Thursday, June 29, 2006

The Future of Oil

Graph 1. A forecast of oil prices, courtesy of the World Bank.

Graph 2. The price of oil by year in constant 2004 US$ since 1970. (Source, BP Statistical Review of World Energy June 2006).

Right now the price of crude oil is close to historic highs, and is fueling inflation. A swirling group of related issues, long ignored, have come to the fore. They are all related but not the same. They include energy independence, CO2 emissions, and the effect on the economy of high energy prices. I’m wary of wading into this topic, but I have an insight that I haven’t seen expressed anywhere else. (That probably means that I’m wrong, but I’ll toss it out there and let the world decide.)

One of the issues that has been discussed is that the price of gasoline is affected by the fact that refineries in the U.S. are running at full capacity. Any hiccup in that production capacity, such as a hurricane, will cause gasoline prices to spike. No new refineries have been built in decades, and the excuse offered by oil companies is the cost of environmental regulation and NIMBY attitudes. Obviously regulation has cost, but this seems disingenuous to me. The way to look at a refinery is to consider what it takes to build one. It takes a huge amount of capital and many years worth of time. That, I propose, is the main reason why oil companies don’t want to build refineries.

Let’s say it takes 10 years to build a refinery and costs billions. An oil company starts building now—why not? They have lots of cash, and right now a new refinery could generate a lot of income. But what about 10 years from now? Well, let’s look at what the World Bank says will happen to the price of oil in 10 years. (See Graph 1 above) This is from a report prepared April 28 of this year.

You can see the problem. In 10 years, the price of oil will be significantly lower than it is now. The investment that looked great suddenly looks like a loser. Now the World Bank is just making a forecast, and they have some smart economists, but forecasts are inherently unreliable. They depend on knowledge of future events that no one has.

On the other hand, knowledge of the past is absolute. If we can expect oil prices in the future to behave as they have in the past, it makes any plan based on long-term high oil prices seem fairly foolish. This is because the price of oil has been very volatile since 1970. (See Graph 2 above.)

Some say that the price of oil will never drop again, at least not significantly. They point to Hubbert Peak, the idea that we may be near the peak of oil production for the world as current fields are depleted and new fields become more difficult to find. They point to the oil-hungry-economies of India and China, both of which are growing rapidly. These two factors, as well as political instability in oil-producing nations and other factors, will push the price of oil up. But there will be downward pressures as well. After the 70s, vehicle efficiency improved markedly in response to high oil prices, and other efficiency measures also helped. (Conservation has a bad rap—Cheney famously dismissed it—but in my mind, conservation is efficiency.) Also, high oil prices encourage additional exploration and production of oil, as well as additional energy production from non-oil sources.

So oil prices will continue to be pushed up and down at the same time. The World Bank believes that downward pressures will outweigh upward pressures in the near future.

So we come back to the refinery problem. I used refineries as an example, but the principle is the same. Let’s say instead of refineries, we want to discuss hydrogen fuel cells. The cost of developing a useful hydrogen fuel cell and bringing fuel cell vehicles to market, along with the infrastructure to support them, will be enormous. And it will take a long time. So investors in this technology are faced with the same problem that oil companies are faced with when they consider building a refinery. What happens to our multi-billion dollar investment if the price of oil is $15 per barrel when the hydrogen fuel cell car factory goes on-line? The same issue faces almost all alternative energy schemes, as well as the production of oil from exotic sources like oil shale.

In other words, the volatility of oil prices prevents the capital investment in projects that could—in the future—mitigate oil consumption. That guarantees that oil shocks will continue to happen and have negative effects on the world economy (not to mention the environmental consequences).

So how can we break out of this cycle?

There are two ways, and both require direct government intervention. First is for the government to directly invest in these capital projects. The idea of a refinery owned by the government is pretty laughable, but governments do own power plants and dams, so there is a precedent for the government being in the energy business. Still, it’s hard to imagine this flying in today’s market-worshipping climate. Government could spend more on pure research, though.

The other kind of intervention would be through government policies that encourage private investors to make these capital investments. This could be achieved by subsidy, taxation, and/or regulation. For example, if CAFE requirements were ratcheted up, auto manufacturers would be forced to create more efficient cars, or cars that didn’t require gasoline to run. Or if a tax were placed on gasoline that would keep it at a minimum price of $4/gallon (inflation adjusted) indefinitely, the hydrogen fuel cell entrepreneurs and their moneymen might feel confident in investing in the hydrogen R&D, plants, and infrastructure. Even though it would take years to make a profit, with a guaranteed floor on the price of gasoline, they could at least be certain that the rug wouldn’t be pulled out from under them.

But taxes, regulation, and government spending aren’t popular. The oil industry—which is politically powerful—would scream bloody murder if gas taxes were increased. But I believe they are necessary to create an economic environment where more efficient use of fuels and development of energy alternatives can be encouraged.

In the 70s, Brazil—hit very hard by OPEC—launched a program of ethanol production from sugarcane. After the price of oil declined in the mid80s, Brazil had to endure ridicule for their super-expensive, government-subsidized sugar-fuel. The Economist, as I recall, was especially derisive. They believed—correctly—that the problem of high oil prices would be solved by the market, and they were. For a while.

But now Brazil seems especially farsighted. They subsidized ethanol during the years when oil was cheap, which allowed the industry to mature there. Now, when they really need it, it’s there. The research has been done and the infrastructure has been built. And, amazingly, Brazil has become a net exporter of oil.

We need this kind of long term approach to energy in this country. When the price of oil drops, as I believe it will, we can’t just sit back and say, “Problem solved.” That’s what we did from 1986 until now, and we’ve been caught with our pants down. Again.


Tuesday, June 27, 2006

I Am The Hulk

...according to this superhero personality test.


Read With Caution

Especially when newspapers or magazines are writing about business or economics. I've mentioned before how the concept of "reserves" are widely misunderstood when the media reports about accounting scandals. Brad Delong has another great example of not getting it on his blog. It traces a statement by economist Gregory Mankiw about outsourcing from the source to the Washington Post to various politicians' responses. Mankiw's idea is fairly subtle, and doesn't get transmitted well--and hell subsequently breaks loose.


Monday, June 26, 2006

Chainsaw Al Massacres Shareholder Value

The summer reading continues with another quickie, Chainsaw by John A. Byrne. Not really a biography of “Chainsaw” Al Dunlap, it only covers his Waterloo—Sunbeam. Sunbeam, which eventually declared bankruptcy after Dunlap finished with it, in one of the notorious accounting scandals of recent times. Financial Shenanigans fell back to Sunbeam for examples of financial chicanery many times—they were guilty of nearly every trick in the book. The particular thing that brought Dunlap down seems almost quaint to describe—recording revenue early and/or recording revenue of dubious quality. What this meant was that Sunbeam “sold” its customers (big retail chains) months worth of inventory, warehoused it for the customers, and gave them absurdly liberal payment and return options. This allowed the company to book sales months (and even a year) before they could ever hope to actually get paid—if they got paid. The retailers could “return” the unsold merchandise (which would mean just transferring ownership, since they hadn’t taken possession of the merchandise in the first place).

Dunlap’s reputation was as a cost cutter who would come into a company, close down most of the factories, and fire most of the workers. Wall Street routinely applauded this type of behavior in the 80s and 90s, and still does to an extent. The idea was that these slash-and-burn executives were creating shareholder value. Just announcing that Dunlap had been hired pushed Sunbeam stock way up.

But Dunlap was a fraud. His modus was to create a company that looked good to Wall Street so that he could sell it and make a fortune. Whether the company was actually good—whether its present value was increased—was immaterial to Dunlap, who was a heartless, soulless, hateful, greedy, abusive, thuggish conman.

The idea of “shareholder value” was a backlash against imperial, conglomerate-building CEOs, and it was probably a necessary corrective. But wasn’t it obvious that if Wall Street suddenly started demanding short-term profit in the name of shareholder value, that locusts like Dunlap would “create” it for them? In fact, there are always two groups of shareholders; those who currently own the stock (or options), and those who will own it in the future. Dunlap’s scheme was to steal from the future owners and reward the present owners (especially himself).

Analysts and investors that rewarded Dunlap for every announcement of layoffs deserve scorn. The book makes clear that many plant-closings had negative NPVs. When one of Dunlap’s executives tried to point this out to him, he was snarled at by Dunlap. Dunlap didn’t care if actual value was destroyed—he only cared what the perception on the Street was. And, irrationally, the Street rewarded him.

Of course, he got his comeuppance. Still, he avoided the jail sentence that he so richly deserved.

Chainsaw is an excellent book, and one that is good to read with more technical books like Financial Shenanigans and Infectious Greed.

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Sunday, June 25, 2006

A Foreign Affair

I just finished Alan Furst’s latest, The Foreign Correspondent. Furst is the author of several books dealing with espionage before and during World War II. The novels are generally unrelated, although Furst provides little touches of continuity as characters and locations from previous novels are sometimes mentioned in the current novels. The Brasserie Heininger, scene of an assassination in Furst’s first novel, always shows up with characters sitting under a mirror that still has a bullet hole from that night.

Carlo Weisz is an Italian émigré, a reporter for Reuters working in Paris in 1938 and 39. He also is the editor of an underground anti-fascist newspaper Liberazione, and both of his jobs put him in contact with spies from all sides of the conflicts that exist and the conflicts to come. The New York Times review complained of the lack of moral ambiguity in Weisz and The Foreign Correspondent, comparing it unfavorably in that regard to the novels of Graham Greene and John LeCarre. This is not a completely fair criticism because there are several moments when Weisz is presented with choices for actions which may lead to the people’s deaths. But the reviewer had a point—Weisz is an uncomplicated protagonist who wants Italy to be free from fascism and the woman he loves to be safe.

Carlo and his fellow émigrés produce plates in Paris, which are smuggled into Italy, printed, and the papers left in public places. The distributors are primarily teenage girls—a class least likely to be suspected by ORVA, the Italian secret police. Weisz becomes editor after the previous editor is assassinated by ORVA.

As war with Germany becomes more certain, and especially after Italy and Germany formally ally themselves to one another, the Sûreté and the British secret service become more interested in Liberazione and Weisz, each approaching him in very different ways. Why should they be so interested? Many reasons, not least is that publishing this clandestine resistance newspaper is part of the war to come, and any given copy is as important as a soldier’s bullet.

Furst makes this clear in one segment where he describes the production and distribution of the paper, from the delivery of the plates to its being read by a particular reader. In this case, the reader is a police lieutenant. He knows one of his men has brought it into the station, but doesn’t know which one, and not being a true-believer himself, doesn’t try to find out. Besides, he likes getting news unfiltered by the propaganda writers who write for the official newspapers. He respects Liberazione and the people who produce it—smart, accomplished, important people, who could have stayed in Italy and been important and rich fascists, but chose to resist. They are the kind of people who might be running the show if the fascists are kicked out. Mussolini will falter eventually, after all. Given this, he decides not to arrest a pair of brothers who he knew had illegally purchased a rifle. Because when Mussolini does falter, the brothers might need their gun.

I loved this detail—an underground paper doesn’t inspire revolutionary action, but rather inspires a small act of inaction that might in the future inconvenience the fascists.

This is classic Furst. None of his characters are going to change the course of the war. They are all foot soldiers, whose actions are, at best, tiny tactical victories. And it is nice that in this case, his foot soldier against fascism is a writer and editor.


Saturday, June 24, 2006

Transfering My Blog to Bloggger

Instead of carefully archiving my blog entries by hand, I thought I'd let Blogger do it for me. A lot of my favorite blogs use Blogger, so I decided to give it a try.

Since I haven't done that many entries in my blog, I'm going to paste the old ones here so they'll be archived here as well.

June 15, 2006

I'm catching up on my reading, and I just finished a good one that has been sitting on my shelf since spring. It's Financial Shenanigans by Howard Schilit, president of the Center for Financial Research and Analysis. It is a very readable step-by-step guide to detecting fraud by reading financial statements.

Most of the big corporate scandals in the past few years have been in one way or another accounting scandals. Either accounting was the primary method of committing fraud, or else accounting was used to cover up other malfeasance. Schilit identifies seven "shenanigans" and the ways they are typically performed. They are:

1. Recording revenue too soon or of questionable quality
2. Recording bogus revenue
3. Boosting income with one-time gains
4. Shifting a current expense to a later or earlier period
5. Failing to record or improperly reducing liabilities
6. Shifting current revenue to a later period
7. Shifting future expenses to the current period as a special charge

All of this has to do with accounting arcana, which is what makes these kinds of scandals so opaque to the public. The public understandably doesn’t understand what's been done, much less how anyone was hurt by it. One misunderstanding that one sees in newspapers occasionally is what a reserve is, and why not having one or underestimating one is bad. The impression given is that reserves are actual money--rainy day funds to pay for future litigation or bad debt.

That's why a readable book like this is useful. It really goes into accounting detail, and explains what the various financial statements are, and how to read them. It gives lots of examples of specific companies caught engaging in specific shenanigans. (Some, like Sunbeam, seems to have engaged in about every kind of shenanigan possible.) He always shows stock price graphs so one can see what the result is to equity when the chickens come home to roost. (He also uses the graphs as a way to brag on the CFRA's ability to see trouble early. They always seem to issue warnings well before the shenanigan is discovered. But, Cassandra-like, their warnings are ignored by investors. If their record at detecting shenanigans is so good, you would expect stock prices to drop every time they issue a warning on a company. Hmm.) Occasionally he offers a pungent detail or two on the company's story, but it would be better if he gave a little more--like this executive went to jail, or that executive was forbidden by the SEC to ever lead a publicly traded company again, etc.

I think this would be a good book for undergraduate and graduate business students, especially those interested in becoming analysts. Aside from giving a lot of practical advice, it would be an entertaining counterweight to the (let's face it) fairly tedious accounting textbooks that one necessarily has to read.

June 5, 2006

I started my internship at Cameron Compression Systems today. I'm basically to continue the work that our ALP team did, using statistical methods for the purpose of demand forcasting of large compressors.

My ALP team generally did well with their internships. Teammates are working at FMC, Intel, Lehmann Brothers, Waste Management, and McKinsey. Most of us are here in Houston, but Daniel Rojo is up in Colorado for the summer (lucky guy).

June 2, 2006

My favorite new website is The author of this site is Michelle Leder, a reporter who specializes in investing and finances. In, she reads proxy statements and SEC filings to dig up excutive compensation outrages. It's hilarious how brazen some of these guys are, and it must be supremely frustrating for stockholders who end up paying through the nose even for incompetent executives.

A typical entry was the one posted yesterday:

"What do you give a top executive who is being investigated by the company’s own board over "allegations relating to improper payments to foreign government officials" and suddenly decides to resign? How about a quarter of a million dollars? For the rest of his life.

"That’s exactly what’s going on at Pride International (PDE), which filed this retirement agreement with outgoing Chief Operating Officer John Blocker Jr. yesterday. Blocker, who was only named COO in January 2005, used to oversee the company’s Latin American operations. Though Pride hasn’t provided many details, a former employee has made allegations about bribes going back a number of years, which has prompted Pride to delay filing both its 10-K for 2005 as well as its first quarter Q."

OK, maybe Blocker isn't a briber. That's still to be investigated. Still, it's hilarious. Even more mind-boggling was this entry from May 24:

"Last year, when Radio Shack (RSH) announced that it had reached a transition/consulting agreement with Chairman and CEO Len Roberts that would pay him over $41K a month to provide advice for 31 months after he stepped down as Chairman and CEO, the stock was trading at around $33 a share.

"Fast forward to today, when the company filed Roberts’ actual agreement in an 8-K and you’ll quickly see that little has changed: Roberts will still collect $41.6K a month through December 2008 and Radio Shack will stay pay up to $100K a year to provide Roberts with office space and an administrative assistant. [...] But the stock price is down around 50%. [...]

"So given all of this, why is Roberts getting the same deal? And exactly what sort of advice will he be providing for that kind of money? Will the new CEO - whenever he or she is named - even want this advice that they’re forced to pay for? [...] But given the challenges the company faces as it tries to recover, it seems questionable as to whether this is the best use of investors’ money."

Most of the CEO compensation horror-stories one hears are about huge quantities of money and whether the executive (or anyone) could possibly be worth it. Or else they're about fraud, like the ongoing options-dating scandal. But what I like about this blog is that in addition to the above stuff, it details the humiliating payments a company has to pay to get rid of a bad executive--indeed, how hard they are to get rid of at all. Len Roberts is going to be hanging around for another three years, whether the new CEO wants him or not! Hah!

I highly recommend this blog.

May 29, 2007

Freakonomics is not what I would have hoped for, given the hype. It deals with a subject near to my heart: counterintuitive facts. The one in the book that has gotten the most attention was the notion that the drop in crime in the early 90s was caused by the legalization of abortion in 1973.

University of Chicago economist Steven Levitt doesn't really seem to use economic theory much in these examples. Instead, he uses statistical methods and data mining. Fair enough--maybe the book should be called "Freakistics," but whatever.

But what he doesn't do, and this drives me crazy, is take the reader through the solution step by step. I realize this is a popular book, but I want to know more about the data, the algorithms, and the statistical techniques. Instead we get a kind of "trust me" narrative. Levitt will say that when we did data mining on this database, we discovered "X." That is completely unsatisfying! At least to me. And I will admit that I'm not average reader: I like math and statistics and want to understand the myriad ways they are applied to real world phenomena. Still, even if I was reading a book about, say, farming, I'd want to know the "how" (in non-technical terms) as much as the "what."

The whole book comes across as written for the least common denominator--it doesn't make its reader work at all. The ideas are interesting, but without further explication, are interesting but unsupported claims. Levitt pats himself (and the reader) on the back for not embracing "conventional wisdom" (a term apparently invented by John Kenneth Galbraith. Who knew?), but the book is full of an equally pernicious kind of "wisdom," received wisdom. Without some better idea of how these results were derived, the book is just Levitt telling you some stuff, and you have to decide whether you want to believe him or not. There is no intellectual journey here.


May 28, 2007

Peter Gent is best known as the author of North Dallas Forty, but in 1983 he wrote another football novel, the completely demented The Franchise. According to Texas Literary Outlaws, this book was written during a period in Gent’s life when he was exhibiting some scarily paranoid behavior. This comes through loud and clear in The Franchise, which is a conspiracy-filled history of a new expansion team, located in the never-named city of Austin. The franchise brings in the coach and quarterback from U.T. (also never named) and starts towards their plan of building a Super Bowl team in three years. At first, the primary villain (among many) of the piece is Dick Conly, right-hand man to owner Cyrus Chandler. Conly is an amoral schemer who knows he’s smarter than everyone else. While he never really becomes a “good guy,” his alliance strategically changes to the good guys later on in the novel. Conly gets most of the best lines. For example:

“It’s about goddam time.” Conly lurched out of the chair and snatched up the crocodile briefcase. “Does the son of a bitch want to take a goddam bribe or not? I have important people to corrupt.”

The book is full of funny, awful, corruption like this. It’s amazingly bloodsoaked--James Elroy would envy the body count--and each outrage is certain to be topped by a later outrage. One can’t call it satirical because the picture it paints of the NFL is not remotely believable. But The Franchise is funny, twisted, and entertaining. It reminds me a little of Carl Hiaasen, but even more extreme. It wasn’t as good as North Dallas Forty, but still quite readable.

May 27, 2007

X-Men: The Last Stand got a mediocre review in Slate, but I found it pretty entertaining. There is a cure for mutants, and many of the mutants who dislike what they are are eager to get normal. If you use the gay analogy, the cure is like those "ex-gay" therapies. (It is shown to be totally like those therapies at the end, when you discover that it doesn't work.) The Beast makes an appearance, and Kitty Pride grows a bit more important. Weirdly enough, they kill off Cyclops, Professor X, and Phoenix. But since they killed off Phoenix last time, maybe they have learned the golden rule of comics: death is never permanent. Mainly, this one worked because it was full of action and clever special effects, making it perfectly mindless forgettable fun.

May 24, 2007

I recently reread The New Confessions by William Boyd. This is one of my favorite books, and rereading it is always a pleasure. That can't be said about a lot of books, even ones I liked a lot the first time around. The Baron of the Trees also has that quality, and they have an unusual connection in that each touches on the European Enlightenment.

The New Confessions is about a peripatetic English filmmaker whose career reminds one a little of Abel Gance here, Luis Bunuel there, with some D.W. Griffith, Fritz Lang, and Hollywood 10 thrown in. It is a credit to the imagination that Boyd can contrive a situation that allows an Englishman to inhabit all these roles. (He repeats this feat in Any Human Heart, but The New Confessions is the better book.) The series of unlikely events is far-fetched but basically believable. Rereading it, I find myself cringing at John James Todd's self-destructive inability to compromise. When I first read it, I admired that. That's one thing that makes this book great; the protagonist embodies these characteristics that are bound to strike one differently as one reads it over again.

John James Todd is not a monster, but he is careless and thoughtless, and hurts people he shouldn't. He's selfish in a very particular way (though not greedy). He is capable of generosity and even heroism. He's incredibly narcisistic. All these qualities make his life interesting, and the novel proposes that his strengths and weaknesses, his weird up-and-down life story are in the end unimportant; his masterpiece, a film adaptation of Rousseau's Confessions, is what counts. The New Confessions is a ringing endorsement of art. For a nonbelieving lover of beauty like me, it's an inspiring notion.

And yet... You read the book because John James Todd's life is so fascinating and moving. And the work of art that is the purpose of his life is, in the end, a fiction. We readers never will see The Confessions because it doesn't really exist. This is the irony of any book about creating great art. Boyd knows the irony is there and plays with it. I suspect he, like me, is a true believer in art. But he is too smart not to realize the problematic nature of writing fiction about art. This separates The New Confessions from, say, Somerset Maugham's The Moon and the Sixpence, an inferior book with a similar theme.

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