is the first issue Stephane Dion has actually taken a stance on. Some within the Liberal ranks will support it on the basis that the plan would either succeed (and get the liberals elected) or fail and have Dion exit the Liberal Party. Either way it's a resolution.

Will The Plan Succeed?
It's too early to tell but here are some interesting notes:

The liberals have obviously scrutinized the plan extensively with political analysts and economists. Early response to the plan indicates economists are split on the economic sensibility of the plan.

Gasoline taxes were excluded simply because it would be too unpopular and not because it is already taxed (diesel is already taxed but did not escape the carbon tax).

The NDP has shunned the plan and said they will not support it.

The Conservatives seem to be taking potential for public acceptance of the plan quite seriously. Stephen Harper seemed to indicate his intent to have a fall election the day after the plan was officially released.

It will likely garner support from Quebec and result in a shutout of the liberals in Alberta (again) and quite possibly Saskatchewan. BC has already committed to implementing a carbon tax that includes an additional gasoline tax--BC residents may not like being squeezed by both the provincial and federal governments at the same time.

Senators McCain and Obama both have more accepting perspectives on anthropogenic climate change predictions compared to their predecessor. This could furter influence public opinion on climate change.

If oil and energy prices fall in the coming months, then more people will soften to the plan. Demand destruction is happening as we continue to see economic growth casualties from the continued high prices. At the same time, a serious disruption to supply (devastating hurricane or a terrorist attack of epic proportions) would undoubtedly cause oil and gas prices to rise.

At first pass I'd guess the plan will ultimately fail to get the liberals elected (and be enacted) because of the complexities, uncertainties and divisiveness of the plan--and also because of the general perception that Dion is not a good leader.

On a side note, while I'm not crazy about poetic symbolism, tulips (pictured above) actually have some very interesting economic history in 17^th century Holland (see Tulip mania). Furthermore, no one really knows for sure whether or not the "Green Shift" will put the economy "in the red". Lastly, it seems the Liberal party has (temporarily?) added green, in addition to red, as it's second colour.

A Changing Climate or a Hurricane of Hoaxes?

2008-06-19T21:54:00.022-06:00

There is no irrefutable evidence of climate change. Most of the speculation about anthropogenic climate change (caused by humans) are based on computer models, which are improving but still rather difficult to validate. That's because even if we can approximate a history match of past climate conditions, we are now trying to extrapolate these models for carbon dioxide levels that have not existed for several millennia on the Earth, if ever. Computer modelling is sometimes considered as much of an art as it is a science because it requires so many assumptions. Good engineering assumptions produce good approximations but bad assumptions produce erroneous results. The only way to have confidence in a solution is consistency. The model must be consistent with historical data as well as with current data. The more data we have that turns out to be consistent with what the model forecasted, the higher confidence we will have that the model is valid. Click here for a recent article on climate change consistency. But some judgement is required to assess how much consistency is required to constitute irrefutable evidence. I don't think we've reached that point yet.

Any sound political and free market policy will be one that considers the economy, society and the environment as an inseparable whole rather than as independent entities. Ignoring the environment in favour of the economy allows the economy to flourish in the short term, but could be detrimental to the longer-term economy. On the other hand, undue and overly-aggressive environmental policy would be crippling to the near-term economy. A sound policy would strike the correct balance between the economy and the environment such that strong but sustained economic growth can be achieved. I don't propose to know where that balance lies, but it certainly won't be reached without international cooperation and commitment. There is no broader a public interest than billions of molecules of air pollution that refuse to adhere to any regional, national or geographical boarders.

It is this mobility of global pollution that makes it such a challenging issue. For example, the U.S. and Australia refused to commit to the Kyoto protocol because it would put them at an economic disadvantage to developing nations like China, who were given a more liberal license to pollute--they had a valid complaint. At the same time, China and other nations still only produce a tiny fraction of pollution per capita compared to developed nations--this view is also valid.

While there is no consensus on the magnitude and scale of anthropogenic climate change, there is a growing belief that regardless of the extent, climate change beliefs will dictate both public and corporate policy.

John R. Fanchi, a petroleum engineering professor, writes:

One [oil and gas] industry response to environmental and social concerns in the context of sustainable development is the triple bottom line (TBL). According to this view, sustainable development must integrate social and environmental concerns into a development plan that optimizes economic profitability and value creation. The three components of sustainable development, and the three goals of the TBL, are economic prosperity, social equity, and environmental protection. The focus of TBL is the creation of long-term shareholder value by recognizing that corporations are dependent on licenses provided by society to do business.

He also states that (Royal Dutch) Shell has taken strongly to this approach. Many other large corporations are advertising themselves as 'green' including all six oil & gas 'supermajors' (ExxonMobil, Royal Dutch Shell, BP, Chevron Corporation, Conoco Phillips and Total S.A.), as well as the two largest North American automakers (GM and Ford) to name a few.

The Cost-Benefit analysis of climate change
Given the massive uncertainties of climate change, it makes sense to do a cost-benefit analysis to assess risk. It could well be that climate change reports have been prompted by alarmist environmental extremists and sensationalistic news reporting, or they could be genuine. The probable scenario is somewhere in between. There are essentially three scenarios that would come out of such an analysis:

Scenario 1: (best case scenario) Climate change predictions turn out to be totally wrong. There is no consequence to inaction and any mitigation steps taken would do nothing but harm global economies.

Scenario 2: (worst case scenario) Dire climate change predictions are mostly right. The consequence to inaction would ultimately devastate global economies and strong mitigation action plans would be the only way to keep long-term economies afloat.

Scenario 3: (best guess scenario) Climate change predictions are partially right. A balanced approach should be taken to mitigate emissions in such a way that economies are able to achieve long-term continual growth.

An economic/environmental success story was the phasing out of CFC's. It was found in the seventies that the ozone layer was being depleted. The culprit was found to be CFC's, were are used as refrigerants and aerosol propellants among other uses. Global agreements were made to phase out the chemical and it is now estimated that the ozone layer will approach natural levels by the year 2050. Suitable alternative chemicals were found with few negative consequences, if any, to global economies. Unfortunately, the climate change issue is much more complicated and far-reaching than the ozone layer was...

And finally, a primer to the next post--Stephane Dion's proposed environmental policy..

What is the logic behind a carbon pricing?
The logic is that because world economies are driven by free-market capital, we should try to estimate and apply a price of an intangible cost (the adverse effect of GHG emissions on our environment). As I've said, nobody has any clue what the environmental and ultimately financial cost of 1 tonne of CO₂ is. If indeed severe weather events can be induced by climate change, then ideally those who created the greenhouse gases would be charged proportionally for the damages it caused. Now, it's unrealistic to think that we will ever know for sure if climate change causes sever-weather damages, let alone how much and get the polluters to pay proportionally. Re-Insurance companies have taken note of the issue some time ago. Re-Insurers are those who insure the insurers--often in the case of natural disasters. For example, in the months following the Mississippi river flooding, a local insurance company might go bankrupt without the reinsurance provided by a company like Swiss-Re. Swiss-Re is the worlds largest reinsurance company, and it has taken note of the climate change issue. They also realize that there is no way to deny insurance claims to large CO₂ emitters on the basis of negligence (they would need irrefutable proof that doesn't exist).

What is the logic for a Carbon Tax?
The basis for a carbon tax is that the environmental cost of greenhouse gases should be priced in monetary terms (again, no one has any idea what that cost is). Then this cost can be added to the price of emission sources via a tax to create artificial disincentives. This is the opposite of fuel subsidies to artificially encourage economic growth (but can also have adverse consequences). It's similar to the logic for taxing cigarettes. Especially since Canada has a public health care system, smoking adds to the financial burden of hospitals with the health issues it causes. By taxing cigarettes, these revenues can be recycled back into the health care system. No one really knows what that incremental financial burden is, even in the comparatively simple case of cigarettes. Add in all the complexities of a global phenomenon like climate change and you have yourself an analogous carbon tax shift.

Next post: Green Shift or Red Shaft? Some Q&A on Stephane Dion's climate change proposal.

Nuclear Power

2008-05-31T16:18:00.013-06:00

Nuclear is one of those industries that sounds vastly different on TV, by people, and in mainstream than what it really is. Many reading this section are going to immediately have different pictures pop into their heads relating nuclear. I will classify them into 3 camps:

The anti-nuclear crowd has images of Chernobyl, Three Mile Island, and WMDs. They will recite stories of mutations, babies born deformed and other horrific images. Nuclear will be painted as a demonic technology that cannot ever be properly utilised and as a consequence will inevitably cause great harm. Vast caverns filled to capacity with spent fuel will ooze poison taking its toll on Mother Earth. We will call these [insert insult here], Greenpeace, WWF, David Suzuki Foundations, and hordes of other groups that say the same dribble.

This is a group of people who really don’t give a darn. They will have images of Homer Simpson, Superheroes, Godzilla, or other creatures that are born of radiation. They will have heard of nuclear accidents and think that nuclear is or is not dangerous, but does give lots of electricity. Feelings either pro or con will be minimal and thus little actual knowledgeable reading or educating will be done. Thus, a "gut feel" type conclusion will be made, yeah or nay.

The pro-nuclear crowd will mainly be composed of people who are actually in the industry (engineers, physicists, scientists), have lived near a nuclear power plant, or people who understand the experts. They will look at incidents like Chernobyl and Three Mile Island and learn from the mistakes and further improve the industry. Stories of mutations, superheroes, and Homer Simpson will also be considered humorous while recognizing that such stories are removed from truth and science.

Now, like any good brainwashing of the masses, the only way to de-program the victims is to hit them with some knowledge (and please question me as much as you want, because I can prove you wrong). Please remember I am also simplifying the information into a digestible manner, so no snarky remarks about exact wording. Let us start with Chernobyl.

Chernobyl

What is considered to be the worst commercial nuclear reactor accident has been studied extensively by many organizations, reported on by hundreds of media outlets, and is a great source of horrific stories of mutations and the dangers of nuclear power. What was not provided to the masses in 1986 was the truth, being that:

The Chernobyl accident in 1986 was the result of a flawed reactor design that was operated with inadequately trained personnel and without proper regard for safety.

The resulting steam explosion and fire released at least five percent of the radioactive reactor core into the atmosphere and downwind.

28 people died within four months from radiation or thermal burns, 19 have subsequently died, and there have been around nine deaths from thyroid cancer apparently due to the accident: total 56 fatalities as of 2004.

An authoritative UN report in 2000 concluded that there is no scientific evidence of any significant radiation-related health effects to most people exposed. This was confirmed in a very thorough 2005-06 study.

Pages upon pages could be written on this incident, and they have been, so rather than repeat and bore you, I will provide you with the following link, and 2 images of the reactor before and after. Note that Chernobyl had no containment building, which all CANDU reactors have had since the first one ever built.

Now you may be sitting there wondering how can the big bad Chernobyl, the accident which brought fear and despair to the world and especially the nuclear industry and assisted in the fall of the Iron Curtain, have had only 54 deaths. Well it did; the media forgot to mention this fact FOR THE LAST 30 YEARS!! The same UN study mentioned in bullet 4, and provided in the following link, stated that more loss of human life and human suffering was caused by poor diets, poor lifestyle factors (smoking, etc.), poverty, and lack of access to health care than Chernobyl ever will.

Thus, the moral of the story is; the worst nuclear incident in the entire history of mankind, caused by poor reactor design, bad training, without regard for proper safety, killed 54 people. This incident brought the nuclear industry to its knees, and caused countries to abandon nuclear power and resort heavily on Coal. On a side note, in May 2005 a train derailment near Amagasaki, Japan caused at least 100 deaths, but there were no cries from Greenpeace to ban trains and shutdown existing train stations.

Now let us discuss Three Mile Island and what happened, or more importantly did not happen.

Three Mile Island

Three Mile Island is one of the funnier incidents in my mind. While the entire US media and public were demonizing the nuclear industry in 1979, the people that worked in the nuclear industry were giving each other high fives and saying “we partially melted the core, and caused no harm to the public. This proves that our safety systems and designs work”. Of course the media, Greenpeace, and other organizations jumped on this like crack addicts and painted a horrific picture. So instead of boring you again, I will provide you with the following bullets of fact and a link to read more about it:

In 1979 a cooling malfunction caused part of the core to melt in the # 2 reactor at Three Mile Island in USA. The reactor was destroyed.

Some radioactive gas was released a couple of days after the accident, but not enough to cause any dose above background levels to local residents.

There were no injuries or adverse health effects from the accident.

Thus, the moral of the second story is; the second worst nuclear incident in the entire history of mankind, caused by a relief valve failing to close, and operators diagnosing the incident to late due to deficient instrumentation and inadequate emergency response, did nothing but scrap a companies equipment. This incident, due to a movie, "China Syndrome", being released brought the nuclear industry to a halt around the world, especially in the US. What makes it really funny is that actual truth and fiction from the movie began to blur, with more and more fiction entering news coverage. As a result, what all these countries did was turned to coal. I should add that over this past Victoria long weekend, 16 people died in car accidents while no cries for banning long weekends were heard from Greenpeace or other organizations.

Nuclear Bad Reputation or Bad Representation?

So far we have learned that the 2 most severe nuclear accidents in commercial nuclear reactors in the world have killed a total of 54 people over 20+ years. Yet somehow the masses have it engraved in their minds that nuclear is dangerous. So, let us apply this logic to other common things that should be banned:

Trains, planes, cars, ships, and virtually all modes of transportation,

Guns, knives, forks, spoons, swords, poles, pitchforks, about anything you can hold in your hand,

Camp fires, swimming, smoking, drugs (the good kind), and virtually anything that can be inhaled or eaten...

Instead of figuring out everything that should be banned that killed more than 54 people, someone tell me something that was invented by man that has killed less than 54 people, that list will be easier to compile.

Nuclear Moneys

So is it all rose pellets, and singing….no. The single largest barrier to nuclear is Capital Cost. Current estimated from all the major nuclear companies put the cost of reactors at $1000 - $2000 per KW, which translates into $1.5 to $2.0 billion dollars. It should be noted that life cycle costs of nuclear power is the lowest, with coal in second place. Furthermore, the price to generate electricity is the lowest for nuclear. This is why France and Sweden have some of the lowest energy costs in Europe (France 80% nuclear, Sweden 50%). The table below includes in the prices, construction, operations & maintenance, fuel and decommissioning.

Source: International Energy Agency, "Projected Costs of Generating Electricity ", 2005.

As for return on investment, well I’m not privy to that kind of info, but the number that floats around the industry to keep a single reactor down for a day is $1 million. Using that number, a single reactor would make $350 million a year (remove some days for maintenance), and thus payback the initial capital in 5.7 years (assuming no interest). This can be done in various ways, public money, private money or a combination. But ask any investor and that turnaround is not fast enough, especially with something as tricky as nuclear power. In the past it has been public money, but governments are trying to create market environment to allow the private sector to take on this tricky deal. Why is it tricky you ask?

Long Time to Build?

Well of course silly, it is tricky because it takes 10 years to build a nuclear power plant... WRONG. It takes 54 months, at least for AECL on Qinshan Unit 1 in China on December 31, 2002. That is first-concrete to full power. So where does this 10 year number come from? Well it actually takes 10 years due to environmental assessments, town hall meetings, filing paperwork with the government, go to court against Greenpeace or WWF, having to redo the environmental assessment (come to same conclusion), redo town hall meetings, re-file paperwork, have a change in government so NDP or Liberal party who cancels/restarts project, have a union strike, go to court again against Greenpeace because on form 456578903 you forgot to cross the "t", re-file paperwork, have laws changed, etc...

I hope you have gotten the picture by now. Long schedule and high budget for nuclear does not come from the technology, but rather the cumbersome overburdening process that is continually forced by various special interest groups, who then argue that nuclear costs too much and takes too long. So what do countries do? They turn to coal.

How Much Nuclear Can the Grid Handle?

So now that budget and scheduling of nuclear has some truth put to it, I guess the anti-nuke crowd needs a new argument--they may try to argue that you cannot have too much nuclear on the grid because it cannot load follow. This argument is hogwash. France has 80% of its electricity generated from nuclear and it load follows quite well, why pray tell? Well nuclear power can actually generate power in the range of 60% to 100% of capacity, but of course the bean counters want to run at full tilt. Theoretically then, nuclear can economically provide 100% of a country’s power. Nuclear is meant to run full tilt all the time, base load, thus it would be advisable to have supplemental generating sources, like coal or natural gas, for peak demand (on a hot summer day for example). Load levelling can help with this issue, by pushing energy consumption from the day into the night, and thus have a more level energy demand.

This is where things like hydrogen or electrical cars could fit in nicely. Use the excess energy from nuclear at night to produce hydrogen or re-charge electric cars. I will not get too futuristic on you, but I will mention that CANDUs are not only good at producing electricity, but they can also be used for desalination plants (making fresh water from salt water), hydrogen generation, utilising spent fuel from US or French reactor designs, utilising actinides and greenhouse heating (done at Bruce in past) just to name a few.

So now with the anti-nukes are biting their nails, and wondering 'boy what is left to scare people about?', this leads us to nuclear waste, or as the industry likes to call it, "spent fuel" .

Spent Fuel?

Spent fuel is exactly what its name implies. For CANDU reactors the fuel stays in the core for about 1 year, it is the removed through online fuelling, and deposited into the storage bay (large pool), after 10 years they move it to dry storage. To date, in Canada all spent fuel from all CANDUs are kept on site and are continuously monitored. Now that may sound scary, but let me give you 2 images:

40 years of spent fuel generated in all of Canada from 22 CANDU reactors is equivalent in volume as a soccer field pile 6 feet high.

The city of Toronto generates an equivalent amount of garbage to Canadian spent fuel is a single day.

Now you might all be thinking of that episode of the Simpsons when Mr. Burns pushed a barrel of radioactive waste into a tree trunk (don’t forget the squirrel with laser eyes). Now that is incredibly inaccurate, because not only does spent fuel not go in barrels, it is also not a liquid. Spent fuel looks exactly the same as fresh fuel, see figure. Every bundle is numbered, tagged, and it's location is known, and continuously monitored.

For some reason this is thought of as being scary, so let me make a comparison between spent nuclear fuel and municipal waste:

Spent fuel comes in solid metallic bundles, which is eventually stored in concrete leak tight multi-layered containers, and are monitored regularly. Containers don’t corrode or react with the environment, and if they did they would be replaced (remember they are monitored), or

Municipal garbage is anything and everything you throw into your trash (paint cans, used chemical bottles, batteries, food, metal, etc.) that is brought to a landfill and just dumped. It sits there for a prolonged period of time decomposing and reacting with whatever is around. Heavy metals leech into the ground, along with other chemicals.

One of these we regard as dangerous, the other is perfectly safe common practice. So which one is safe? I’ll leave that up to you to figure out, but I will say this; I would rather live near a spent fuel storage facility then a garbage dump.

I should also mention, that the reason spent nuclear fuel should not called waste is because the it can be reprocessed to produce additional fissionable material which can be extracted and re-used.

Summary

We have all been lead to believe that nuclear power is a big bad scary demonic technology that can only do harm. Thanks to the likes of Greenpeace, WWF, David Suzuki Foundation, and many other special interest groups, and due to their tireless efforts, and war on nuclear for 30 years now, they have accomplished a great feat. This is causing the construction of many dirty coal power plants around the planet that emit large quantities of air pollution. They have systematically blocked, cancelled, and prevented the expansion of nuclear power. They have subsequently caused the industry to superfluously increase safety standards (to a point that some may call ridiculous); blocked, prolonged, and took companies to court over environmental assessments, town hall meetings, and general paperwork; all which of unnecessarily add to capital costs.

Nuclear power is safe, clean, and generates cheap constant electricity. It is essentially the exact opposite of what the current mainstream public thinks about it. There are many other added benefits, and of course the above could be expanded upon greatly, which I will leave to next time, otherwise I won't have an excuse to come back and write in Kent’s Blog.

Up and Atom,
Laszlo Zsidai

The Alternatives

2008-05-24T17:23:00.021-06:00

In recent days we've seen oil prices top $135/barrel. The market has begun to show a negative response to such high prices. Major airlines announced major cutbacks in staff, flights and effectively hiked prices. The Ford Motor company (NYSE:F) has announced that its bid to become a profitable company again won't happen until 2009 and that it would change its 'focus'. According to its annual reports, Ford's Automotive division has not turned a profit since before 2002. General Motors (NYSE:GM) shares hit a 34-year low (that's without adjusting for inflation).

Consumption data has yet to show an actual reduction in demand but with projected reductions associated with these types of announcements, it appears as though oil prices may come down at the expense of the U.S. economy. America needs to close the gap on its energy deficit. And soon.

Why hasn't the United States opted for Energy Independence earlier?
It pretty much comes down to cost. The financial cost of oil in the last century was so low that exploiting this allowed the economy to grow at a rate much higher than it would if more expensive renewable energy sources were used. For example, running a car on corn-based ethanol is much more expensive than running it on gasoline when you look at the overall costs. It also costs money to improve fuel efficiencies--few people will pay the extra cost of a hybrid because it simply doesn't pay out (this may change in the near future). American policymakers obviously didn't anticipate how quickly oil prices would rise otherwise they would have done more. Some did have this foresight, but for the rest of us, 'hindsight is 20/20' sums it up.

How do we measure energy cost?
There are several ways to do this. One very good indicator is Energy Returned on Energy Invested (EROI or EROEI). It's basically a ratio of the energy produced by a particular energy source to the energy required to produce it. Think of it as a rough indicator of how much it will cost to produce one gigajoule of energy (higher number=cheaper cost). For example, in order to get gasoline, an oil well needs to be drilled, produced and the products refined. All of this takes energy, but for the case of oil, the energy output is about thirty times the energy required to get it out of the ground and produce it. High-quality (high EROI) oil reservoirs like the supergiants are the first to be exploited. As these become depleted, oil prices go up, which leads to lower quality (lower EROI) reserves like the oil sands being exploited. The key to this is that for non-renewable energy sources, EROIs always trend downwards and energy prices trend up. The following table lists rough estimates of the EROI for different energy sources.

Why is hydrogen negative?
Hydrogen is not a potential energy source. It is a potential energy carrier like electricity. It can potentially be used as a transport fuel but because of thermodynamic energy losses (nature's inefficiencies), some energy is lost in the process. I have heard some claims that cars can run on water. There are only two ways that a car will be able to 'operate' on water:

The car has some sort of very advanced 'charger' device. You fill it with water and plug it in overnight and it splits water molecules into its elemental hydrogen and oxygen via electrolysis, and stores it in a tank for use by a fuel cell device while driving. The technology to do this isn't competitively priced yet and associated electricity costs are high.

The laws of thermodynamics are wrong.

More than 90% of industrial grade hydrogen is currently produced by ripping the molecule from natural gas. This method is much more economic than using electricity to split water, but it obviously doesn't reduce the need for fossil fuels.

What about plant-based ethanol fuels?
It's currently debated whether or not corn-based ethanol can net more energy than it requires to produce it. Even if it does, it's unlikely to make America energy-independent given such a low rate of energy return. It took Brazil 30 years to get to the point of using subsidy-free cane-based ethanol, which has a much better rate of return than corn does. Technology improvements will help improve the EROI but this will take years to do. And as we've seen, the huge farming areas required to produce transportation-grade ethanol can also lead to food shortages.

So what is the solution?
Most experts agree the future of energy will need to include some sort of balance between 'all of the above'. Wind and solar are still developing technologies and they have constraints that won't allow them to meet more than 20-30% of America's energy needs. For example, if the sun isn't shining, you won't produce any electricity with solar--this may be okay in some instances, but not if you're using it to heat your home. The other problem is that energy sources that generate electricity can't be used as transport fuels yet because electric and hydrogen fuel cell vehicles are still 15+ years from being competitive on the market. The Chevy Volt looks promising, but they had to go back and redesign the lithium-ion battery (they had some issues with fires, explosions and such). It appears the only solution for Americans right now is to improve fuel economy standards and eliminate unnecessary driving.

What else can be done?
The policymakers need to look at the 'big picture'. If fossil fuels are conserved for applications in which there currently no feasible alternatives (primarily transportation), then the price of crude will come down. For example, heating oil and natural gas is used to heat many homes in America. This is the most efficient way of heating a home, but the simple alternative is electricity. The cheapest way to get electricity without the use of hydrocarbons is nuclear (in terms of EROI, hydroelectric is better but it is effectively maxed out). Nuclear is also the only proven technology that is 'market ready'. Nuclear may have some legitimate concerns, but for some reason it is no longer considered 'green' despite the fact that it has essentially zero emmissions. Plans are currently in the works to build a nuclear plant to power energy-intensive Canadian oil sands projects. The oil sands require steam for oil extraction, and hydrogen to upgrade heavy oil to lighter 'synthetic' crude, both of which are well suited for nuclear power plants. Currently, we are using natural gas for this. I think I'd rather save natural gas for the barbecue.

Next up: guest writer Laszlo Zsidai will give us some of his perspectives on nuclear from his experience in the industry.

Additional reading:

Indiana Senator Lugar's answer to $100 oil

Wake Up, America...

"It's the flows, stupid!"

The American Half-Trillion Dollar Problem

2008-05-19T20:35:00.003-06:00

As I primer to this section, I must note two things.

I'm not an economist nor do I have much academic training in economics.
I'm not an alarmist--I did not buy any candles, canned foods or bottled water in the days before Y2K; I took the Spadina streetcar (unmasked) during the SARS outbreak in Toronto; and I didn't think that World War III was imminent on September 11^th, 2001.

That said, I do think the U.S. crude oil trade deficit numbers are quite alarming. In this post I'll try to explain why.

What's so Alarming?
The U.S. is the third biggest producer of oil in the World. Most people don't know this because it's overshadowed by the fact that they are also the World's largest consumer of oil (they use 23% of global production). The difference is a 15.5 million barrel a day trade deficit. The worst part about this is is that with declining domestic oil production, rising prices, and relatively stagnant demand, the problem seems poised to get considerably worse in future years and there's no end to the problem in sight. Below is a chart of domestic (United States) crude oil production.

As you can see, production peaked in 1970 and spiked again in 1985 due to heavy investment initiatives following the 'oil crisis' of the early seventies. With the subsequent decline, despite record prices, is a clear that as a whole, oil production in the United States is in the late stages of Secondary recovery and in many areas Enhanced Oil Recovery (EOR). This means higher production costs for lower recovery rates. Few areas on American soil remain unexplored (Alaska for example still has some potential). This declining trend is not going to miraculously reverse itself, and the crude oil trade deficit will likely only widen.

Why didn't Government do anything?
What's clear is that the Bush administration realized not only that the US was "addicted to oil", but also that this could present a serious problem for the future. In their defense, I'm not sure anyone anticipated such high prices at this time (NYMEX CL:$127/bbl on May 19, 2008). One thing Bush's administration did was to push the development of "clean coal" technology knowing the abundance of domestic coal supplies. Secondly, they banked on the idea that Enhanced Oil Recovery projects could somehow stop the declines of domestic oil supply by subsidizing these projects. Recall in my last post (How High Will They Go?) I used the analogy of drying clothes to illustrate how much more difficult and expensive it is to remove the last bit of fluids from mature reservoirs. I now see advertisements on US television networks noting that the United States has plenty of domestic oil reserves to meet demand. While there is still plenty of domestic oil, it won't be coming out of the ground quickly or cheaply. I'm not sure who paid for these ads but it could have been the Independent Petroleum Association of America (IPAA) who are looking to get more government subsidies. Bush has repeatedly begged OPEC to raise quotas to no avail, but Saudi Arabia has recently agreed to raise production by 300,000 barrels a day. This could help bring down prices a bit in the coming days.

Didn't the U.S. invade Iraq to secure supply?
Haha. Well, many people certainly believe this, but I will try to avoid the controversy of this claim and just state the facts. The stated reasons for the Iraq War were weapons of mass destruction (before) and humanitarian causes (after). It could just be a coincidence that Iraq also has the second largest volume of proven conventional oil reserves in the world at 112 billion barrels. Still, I can't think of a good explanation why former Secretary of Defense Donald Rumsfeld had a change of heart after cordial meetings with Saddam Hussein in this 1983 video from the National Security Archives. Regardless of the reasons, even if oil security were the true goal of the war in Iraq, then it undoubtedly failed in this regard. Iraqi oil production is down about 400,000 barrels a day since the start of the war. Prices have gone up steadily since news of the war broke, and instability in the region is now much higher than it was under Saddam Hussein. An very recent op-ed in the Boston Herald has some more perspectives on this (link).

How big is the problem?
At the oil prices of the last century, the deficit wouldn't present too much of a problem other than during the oil embargo years. Now, it adds more than half a trillion dollars to the trade deficit each year (assuming a very conservative oil price of $90/bbl). Perspective: US$500 billion is about the same as total annual U.S. military spending! And it means indirect funding of countries like Iran and Sudan, who sell their oil to other countries at near-market prices. The chart below shows the monetary deficit in inflation-adjusted 2007 US dollars (with consumption and production rates plotted on the right axis as areas). It is only plotted up until the end of 2007. If oil prices average $120 a barrel in 2008, Americans will be paying US$1.8 billion a day in exchange for foreign oil imports. Thankfully Canada will get to add nearly 20% of this to its GDP.

Consequences?
I would liken it to a huge battleship going full speed and then having a giant anchor thrown overboard. Initially, it may have enough momentum to keep going for awhile, but unless action is taken quickly, it will slow and come to a dead stop. Some of the more pessimistic economists I have heard claim the American economy is in worse shape for the future than it was at the start of the great depression. I personally don't see this level of severity because with 25% of the world's oil consumption, a recession alone should reduce demand enough to bring down oil prices. Another saving grace is that many of the international oil and gas corporations are American, which means they will bring some of this deficit back into the country in the form of profits.

What next?
Well, certainly dwelling on the past won't do anything. But solutions need to be found, and quickly. Next up is a look at America's energy options for the future. Keep it locked..

How High Will They Go?

2008-05-16T22:06:00.001-06:00

Crude oil prices, like many other commodities, are traded on world markets. This of course means that the prices are set by a balance between supply and demand. Markets fluctuate, and at any given time oil can be overvalued or undervalued, but over time the market will correct and average itself out. This is one of the the basic macroeconomic principles for ideal conditions, and historically, it has worked relatively well.¹

In order to predict oil prices, one has to comprehend the supply/demand balance.

Demand
In general, economists can assume that world demand is mostly independent of price. This is normally a good assumption because people will always need to heat their homes, transport goods, move people, and so on. Given this assumption, it's just a matter of forecasting global economic growth and the corresponding crude oil requirement for that growth. The assumption can fall apart under excessive prices, in which case we can do a price forecast and estimate demand accordingly. Either way, predicting demand for oil is a walk in the park compared to predicting the supply of oil.

Supply
I would say there are three major factors when it comes to oil supply: Reserves, Recovery rates and Geopolitics.

Reserves
Estimating how much oil there is thousands of meters below ground is at best pseudo-science. Especially when those reserves are beneath a seabed hundreds of metres offshore. Seismic technologies can give us a decent initial guess of the volumes in place. Once an exploratory well is drilled, a considerably improved estimate can be obtained using established logging, coring and testing techniques. Many areas in the world have not even been explored yet, but even if exploration in these areas began today, its oil would take over 5 years to hit the market and have no impact on short-term supply.
Rates and Recovery
Even if we did know exactly how much oil there is in the ground, this tells us nothing about how quickly we can get it out and at what cost. Virgin reservoirs are typically produced in three stages:

Primary recovery. Virgin reservoirs are at high pressures and produce at high oil-water ratios (lots of valuable oil, not much invaluable salt water). Some wells are termed 'gushers' because they initially flow without even being pumped. Eventually though, external energy is needed by pumps to continue the recovery process.
Secondary recovery. As pressure decreases over time, pumping alone may not be sufficient to keep the well flowing economically. Fluids are injected into the reservoir to maintain pressure support (most commonly produced water). Most of the recoverable reserves are recovered at this point and at a relatively low operating cost.
Tertiary recovery or Enhanced Oil Recovery (EOR). Eventually, the produced fluids are virtually 100% water with very little oil. The properties of the reservoir itself must be altered in order to unlock the residual oil trapped in the pores of the rocks. Any combination of steam and/or surfactants and/or other chemicals are injected into the reservoir to achieve this favourable alteration. Operational costs are high and recovery rates are low compared to primary and secondary recovery.

A useful analogy to the recovery stages is that of of drying clothes while doing laundry. No analogy is perfect of course but I think this one illustrates the important points quite well. I'll be coming back to this in my next post so I want to make sure it's clear. Click here to see the analogy.

Geopolitical Stability
There are many regions of the world that have plenty of reserves with very favourable recovery conditions that have yet to be tapped. Many of the untapped reserves are also in places with high geopolitical instability. Not only can this interrupt supply, it deters investment and also creates a 'fear premium' on the price. Even in politically stable areas, oil exploration can be restricted for both social and environmental reasons.

Do the fundamentals support the current prices or not?!?
This is still the subject of much debate. Here are the three basic perspectives:

Oil is overpriced. This group of people think the market is well-supplied and high prices are mostly due to a very large geopolitical risk premium added to the price by speculative traders. Given the rapid rise, the price escalation is a bubble that will ultimately burst in the form of a market correction. They believe new discoveries and technology will help supply meet world demand for the next 40 years or more.

Support: An article last month inferred that oil prices rose after news that pirates attacked a Japanese oil tanker resulting in "hundreds of litres of oil" being spilt. To put that into perspective, 1000 litres of oil is less than one hundred thousandth of a percent (0.00001%) of daily world crude production. There's absolutely no reason something that small should effect prices. Also, check out Wall Street's crude ways by David Weidner of MarketWatch.

Oil is relatively well-priced. These people are what I would call the moderate "peak oil" theorists. They believe that while reserves are plentiful, geopolitical risk and depletion of high-quality reserves will keep the prices high indefinitely. Soaring demand from China is believed to be the single largest reason for the increase under this schema.

Support: Demand from China has increased and average of 7% each year since 1991 despite higher prices. If the existing trend continues, China's consumption will surpass that of the United States by the year 2024. Click here to see a supporting chart using data from the U.S. Department of Energy.
Oil is undervalued. Hard line "peak oil" theorists fall into this category. Most people in this group believe tat world oil production has essentially already peaked and increasing demand will only increase price. Many believe reserves and recovery rates have been largely overstated by the industry (in order to encourage investment). Publicly traded companies are regulated by agencies such as the Securities Exchange Commission, which has rules to minimize this overstatement risk. National oil companies are generally regulated by the fact that foreign investors usually require confirmation of good reserve estimating practices by external auditors. Saudi Arabia, the world's biggest oil producer, is an exception because Saudi Aramco doesn't trade on any public markets nor does it require any foreign investment to operate.

Support: Royal Dutch Shell overstated its reserves by about 23% in 2002, and were subsequently fined $150 million by the SEC and it's British counterpart.^* Although this was the highest-profile case, there are other examples of proven reserve overstatments. Dr. Jim Buckee, former CEO of Talisman Energy Inc. has said that peak oil is 'here or hereabouts'* and thinks oil will get to the $150 to $200 a barrel range before it will have any impact on demand.

What's my personal position on oil price?
Personally, I'm undecided. I think the days of $40 oil are certainly over, but I'm not yet convinced the excessive rate of increase is warranted. Given the rapid rise in prices, I don't think the market has had enough time to respond yet if a reduction in demand is imminent. The other factor that is rarely mentioned is the recent trend of oil nationalisations. Russia and Venezuela are two of the world's biggest oil producers that have nationalized their oil so far this century. The bigger piece of the pie being taken by these governments is ultimately being passed on to consumers in the form of higher prices. Less imperative but worth noting in this regard is Alberta's recent royalty rate increase.

I guess this would put me somewhere between perspective (a) and (b) with a bias towards the latter. I'm not investing directly in oil at these prices, although I would have in 2006 when prices were well below $70/bbl (I didn't have the capital).

My next post will be on the U.S. economy. As a consumer of 25% of the world's crude oil production I don't think we can ignore the status of the U.S. economy when it comes to predicting demand and subsequently price. As always, stay tuned..

Notes

I've never taken a course in economics so please correct me if I said something that would offend the founding fathers of economic theory.
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Gas Prices

2008-05-12T19:41:00.010-06:00

In May of 2005, I remember wondering how gas stations would display their price when it hits the century mark. A couple months later I was watching images of Hurricane Katrina on CNN. The damage to billion-dollar oil platforms in the Gulf was enough to push gas prices from 90 cents a litre to well over the century mark. At first, many gas station displays showed 00.0, but it wouldn't take long for gas stations to put in the capital and upgrade their signs to be capable of showing prices north of the 99.9 cents per litre mark. Apparently they realized these prices were the new norm.

Why are gasoline prices so high?
Crude oil prices.

The price of oil on NYMEX at the time of writing is $126 a barrel (May 9, 2008). That's about double the price a year earlier and will ultimately translate into an average gasoline price of about $1.32/L in Canada and $3.78/gallon in the U.S. (I expect prices at the pumps to be in this range entering the long weekend).

The chart below shows normalized crude oil prices compared to normalized gasoline prices in real Canadian dollars from January 1987 until May 2008.

large size

(you will need a Google account to access the source link)

As the chart shows, the price Canadians pay at the pumps has actually lagged quite a bit behind the crude oil price since 2004. The break is mostly thanks to the increased value of the Loonie compared to the Greenback (American gasoline consumers are not as fortunate in this regard).

What about price gouging right before long weekends in the spring?
This is probably due to speculative commodity traders. In anticipation of higher demand, they buy more oil and the price gets to consumers before the demand is actually there. An energy analyst I heard on CBC the other day said there is no evidence of any price gouging. I haven't seen any conclusive numbers myself that would either confirm or deny this claim.

Would boycotting gas stations help?
Yes and no. Reduced demand means improving the supply/demand balance and subsequently lower prices. But reducing demand doesn't seem to be the objective of the "boycott oil company X" initiatives I've seen on the Internet and in emails. This strategy will not work unless a significant number of people actually reduce demand and not just buy gas from somewhere else or wait until after the weekend to fill up. Toronto is the largest Canadian market and has the lowest gasoline prices in the country thanks to the so-called 'gas wars'. Torontonians pay even less on average than Calgarians who save about five cents per litre in lower provincial gas taxes. Smaller, more remote regions such as Halifax are amongst the highest in Canada. This is a pretty good indication that free-market competition forces are working as they should.

sourced from Natural Resources Canada

Can we petition government to put a cap on prices?
Sure we can. But I don't think this is a good idea. Part of the reason oil prices are so high is because of increasing demand from China, an emerging economic power that subsidizes its oil price to stimulate growth. China's economy can afford the higher price mostly because per capita consumption is only about 1/6^th of a barrel of oil per month. Here in North America, each of us use over 2 barrels per month. The approach makes sense for an emerging economy like China's but for the established economies of Canada and the United States it's an unsustainable Band-Aid approach.

In Canada, the taxes on gasoline at $1.25/L range from 25 cents to 40 cents depending on the province [detailed breakdown]. Most of these taxes are dedicated towards transportation infrastructure. Ultimately the question becomes who is going to pay to repair roads and bridges under a tax holiday or even a price cap. The most likely answer is taxpayers. Tax shifting can be good policy but I don't see why it would be in this instance.

Canada has a lot of oil and gas. Why are we selling so much of it across the boarder with such high prices?
We are essentially committed to free market prices under international free trade policies such as NAFTA. In 1980, the Trudeau government decided to regulate prices in with the National Energy Program. It was not very popular in the west and polarized the country. With tens of billions of dollars lost from the Alberta economy,^[*] I don't think we'll see a repeat of this policy anytime soon.

How high will crude oil prices go?
Stay tuned. I'll discuss this in my next post.