Saturday, June 2, 2012

Shale gas. The promised gas revolution can do the environment more good than harm

The amount of gas available is interesting. Aivars Lode
Jun 2nd 2012 | from the print edition

THE story of America’s shale-gas revolution offers hope in hard times. The ground was laid in the late 1990s, when a now-fabled Texan oilman, George Mitchell, developed an affordable way to extract natural gas locked up in shale rock and other geological formations. It involves blasting them with water, sand and chemicals—a technique known as hydraulic fracturing, or “fracking”. America’s shale-gas industry has since drilled 20,000 wells, created hundreds of thousands of jobs, directly and indirectly, and provided lots of cheap gas. This is a huge advantage to American industry and a relief to those who fret about American energy security.

The revolution should continue, according to a report published this week by the International Energy Agency (IEA). At current production rates, America has over a century’s supply of gas, half of it stored in shale and other “unconventional” formations. It should also spread, to China, Australia, Argentina and Europe. Global gas production could increase by 50% between 2010 and 2035, with unconventional sources supplying two-thirds of the growth (see article).

A number of things could prevent this, however. Many of the factors behind America’s gas boom, including liberal regulation of pipelines (which encouraged wildcat exploration by small producers), a well-aimed subsidy and abundant drill-rigs, do not exist elsewhere. Its sheer rapidity is therefore unlikely to be matched. A greater threat stems from environmental protests, especially in some European countries, which could kill the shale-gas industry at birth. France and Bulgaria have banned fracking. Greens in America and Australia (see article) are also rallying against the industry.

The anti-frackers have reasonable grounds for worry. Producing shale gas uses lots of energy and water, and can cause pollution in several ways. One concern is possible contamination of aquifers by methane, fracking fluids or the radioactive gunk they dislodge. This is not known to have happened; but it probably has, where well-shafts passing through aquifers have been poorly sealed.

Another worry is that fracking fluids regurgitated up well-shafts might percolate into groundwater. A graver fear is that large amounts of methane, a powerful greenhouse-gas, could be emitted during the entire process of exploration and production. Some also fret that fracking might induce earthquakes—especially after it was linked to 50 tiny tremors in northern England last year.

But the risks from shale gas can be managed. Properly concreted well-shafts do not leak; regurgitants can be collected and made safe; preventing gas venting and flaring would limit methane emissions to acceptable levels; and the risk of tremors, which commonly occur as a result of conventional oil-and-gas activities, can be contained by careful monitoring. The IEA estimates that such measures would add 7% to the cost of the average shale-gas well. That is a small price to pay for environmental protection and the health of a promising industry.

For as well as posing environmental risks, a gas boom would bring an important environmental benefit. Burning gas emits half as much carbon dioxide as coal; so where gas substitutes for coal, emissions will fall. America’s emissions have fallen by 450m tonnes in the past five years, more than any other country’s. Ironically, given its far greater effort to tackle climate change, the European Union has seen its emissions rise, partly because of an increase in coal-fired power generation in response to Europe’s high gas price.

Cleaner, but not clean enough

By itself, switching to gas will not reduce emissions to anything like the levels required to avoid a high risk of serious climate change. This will take much crunchier policies to boost renewable-energy sources and other clean technologies—starting with a strong price on carbon emissions, through a market-based mechanism or, preferably, a carbon tax. Governments are understandably unwilling to take these steps in straitened times. Yet they should plan to do so; and in the coming years cheap gas could help free cash for more investment in low-carbon technologies. Otherwise the bonanza would be squandered.

Tuesday, May 29, 2012

Banks Shrink From Counterparty Risk as Euro Crisis Rolls On

This happened in the USA back in 2010, I wonder if and when this will next happen and if it will be in the bricks? Aivars Lode

By Reuters
Tuesday, May 29, 2012

LONDON (Reuters)—Alarmed by Europe's latest debt crisis and its unpredictable outcome, banks are getting increasingly picky about who they do business with for fear of taking on risky exposures to rivals who could be about to be whipsawed by bad debts.

Greece's slow-motion crash towards default, coupled with the poor health of banks in Spain, have left banks wondering if any of their fellow institutions will end up holding catastrophic losses and will be unable to meet their obligations.

All banks then are becoming increasingly cautious about their dealings with counterparties perceived to be in the firing line — making it harder for those firms to do their everyday business, throwing grit into the cogs of the financial system and ultimately crimping prospects for economic recovery.

"Banks are particularly wary of counterparties at the moment and no compliance officer is going to take on exposure to a counterparty just because historically they have a strong track record," said Christopher Wheeler, an analyst at Mediobanca.

In the fast-moving banking sector, failures can happen quickly. Just ask anyone involved with MF Global, which collapsed overnight in October last year after clients and trading partners pulled back amid rumors of a trading loss in the European sovereign debt crisis. Three years previously, Lehman Brothers became the largest bankruptcy in U.S. history, after it was brought to its knees by a combination of losses, nervous clients and credit rating downgrades.

Failures like those can leave massive losses splattered across the financial system — reason enough for compliance officers to rein in risky exposures to their peers.

For any bank, loss of trust is potentially fatal and can catch it in a pincer movement where it rapidly finds it harder to borrow money, while being asked to put up more costly security in its daily trading.

There are signs in the market this is already happening.

"Banks are being very cautious over who they do business with. They are avoiding counterparties they perceive to be risky ... and this attitude will become more extreme if market conditions deteriorate further," Mr. Wheeler said.

Virtually Invisible

An added problem is that many of the markets in which investment banks participate are virtually invisible to regulators. The $400 trillion market for interest rate swaps, for instance, is largely traded over the phone.

Banks trading these instruments — which offer protection against changes in interest rates — have a direct exposure to their counterparties, which needs to be managed by their in-house risk management teams.

This is not a new challenge, but the function takes on added importance in times of financial stress when firms ask for extra security to be put up on trades, aiming to ensure they are not left on the hook by a counterparty default.

Banks then are raising the so-called margin calls — cash or securities held for the period a trade is live — which they demand from firms they perceive to be risky, piling more pressure on such firms. If these positions are traded on an exchange, margin contributions are set by the exchange itself, by calculating the industry's exposure to any one trading house. This makes it a reasonably straightforward process.

But in the unlisted over-the-counter markets where the most complex and risky derivative instruments trade, margin calls are determined by individual firms based on their perceived exposure to trading partners — a more arbitrary process.

Given the skittish nature of the markets, trading houses are demanding more and more collateral from counterparties upfront, which piles the pressure on those firms seen as risky.

"Firms are really having to do their homework at the moment and put in place the relevant security against counterparties," Mr. Wheeler said.

At the same time as margin calls are on the rise, the European debt crisis has led unsecured lending between banks to all but dry up, forcing banks in turn to put up expensive collateral to get access to money.

Wave of Downgrades

Banks' plight could be about to get even worse, with analysts expecting a wave of credit ratings downgrades of major global lenders, making a return to unsecured markets unlikely in the short to medium term. Moody's for instance has said it will conclude a review of financial institutions by the end of June.

All this means a very real pressure to put up more collateral, both to secure funding and to continue trading with counterparties in financial markets. And the pressure on bank funding will only increase as new regulation forces banks to find and allocate extra collateral against various banks practices.

"A knock-on effect of the credit crisis is that regulators want the financial market to be more resilient and, to that end, they want all credit exposures to be collateralized," said Olivier de Schaetzen at settlement house Euroclear.

Policymakers in the United States and Europe are keen to pass reforms that will force complex debt instruments to trade more like shares and futures by using exchanges.

From next year, swaps and other derivative instruments — often worth hundreds of millions of dollars — will have to be channeled through exchange-backed clearing houses, which guarantee pay-outs in case any counterparty goes under.

Clearing houses in turn will require trading firms, including banks, to put up extra collateral so as not to expose themselves to heavy losses.

The U.S. national bank regulator has said the regulatory changes could increase the value of collateral by $2 trillion, an increase of 50 percent from current levels.

Said Mark Higgins, managing director of clearing and collateral management at BNY Mellon: "By most estimates firms are going to need many more billions or even trillions of extra collateral to meet their additional requirements."

Monday, May 28, 2012

There are two types of value: intrinsic value and speculative value.

Thanks Rob, thoughtful and provoking when thinking about investing. Aivars Lode


The best definition of intrinsic value is cash flow.  Pretty simple. Easy to
calculate and mostly what "fixed income" (e.g. debt, bond) markets are all

The other type of value is speculative value sometimes called equity. The
most obvious manifestation of speculative value is the stock market, where
"equities" are issued, then bought and sold, over and over.

Speculative value (equity) is basically the concept of buying and selling a
title to some "asset". (The term asset is used loosely in the context of
equities.) The buyer of the title to the asset believes that in the future
there will be some event or change of perception that will allow them sell
it for more money than what they paid when they bought it. The thing backing
up the equity could be completely vacuous like an eyeball looking at a
webpage (worth speculatively millions), or a physical thing like a building,
which may have a replacement cost of say $10 million but could be be worth
zero or even have negative "equity" (you have to pay to demolish it.)

In theory, over the long term, the events that create equity value are an
increase in dividends (more on dividends in a minute) or an improvement in
the balance sheet (retained earnings, accumulation of sellable assets,
issuance of notes payable, etc.). But in the real world equities are valued
on pure perception (speculation). Actually, the second or third derivative
of perception (i.e. "I perceive now is the time to buy equities, because I
perceive that others who do not perceive now is a good time to buy equities
will down the road perceive that others will perceive that they should buy
equities in larger numbers... "ad infinitum) In other words the equity value
of an equity is derived from the belief that someone in the future will
believe that down the road further, someone will else will pay more. It is
really that simple. The real trick to equity pricing is to try to figure out
what people believe and what is likely to change their minds - 100%
psychology and like ALL FORMS of psychology, no science whatsoever - just

I am not saying people do not love to toss around numbers in equity markets.
Is there growth in earnings? Is there growth in revenue? Is this "expected"
or not (e.g. beat the official estimates and/or "whisper numbers")? Does
this company's "equity" have the same price to earnings, or price to
revenue, ratio as a competitor of the same size, balance sheet, same growth,
same margin, etc. If not, can these discrepancies be accounted for? Does the
company pay a dividend? Is it increasing?  etc. etc. But these are just
mental masturbations The only thing that matters is playing the perception
game. This is why stocks frequently go down after a stunningly good quarter.

Equity markets move from a numeric analysis to a perception analysis in the
blink of an eye,  That is not to say the numbers do not matter to some
extent, but numbers only matter to the degree they change perception.
So-called good numbers do not always lead to a good change in perception
(again, not the first derivative). There is a ton of evidence in equity
markets that demonstrates these phenomenon, but my favorite is looking at
the stock price movements when a company "misses the quarter" could go up -
could go down - could stay the same - depending on what the expectations are
and how they changed. Hence the source of, "I buy on dips."

One other note before moving on to intrinsic value is an analysis of
dividends. For equities that pay dividends, a partial intrinsic value can be
found in the ratio of dividend amount to speculative price. But be careful,
paying a dividend actually reduces the theoretical equity value of a company
(reduces cash).  Dividend values of equities (unless the dividend is
abnormally high compared to a corporate bond) is typically a minor kicker to
the stock. Increasing dividends has a de minimis impact on equity value as
compared to speculative values (i.e. the attempt to buy low and sell high).
Sometimes an increase in dividends will move a stock, but not because of the
intrinsic value, but because it is perceived to be a signal that will be
perceived by non-believers that the company has more "good news" which will
further change perceptions in the future. I am quite serious.

Bottom line: equities are valued on speculation.

Intrinisic value is a whole 'nother kettle of fish.

Intrinsic value is almost all mathematics. Intrinsic value is simply the
cash flow generated by an "asset". The formula can be quite complex taking
into account the net present value of the cash flow and the risk the that
cash flow is not secure and steady (predictable).  But no cash flow - no
intrinsic value. Period. For investors to balance a portfolio the future
will be products that have a relatively high cash flow (yield) with
relatively low risk.  Funds that do not take equity, but accumulate "bonds"
by concentrating on securing intrinsic value claims (cash flow) via secured
structures will provide stability in an investment portfolio.  Investments
are technically more like Convertible bonds than straight debt, because of
covenants that give ultimate control of operations without a traditional
default event. Funds like this are the future unique, modern,
differentiated, not a PE, not a VC, not a traditional bank, not a
hedge-fund, etc.

There is some confusion around intrinsic value "assets" like corporate and
government bonds because, in addition to yield, they also have a "price" -
i.e. some bonds do indeed trade. Bond trading is the result of a pseudo
perceived speculative value around relative yield and relative risk.  The
factor that causes speculative changes in the price of bonds is the global
shifts in interest rate expectations (speculation) for the same level of
risk. If you own a ten year U.S. Treasury eight years away from maturity
with an intrinsic value (yield) of 2% and the market begins to speculate
that the government will next issue ten-years for 2.2%, then the "price" of
your bond will go down. Notice that the price of the bond does not change
when the new higher rate bonds are sold if the speculation on future rates
is confirmed and does not create new speculation. But this assumes you would
sell it before maturity (now). If you own a ten-year bond with one year left
to maturity the speculative impact of a change in global interest rates is
tiny. If your intent is to hold to maturity the "price" of your bond beyond
intrinsic value is irrelevant.

Consequently, intrinsic value assets that do not trade do not have
speculative value. Intrinsic value assets that do not have a maturity are
probably impossible to speculatively price objectively, anyway.  The only
objective value is the current cash flow.

Sunday, May 27, 2012

Public Pensions Faulted for Bets on Rosy Returns

The truth is hitting home. There are barely any home runs for investments. Aivars Lode

Published: May 27, 2012

While Americans are typically earning less than 1 percent interest on their savings accounts and watching their 401(k) balances yo-yo along with the stock market, most public pension funds are still betting they will earn annual returns of 7 to 8 percent over the long haul, a practice that Mayor Michael R. Bloomberg recently called “indefensible.”

Now public pension funds across the country are facing a painful reckoning. Their projections look increasingly out of touch in today’s low-interest environment, and pressure is mounting to be more realistic. But lowering their investment assumptions, even slightly, means turning for more cash to local taxpayers — who pay part of the cost of public pensions through property and other taxes.

In New York, the city’s chief actuary, Robert North, has proposed lowering the assumed rate of return for the city’s five pension funds to 7 percent from 8 percent, which would be one of the sharpest reductions by a public pension fund in the United States. But that change would mean finding an additional $1.9 billion for the pension system every year, a huge amount for a city already depositing more than a tenth of its budget — $7.3 billion a year — into the funds.

But to many observers, even 7 percent is too high in today’s market conditions.

“The actuary is supposedly going to lower the assumed reinvestment rate from an absolutely hysterical, laughable 8 percent to a totally indefensible 7 or 7.5 percent,” Mr. Bloomberg said during a trip to Albany in late February. “If I can give you one piece of financial advice: If somebody offers you a guaranteed 7 percent on your money for the rest of your life, you take it and just make sure the guy’s name is not Madoff.”

Public retirement systems from Alaska to Maine are running into the same dilemma as they struggle to lower their assumed rates of return in light of very low interest rates and unpredictable stock prices.

They are facing opposition from public-sector unions, which fear that increased pension costs to taxpayers will further feed the push to cut retirement benefits for public workers. In New York, the Legislature this year cut pensions for public workers who are hired in the future, and around the country governors and mayors are citing high pension costs as a reason for requiring workers to contribute more, or work longer, to earn retirement benefits.

In addition to lowering the projected rate of return, Mr. North has also recommended that the New York City trustees acknowledge that city workers are living longer and reporting more disabilities — changes that would cost the city an additional $2.8 billion in pension contributions this year. Mr. North has called for the city to soften the blow to the budget by pushing much of the increased pension cost into the future, by spreading the increased liability out over 22 years.

Ailing pension systems have been among the factors that have recently driven struggling cities into Chapter 9 bankruptcy. Such bankruptcies are rare, but economists warn that more are likely in the coming years. Faulty assumptions can mask problems, and municipal pension funds are often so big that if they run into a crisis their home cities cannot afford to bail them out.

The typical public pension plan assumes its investments will earn average annual returns of 8 percent over the long term, according to the Center for Retirement Research at Boston College. Actual experience since 2000 has been much less, 5.7 percent over the last 10 years, according to the National Association of State Retirement Administrators. (New York State announced last week that it had earned 5.96 percent last year, compared with the 7.5 percent it had projected.)

Worse, many economists say, is that states and cities have special accounting rules that have been criticized for greatly understating pension costs. Governments do not just use their investment assumptions to project future asset growth. They also use them to measure what they will owe retirees in the future in today’s dollars, something companies have not been permitted to do since 1993.

As a result, companies now use an average interest rate of 4.8 percent to calculate their pension costs in today’s dollars, according to Milliman, an actuarial firm.

In New York City, the proposed 7 percent rate faces resistance from union trustees who sit on the funds’ boards. The trustees have the power to make the change; their decision must also be approved by the State Legislature.

“The continued risk here is that even 7 is too high,” said Edmund J. McMahon, a senior fellow at the Empire Center for New York State Policy, a research group for fiscal issues.

And Jeremy Gold, an actuary and economist who has been an outspoken critic of public pension disclosures, said, “If you’re using 7 percent in a 3 percent world, then you’re still continuing to borrow from the pension fund.”

The city’s union leaders disagree. Harry Nespoli, the chairman of the Municipal Labor Committee, the umbrella group for the city’s public employee unions, said that lowering the rate to 7 percent was unnecessary.

“They don’t have to turn around and lower it a whole point,” he said.

When asked if his union was more bullish on the markets than the city’s actuary, Mr. Nespoli said, “All we can do is what the actuary is doing. He’s guessing. We’re guessing.”

Vermont has lowered its rate by 2 percentage points, but for only one year. The state recently adopted an unusual new approach calling for a sharp initial reduction in its investment assumptions, followed by gradual yearly increases. Vermont has also required public workers to pay more into the pension system.

Union leaders see hidden agendas behind the rising calls for lower pension assumptions. When Rhode Island’s state treasurer, Gina M. Raimondo, persuaded her state’s pension board to lower its rate to 7.5 percent last year, from 8.25 percent, the president of a firemen’s union accused her of “cooking the books.”

Lowering the rate to 7.5 percent meant Rhode Island’s taxpayers would have to contribute an additional $300 million to the fund in the first year, and more after that. Lawmakers were convinced that the state could not afford that, and instead reduced public pension benefits, including the yearly cost-of-living adjustments that retirees now receive. State officials expect the unions to sue over the benefits cuts.

When the mayor of San Jose, Calif., Chuck Reed, warned that the city’s reliance on 7.5 percent returns was too risky, three public employees’ unions filed a complaint against him and the city with the Securities and Exchange Commission. They told the regulators that San Jose had not included such warnings in its bond prospectus, and asked the regulators to look into whether the omission amounted to securities fraud. A spokesman for the mayor said the complaint was without merit.

In Sacramento this year, Alan Milligan, the actuary for the California Public Employees’ Retirement System, or Calpers, recommended that the trustees lower their assumption to 7.25 percent from 7.75 percent. Last year, the trustees rejected Mr. Milligan’s previous proposal, to lower the rate to 7.5 percent.

This time, one trustee, Dan Dunmoyer, asked the actuary if he had calculated the probability that the pension fund could even hit those targets.

Yes, Mr. Milligan said: There was a 50-50 chance of getting 7.5 percent returns, on average, over the next two decades. The odds of hitting a 7.25 percent target were a little better, he added, 54 to 46.

Mr. Dunmoyer, who represents the insurance industry on the board, sounded shocked. “To me, as a fiduciary, you want to have more than a 50 percent chance of success.”

If Calpers kept setting high targets and missing them, “the impact on the counties won’t be bigger numbers,” he said. “It will be bankruptcy.”

In the end, a majority decided it was worth the risk, and voted against Mr. Dunmoyer, lowering the rate to 7.5 percent.

'Classic' retirement becoming less likely

Following the crisis in the 90’s in Australia, individual Australians realized that they could not retire asper their expectations. What did they do? They focused on a passion of theirs and Australia has moved to a much more cultured place than it was. Aivars Lode
Some may have to work, while others may be forced to retire due to layoffs or ill health

May 27, 2012 6:01 am ET

Once upon a time, the storybook vision of retirement focused on endless leisure hours filled with golf and travel. Whether that idealized vision was ever real for the majority of retirees is questionable. But for a growing number of today's workers, it is downright laughable.

The one-size-fits-all vision of retirement has become a victim of the Great Recession and its collateral damage to investment portfolios, home values and job security. Increasingly, employees who don't have a pension expect to work past traditional retirement ages, if they can, as a way to make up the shortfall in their nest eggs.

The stark reality is that many won't have the choice, due to layoffs or health issues.

In an online survey of more than 3,600 private-sector employees, nearly 70% said that they won't be able to accumulate enough money to fund a comfortable retirement even if they work and save until 65.

“American workers are adjusting their expectations of retirement, including working past age 65 and planning to work part time in retirement,” said Catherine Collinson, president of the Transamerica Center for Retirement Studies, which conducted the survey. “Now it's time to provide an updated road map to help them achieve retirement income to last throughout their lifetime.”

People need to develop a clear vision of their retirement, including a backup plan in case they can't work as long as they envision, Ms. Collinson said.

It might mean downsizing to a smaller home or relocating to a less expensive area, annuitizing a portion of their nest egg to ensure that they don't outlive their money or relying on family members for help.

“Life's unforeseen circumstances, such as a job loss or health issues, can have a devastating impact on the best-laid plans,” Ms. Collinson said. “The "what if' scenarios are mission-critical for American workers of all age ranges to include in their long-term preparations.”

A new study from MetLife Inc.'s Mature Market Institute proves that point.

Despite predictions to the contrary, the study found that more than half of 65-year-old baby boomers are fully retired or working part time. And half those who are retired said that they retired earlier than they had expected, mainly because of health problems.

Just as John Lennon wrote: “Life is what happens while you're busy making other plans.” Of course, the musician, who died at 40, never had to worry about retirement.

Financial advisers need to adapt their investment techniques and how they communicate with clients to embrace this splintered vision of retirement.

“Not all pre- and post-retirees have the same goals,” said Laura Varas, principal of Hearts & Wallets, a research firm specializing in retirement market trends for the financial services industry. “It is critical that the financial services firms know their audience.”

Based on nationwide focus groups, the firm's study divides older investors into three main groups, based on their preferences and attitude about retirement income and advice.

“Full-steam aheads” plan to work, at least part time, to avoid mental deterioration and maintain their independence.

“Balancers” view part-time work as an insurance policy for the future and a way to earn spending money.

“Leisure pacers” plan to stop working — or already have — but are more involved with their finances than ever before.

Although many firms think of retirement income planning as a service that helps older Americans decide how and when to tap their personal assets, the term “retirement income” means different things to different types of older investors, Ms. Varas said.

For example, the first segment interprets “retirement income” as a reference to entitlement programs such as Social Security.

“Because this group tends to take responsibility for themselves and others, they don't even think "retirement income' applies to them,” Ms. Varas said. “This misunderstanding is a tragedy because many of these offerings are specifically designed for people like them.”

Chris Brown, another Hearts & Wallets principal, cautions financial services firms and advisers about expecting older investors to consolidate all their assets.

“Retirement income services may help providers increase wallet share, but only a minority of older investors will consolidate with a single provider,” he said.

Some investors who have been burned by advisers in the past, for example, still may work with one but will put in extra time checking up on the adviser's recommendations.

And while marketing to seniors, be careful how to word your pitch.

“Pre- and post-retirees don't see themselves as senior citizens,” Mr. Brown said. “Financial services firms and advisers that use positive wording, such as "freedom,' to describe this phase of life, will have a stronger connection with this market segment.”