The Mae West Principle and the renewal of Brazil

If you have read this blog for a while, you will remember my deeply held belief that Mae West holds the future of Brazil in her hands, so to speak.

Mae West, was a leading Hollywood “femme fatale” in the 1930s and 40s.  She was also renowned for her double entendres and quick wit.  My favorite remark of hers is: “I can resist everything except temptation.” 

Had the Royal Swedish Academy of Sciences been more perceptive, it would have awarded her its Nobel Prize for Economics in 1980, before she died, rather than to Lawrence Klein, the father of econometrics.  Seriously, I believe that the above Mae West Axiom has greater potential for economic growth in Brazil than any combination of Klein’s models.

Back in 2015, I wrote a post in which I argued that the massive corruption scandal at Petrobras had been facilitated by its status as government-controlled national champion, leaving politicians too close to the levers of power and to the cash coffers.  Similar instances of corruption were uncovered at Eletrobras, the giant electric energy holding, also controlled by the government. 

The Mae West Axiom, if it had been followed, would have offered a simple solution: privatize Petrobras and transfer control out of government hands, and you will greatly reduce instances of corruption.  Indeed, Vale (the iron ore giant), the telecoms and the steel companies the control of which had been sold to private investors, didn’t suffer the same corruption abuses.

Which brings us to the present.  Today, the Public Prosecutor’s Office charged Aldemir Bendine with corruption for facilitating the business of Odebrecht with Petrobras in return for personal payments.  What is so damning, and instructive, is that Mr. Bendine was appointed CEO of Petrobras in 2015 to clean its finances and practices, after the huge Lava Jato scandal had come to light!

I must confess that I totally misjudged the man at the time, perhaps because we both are fans of the rock band Queen (?).  If one needs any further proof of the lack of accountability at government-controlled behemoths, I don’t know what beats that.

Also today, the stock price of Eletrobras shot up a massive 32% to 49%[1].  What triggered such unheard movement?  The news that the Ministry of Finance intends to privatize the company.  Since its shares are already publicly traded, this means selling shareholder control to private interests with the state retaining the equivalent of a golden share to veto certain key decisions. 

A greater no-confidence vote in government control, I have never seen!

When Petrobras did its IPO, popular and political resistance made it impossible to actually privatize the company.  The later discovery of massive offshore deposits actually caused a quasi renationalization, and brought Petrobras close to bankruptcy.  It remains to be seen if the current unpopular government will be able to also free Petrobras; one would hope that the Brazilian people would be fed up with the scandals and pick the obvious way out, but “black gold” elicits much stronger emotions than do kilowatts.

Which brings us back to Mae West:” between two evils, I always pick the one I never tried before.”  Brazil has long had government control over its national champions, Petrobras and Eletrobras.  This did provide its politicians with sinecures and juicy consulting contracts for them and their friends; but it also brought prison sentences, personal embarrassment and destabilized the country.  How about trying something new, clearly unpalatable, but safer?  Maybe.

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[1]  Depending whether one considers the non-voting or the voting shares.

North Korea, no good options but no middle ground outcomes either

It is decision time for North Korea, China, South Korea and the US.  As North Korea has reportedly mastered ICBM technology and possibly nuclear warhead miniaturization, the world is at a crossroad.  There seems to be little room left to safely kick the can down the road.

Each of the above actors will have to make momentous decisions in the weeks and months to come.  None will be easy or popular.  For better or for worse, both payoffs and penalties will be outsized.

The quasi-consensus advice, from here at home and abroad, is for the US to “engage in meaningful negotiations” with North Korea.  In my view, it would be premature or wrong.

The US has tried to dissuade North Korea from building nuclear weapons for a quarter century, to no avail.  Such effort was undertaken by both Democratic (Clinton, Obama) and Republican (Bush) presidents, variously viewed as thoughtful, dovish, impulsive, hawkish or pragmatic.  It made no difference.  It is thus logical to conclude that North Korea doesn’t want to negotiate away its nuclear militarization.

North Korea is governed by a repressive elite which presides over an impoverished country which treats its people very badly.  Even its ambassadors, privileged as they are, defect when given the chance.  There is little doubt that this elite views its nuclear achievements and armament as the way to repulse would-be attackers and stay in power.  Could the US guard them against such threats?

The answer is simply NO because the greatest threats are from within North Korea.  Neither China, nor Japan, nor the US would want to conquer the DPRK[1], a country devoid of natural resources and populated by 25 million poor people.  South Korea may wish for a reunification, as West Germany did, but it would make no sense to do it militarily; even a peaceful reunification would be difficult: the cost of integrating one North Korean would have to be borne by two South Koreans; in the German case, the ratio was a better, yet still taxing, 1:4.  The only real threat to Kim’s regime is from within.  The US couldn’t and wouldn’t protect the Shah of Iran or Mubarak in Egypt, where it had greater strategic interests; this is truer still for Kim.

China has enjoyed having North Korea as a buffer along its border.  Their relations could never have been described as cordial, but both countries found some mutual benefits.  As China seems to take a more authoritarian tack, its tolerance for the DPRK may endure.  Nevertheless, a nuclear North Korea brings big short and long-term challenges: it could force the US to strike and destabilize a neighbor with 25 million people to eliminate an existential threat;  longer term, Japan, and possibly South Korea, may conclude that the US won’t risk a nuclear war to fulfill its military obligations and decide to build their own nuclear arsenals.

For the rest of the world, a nuclear North Korea brings obvious risks, the biggest one being proliferation.  There is evidence that North Korea provided technical assistance to both Iran and Syria in the nuclear arena.  A pariah nation with nukes would logically increase trading on its weapon expertise, and such activity may not be limited to nation states.  Finally, it would encourage countries close to the threshold of nuclear power, such as Iran, and others to push the envelope.

In my view, the two most likely outcomes are as follows:

1)   Covertly prodded/encouraged from abroad, local factions unseat Kim with the understanding that they will dismantle their nuclear weapons.  Joint inspections by the International Atomic Energy Agency, China and the US will insure compliance.  China and the US agree to a multi-year, multi billion dollar economic assistance program.  The US agrees not to move its South Korean military bases or units further North.  The US recognizes North Korea.

2)   The US strikes North Korean ballistic installations and nuclear assets.  It also effectively disables its communication networks and electricity grid.  It warns that any North Korean attack on the South will be met by an overwhelming conventional response.  The US also offers to initiate talks about nuclear disarmament with legitimate North Korean counterparts, effectively forcing Kim to step down.

There is a third possibility, although I see it as less likely: as the world gets increasingly concerned about the fallouts of a military confrontation in the Korean peninsula, Europe, China and the US step up their sanctions to the point where they really hurt everybody in North Korea and endanger the stability of the regime.  At that point, the DPRK government turns to (personal) survival mode and agrees to enter into negotiations.

In conclusion, parties negotiate when it is the most palatable option they have.  A very good example of this is the recently signed Colombian peace accord after the FARC started to suffer heavy tactical and strategic losses.  For decades, the US has been willing to negotiate denuclearization while North Korea hasn’t.  Recently, the commercial and military pressure on North Korea has increased notably, but time is running out.  This is why I believe that the above two scenarios are the most likely.

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[1]  The Democratic People’s Republic of Korea.

Does coal have a future?

CNBC viewers may have been surprised to hear NEC Director Gary Cohn say that “at some point in the cycle, coal will be competitive again”.  Really?  After all, such technological innovations as fracking and horizontal drilling caused US oil and gas production to almost double in just one decade, and natural gas to become the fuel of choice for power plants.

Cheap prices for natgas and pollution issues for coal are the big market drivers.  But both could see changes if not outright reversals.

In the US, natural gas prices broadly averaged between $8.8-$4 per Million Btu in the 2000s but dropped to $4.4-$2.7 over the 2010-2015 period.  After touching a low of $1.49 in March 2016, they rebounded above $3 this year.  Logically, such rebound in price benefitted coal: First quarter 2017 electricity generation from coal grew 5% year-on-year.

Pollution is the other key factor.  According to the Energy Administration Agency, in 2016 coal-burning power plants worldwide released around 2 lbs of CO2 per Kwh.  They also released other undesirable gases, metals and particules.  Natgas-fired plants only released 0.8-0.9 lb/Kwh[1].  As the world pushes for lower emissions and countries may tax CO2 at $30-$50/t, coal is handicapped.

But technology is beginning to change that.  High Efficiency-Low Emissions coal-fired plants are already reaching efficiency levels of 45% vs. 33% for conventional ones, and 50% is a realistic goal.  By comparison, state-of-the-art natgas power plants exceed 60%.

Today, the most advanced Japanese combined cycle plants which feed pulverized coal and burn it at very high temperatures achieve emission levels of around 1.5 lbs/Kwh.  By the early 2020s, 1.2-1.3 lbs/Kwh will likely be achieved.  Further out, fitting these plants with Carbon Capture and Storage (CCS) technology could actually transform coal into a clean fuel with CO2 emissions in the 0.2-0.25 lb/Kwh range.  Of course, such technologies will need to be cost effective, and developing them will take time (10 to 15 years).

But coal is the most abundant energy source on earth, and countries such as China, India and South Africa which don’t have much oil, do have a lot of coal.  It is easy to store and to transport.  Coal-fired plants provide cheap energy around the clock, day and night, rain or shine.  From an economic and strategic point of view, it is therefore a very valuable commodity. 

Its pollution characteristics and the great technological advances which benefitted natural gas have pushed it aside (at least in developed countries), but technology and the need to produce more electricity will likely bring it back.

A contrarian investor with a long term view should keep an eye on it.  The interested reader may take the demise of coal with a grain of salt.  Dirty coal is slowly dying, but clean coal will likely rise from its ashes.

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[1]  Depending whether one uses data from developed or emerging economies.

The challenges of renewable energy: solar

Today, Chilean mining giant Antofagasta Minerals announced that it had sold its minority interest in the Javiera photovoltaic solar power plant (though it will continue to off-take electric energy from it).  Looking at the photo provided with the press release, one can’t help reflect on the challenges facing renewable energy sources, solar in this case.

The most obvious is that solar takes a lot of space!

The Javiera plant shown here has an installed capacity of 69.5 MW, yet it covers hundreds of acres.

The largest solar plant to date is in Kamuthi, India; its capacity is 648 MW and it reportedly covers a very tight 10 sq. km (2,470 acres) for a land to capacity ratio of 3.8 acre/MW.  The most efficient large scale one in the US, the 550 MW Topaz Solar Farm, occupies 25 sq. km for a 11.2 ratio.

Concentrated Solar Power (CSP) plants use parabolic mirrors to heat a fluid which then generates steam to drive traditional turbines.  They are more efficient than the photovoltaic types.  Yet even in the most favorable environments they still occupy a lot of ground:  Mojave One with a nameplate capacity of 280 MW covers1,765 acres for a 6.3 ratio.  The ratio is 6.8 at Solana, 15 at Crescent Dunes and 4.5 at SEGS.

In comparison, a 56 MW GE LM6000 combined cycle gas-fired power plant has a much smaller footprint than Javiera, as evidenced by the photo on the left.

Nuclear plants too are far more space efficient.  And they generate a lot of electricity.  The Millstone Nuclear Plant, CT, has a capacity of 2,037 MW on a 500 acre site for a ratio of 0.25 acre/MW.  The ratio is 0.16 at Peach Bottom, PA, and 0.4 at Susquehanna, PA.

Clearly, the desert of Northern Chile is ideal to find ample space for a solar farm, but not all lands are so devoid of potential use.

The second great challenge is capacity utilization.  In the US, nuclear plants produce energy more than 92% of the time.  By contrast, solar photovoltaics average 18% and CSP types can exceed 30%.  Javiera is probably in the mid 20s ballpark given the extremely favorable climate of Northern Chile.  But how many places in the world offer ideal climatic conditions and a ready customer (in the case of Javiera, a copper mining concern)?  Instead, generators in desolated places will need to build hundreds of miles of transmission lines to connect with populated areas.

Finally, there is the cost factor.  A popular methodology is the “levelized cost of electricity” or LCOE whereby initial capital costs, operating costs and fuel costs are combined over the useful life of a generating plant to calculate a lifetime cost of generating a MWh.

In the US, the EIA has the following LCOE estimates for plants entering service in 2020:

(in US$/MWh)	Minimum	Average	Maximum
Solar- photovoltaic	97.8	125.3	193.3
Solar- CSP	174.4	239.7	382.5
Advanced Nuclear	91.8	95.2	101.0
Coal-conventional	87.1	95.1	119.0
Coal-IGCC	106.1	115.7	136.1
Natural gas-advanced	68.6	72.6	81.7

It should be noted that these projections depend on the assumptions made, in particular, the future price of fossil fuels.  Nevertheless, some patterns are apparent:

1.     Natural gas is by far the cheapest fuel for electricity generation,

2.     Solar energy is cheap in places like the Mojave Desert and Arizona because of exceptional climatic conditions, not so elsewhere,

3.     Coal, natgas and nuclear plants costs don’t vary much with location.

However, the above LCOEs are imperfect in two fundamental respects:

1.     They do not include the cost of standby plants for solar, which is substantial since solar capacity utilization averages under 20%, and

2.     They assume that all plants sell their electricity at the same price.  In reality, an intermittent producer like solar doesn’t have the luxury to pick when to sell electricity and could well be stuck with off-peak demand and prices more often than fossil fuel fired power plants.

Still, solar technology has made great progress in the last decade.  It likely will continue to do so.  However, it is crucial for these producers (and the taxpayers) that energy storage technology advance to improve the economics of the system.  Rather than paying out excessive subsidies, the states and the federal government should invest, or encourage more investment, in R&D.

“There you go again…”

Earlier this week, the manifesto of the British Labour  Party was leaked, and it contained some eye-popping revelations, among them, the pledge by its leader Jeremy Corbyn to renationalize British Mail, the railroads and the electric distribution and transmission companies. 

In their early years, newly privatized railroad companies in the UK did have customer and maintenance problems.  But to imagine that public sector status is the panacea takes one’s breath away when there are such glaring examples to the contrary.

Across the Channel, Areva, the French government-controlled nuclear reactor builder, went almost bankrupt and had to be rescued by the state and EDF.  EDF itself, because of government-mandated electricity pricing policies, saw its debts balloon and needed a large capital increase.

But the most graphic demonstration of the damage government meddling brings to national champions is Brazilian giant oil and gas producer, Petrobras.  Until 2005, it was a company famous for its technological excellence in deep water drilling and its ability to navigate the Brazilian political and commercial waters with ease.

All that changed when global oil prices soared, Petrobras made huge offshore discoveries and President Lula decided that the company’ riches should accrue exclusively to Brazil and bankroll his political movement.

In 2010, a $70 billion capital increase[1] and a new Hydrocarbon Law gave the government a very tight hold over the company.  That control pushed Petrobras to the brink: its debts ballooned from $21 billion in 2006 to $132 billion by the end of 2014 through a combination of excessive investments, “diworsification” and corruption[2].  Meanwhile, the company systematically missed its production targets.

The steep fall in oil prices, the discovery of the vast corruption scheme and a change in government forced Petrobras and the state into a hard restructuring.  The results have come quickly for a company of this size, and have left many analysts incredulous;  this was evident in the quarterly conference call this morning.

The company has already shed $13 billion worth of assets, cut its workforce by 17%, and reduced its annual capex by close to $10 billion.  Crucially, while its capex used to far exceed its operating cash flows, Petrobras is now looking to generate free cash flows of over $14 billion this year and next.

In France, Emmanuel Macron has been less sanguine about nuclear energy than his opponent François Fillon, but it is fair to expect that he will not want to pony up billions into Areva and EDF.

Mr. Corbyn’s manisfesto is unlikely to come to fruition, but it is amazing that the lure of nationalization remains so strong for educated people who should know better.  But when a politician wants to change society rather than making it better (whatever this means), sound economics rarely stand in the way.

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[1]  Actually the exercise was not as successful as the government expected as the Brazilian state did not win a 2/3 majority as a result.  While minority investors contributed cash, the state contributed rights to produce deep offshore oil.  In itself, this capitalization was a model of bad governance.

[2]  The cumulative amount of the bribes was not in itself life threatening, but the massive cost overruns and uneconomic projects that corruption allowed clearly was.

First thoughts on Emmanuel Macron’s election

Emmanuel Macron was elected today president of France.  While this didn’t surprise anybody, a few observations are in order.

The margin of victory, 65.2% to 34.8% for Marine Le Pen, is wider than even the most optimistic estimates made just after the first round (see previous post).  I have little doubt that the debate of May 3^rd accounted for most of this shift.  Le Pen’s behavior and tactics were so awful as to turn off many uncommitted voters.

Le Pen still scored the most votes and the highest electoral percentage that the Front National ever got in a national election.  She succeeded in attracting some votes from the Extreme Left and from the Right.  But more than an endorsement of her leadership, this reflects the deep frustrations and the anger felt by a large minority of the population.

Faced with a choice between anger and gradual change, abstentions (at around one in four) were 25% higher than normal[1].  Blank votes[2], at an estimated 12%, were two and a half times the 5.4% average of the last twenty two years.  In all, compared to historical trends, an extra one in seven voters refrained from expressing a choice.

It would be easy to show that only half of the registered voters chose Macron[3] while the other voted against him or not at all.  That would be overly pessimistic.  He has three big things working for him:

One is momentum and the fact that, with the possible exception of Les Republicains[4], the political opposition is both fragmented and in disarray.  This should help him score very well at the forthcoming legislative elections in June.

The other is that he has read the political scene and the French population better than anybody.  It is easy to forget that, when he announced that he would run without the support of any established party, he was laughed at by almost everybody[5].  This probably explains why his program seems so gradual, some will say timid:  the French want change but are not ready yet to pay the price for it. 

Last but not least, Macron seems ready to depart from his predecessors in one very significant way.  He seems willing to spend the time to explain his policies to people, in simple terms, again and again.  This is something that US audiences are familiar with (think of Reagan or Obama), but it is a novelty for the French.

After five years of hectic buzz under Sarkozy and five years of frustrating stagnation under Hollande, France is about to try a new approach.  I think that Macron is best suited for it.  In his speech to his supporters tonight, he repeatedly stressed how “immense” the task ahead will be, implying but not expounding to his audience its inevitable costs.  He acknowledged the frustrations that led people to vote for extremism, promising to address the underlying issues.  Finally, earlier in the week, he stated that he would seek to reform the European Union failing which extremism in France would win.  Echos of de Gaulle famous “Je vous ai compris”[6]?

The French want change, but what change and at what price, this remains unclear.  Macron seems to have grasped this situation and offered a palatable way forward.  One of his biggest challenges will be to convince voters on the Left to accept more economic liberalism and to convince voters on the Right to give the European Union another chance.  Both Left and Right will be unforgiving as far as security is concerned.

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[1]  Abstention rates at presidential elections have been trending up over the last 40 years.  Except for an abnormal 31.1% in 1969, they rose from the mid-teens in the ‘60s, ‘70s and ‘80s to around 20% since 1995.

[2]  First estimate for blank votes is 12%.

[3]  65.2% x 0.75=48.9%.

[4]  Fillon and Sarkozy’s party.

[5]  I didn’t think he stood a chance.

[6]  I heard you.

The world most exclusive club?

The world of golf was shaken to its core yesterday when Prescott Bullnose, a prominent businessman from Raleigh NC, announced that he would quit the famous Augusta National Golf Club on the pretext that “he was fed up with the sadistic juxtaposition of blooming magnolias and slippery bentgrass greens”.  Members also recalled that he had complained repeatedly about the sour béchamel sauce in the eggs Benedict served at the club restaurant, and about the lack of response from the chef who famously cracked that he “answered to higher authorities”.

Lamartine Talmadge, the acting club president and mayor of nearby Lumenville, didn’t mince his words: ”Nobody walks away like that from the greatest golf club in the world! Nobody! All y’all mark my words, that dog won’t hunt! Now, I declare we will teach this man a lesson!”

Whereupon Talmadge mentally added the money that he could shake from Bullnose, his share of the next three years of clubhouse maintenance, the projected redesign of the eight, tenth and thirteenth holes, the expansion of the press room and the resurfacing of Route 28 from the Berckmans intersection:” no less than $1 million he owes us, no less!”

“Darn it…God!” The mayor howled in pain; he had smacked his hand on his desk and pierced his palm with a brass tack.  That got him angrier still:” Nobody skedaddles out of this club to live the happy life, and least of all this high cotton feller!  No siree, he ain’t gonna grin like a possum eatin’ a sweet tater when I’m done with him.”

Now, there is no Prescott Bullnose at Augusta National, the béchamel there is likely superb, and even if it were not, surely, it is most unlikely that it would cause a member to walk out from one of the world’s most sought after golf clubs.  A switch to pancakes or waffles would make more sense.  

Save for personal or financial reasons, nobody quits great clubs, unless these clubs fail massively in the services offered.  There is no need to threaten retribution for exiting members as many more applicants are waiting to get in, possibly willing to pay higher fees for the privilege.    

So when the UK decides to exit the European Union whose member countries then try their hardest to make that exit as painful as possible, and when the president of the European Commission behaves badly with the UK prime minister, alarm bells should be ringing.

A small majority of Britons judged that membership in the EU carried no net benefit.  A large minority of Dutch and French people agree.  Indeed, pro-Europe candidate Emmanuel Macron recently declared that, if elected, reforming the Union would be one of his priorities and that failure to do so could trigger Frexit (exit by France).

Club Europe is in crisis.  As often in such circumstances, the reaction from the top is denial, fear and punishment of the critics.  No doubt that one more exit from the EU by a core member would be lethal.  Change is as inevitable as it is necessary.  Would it entail a “two-speed” structure?  A more decentralized government?  Effective enforceability of sanctions against non-conforming members?

There is time to reflect on all of this.  EU members must also realize that the UK could counter their excessive demands by threatening to simply break away and rely on WTO provisions; this would be even more damaging to their goals of keeping everybody in line.

Pressure is mounting.  The clubhouse is growing restive.  Core member France might well be the ideal one to promote domestic as well as union-wide reforms, offering to reduce spending in exchange for Germany to move in the opposite direction.   2017 will be interesting.