[ISSUE 40] - Interesting Things...

@GSElevator – #1: The cool thing about England is that you can tell if someone is poor by how they talk.

1. Quote Of The Week / 2. We May Be Heading For $5 Oil / 3. 3. Indonesias Unstimulating Stimulus / 4. Interesting Links / 5. Joke Of The Week

1. QUOTE OF THE WEEK

For some historical perspective, it is worth recalling the famous March 4, 1999, article in The Economist, entitled “The Next Shock?”, which warned of a persistent glut of oil due to technology and productivity gains that may lead to $5 oil:

“Rapid technological advances have pushed the cost of finding, developing and producing crude oil outside the Middle East down from over $25 a barrel (in today's prices) in the 1980s to around $10 now.”

2. WE MAY BE HEADING FOR $5 OIL

A similar dynamic exists today, where more than $1 trillion of future oil investment has been deemed uneconomic at current prices, according to Wood Mackenzie. Shell’s $4 billion dry hole in the Arctic underscores the challenge of developing new sources of oil in a low price environment.

Faced with disappointing results in its latest Arctic project, Shell has concluded its Arctic drilling program deciding to suspend activities in Alaskan waters indefinitely, though it had earlier anticipated it might be able to produce 650,000 barrels per day of oil for 35 years from the Outer Continental Shelf (OCS). From 2025 until 2060, the OCS had been expected to power Alaska’s economy and contribute up to 10 per cent of U.S. domestic oil production.

Wood Mackenzie has estimated that $220 billion of oil industry investment has already been postponed this year, concentrated predominantly in offshore projects and Canadian tar sands. They further estimate that up to 20 billion barrels of oil equivalent of oil and gas will not be developed until prices rise. Altogether, some $1.5 trillion of future investment spending is at risk of being uneconomic due to low oil prices.

Recent research by Rystad Energy and Morgan Stanley shows that cost structure is driving project cancellations and postponements. All the new production areas – deepwater, ultra deepwater, shale oil, tar sands and the Arctic – all look very unattractive at current oil prices.

Unfortunately, most of the incremental projects for the quoted oil companies are in the high-cost groups. With hopes for a significant turnaround in oil prices fading quickly, the oil companies face the prospect of having to allow their production to shrink in order to survive. While depletion rates onshore typically approximate 5% to 8% a year, for post-peak production offshore they are often as high as 15% to 20% a year.

The North Sea is operated by a combination of the oil majors and is at the forefront of production technology. Yet despite all this expertise, continuing investment and the recent incentive of high oil prices, production has fallen steadily, from a peak of 6.4 million bpd in 2000 to just under 3 million bpd in 2014.

It is also worth noting that despite the growth of OPEC crude oil production since last year OPEC’s total combined crude oil capacity has fallen by 150,000 bpd since October 2008. Spare capacity remains relatively tight by historical norms, and now hovers in the 2 to 3 million bpd range. If demand stays flat or declines, low levels of spare capacity are unnoticeable. But if there is an unforeseen oil supply outage or demand surge, this cushion could be put to the test quite rapidly.

According to recent estimates from the U.S. EIA, domestic oil production fell over 400,000 bpd from its April 2015 peak through the beginning of October. The EIA also noted that during the 12 months ended in June, some 83% of U.S. onshore E&P cash flow was devoted to debt service. Access to capital is now the biggest threat to U.S. oil production. It is no secret that losses have been mounting in the highly-levered shale space, especially for unsecured debt. Spreads on high-yield energy bonds have risen about 500 basis points since last fall, as well.

It is going to be increasingly difficult for global oil supply to meet demand between 2017 and 2020, unless there is a protracted recession. However the outlook is more nuanced for the next 12 months. Repeated downgrades to the global economic outlook - especially in emerging markets - could keep oil in a trading range between $40 and $60 a barrel for the next 12 months. A markedly weaker dollar and/or new stimulus in China and other emerging markets would also cause an abrupt upturn in sentiment.

3. INDONESIAS UNSTIMULATING STIMULUS

In early September, Joko Widodo, Indonesia’s president, promised a “massive deregulation” aimed at attracting foreign investment. Outsiders were thrilled. Jokowi’s predecessor, Susilo Bambang Yudhoyono, left the country’s business climate choking whereas Jokowi has openly courted foreign capital.

Over the past six weeks his administration has unveiled a series of deregulatory measures. On September 9th the government made it easier for foreigners to open bank accounts, struck down import restrictions on goods such as tyres and cosmetics that were designed to protect local industries, and eliminated some onerous and silly business regulations. No longer, for instance, must Indonesian-language labels be affixed to imported goods before they arrive; now they can be printed in Indonesia and attached before public circulation.

Tom Lembong, Indonesia’s Harvard-educated, ex-Morgan Stanley banker and new trade minister, says that Jokowi, who developed a reputation as a pragmatist while governing Jakarta and his hometown of Solo, loves these sorts of “simple, practical…measures that are completely and directly felt by industry.” And to its credit, Indonesia has resisted the temptation to panic in the face of a plunging currency and rising bond yields. It has, for instance, maintained fiscal discipline – aided by a law that caps the budget deficit at 3%.

Markets nonetheless seem unconvinced. The rupiah continued its slide after the first two announcements. It has recovered some ground this month, along with other emerging-market currencies, but has still fallen by 8% against the dollar this year. Economic growth is at its slowest since 2009. Nobody doubts the new deregulatory measures are better than nothing, but they are hardly “massive”.

One foreign businessman, long resident in Indonesia, assesses them as resulting from “bureaucrats talking to themselves about how we can be a better bureaucracy rather than how we can be more receptive to foreign investment.” For the most part, Jokowi’s measures remove regulations that should never have been implemented in the first place. They neither fundamentally change Indonesia’s investment climate nor signal to investors that Jokowi is preparing for bigger reforms.

Indonesia’s negative-investment list, which details the sectors that are barred to foreign capital, remains sizeable. Hiring foreigners is still a burdensome process: one rule requires businesses to hire ten Indonesians for every foreign worker. Businesses complain that bureaucrats pass rules hastily, without even trying to understand their effect on the private sector.

A rule banning metal-ore exports remains in place; it was intended to encourage a domestic smelting industry but instead has cost thousands of jobs and billions in export revenue. Infrastructure development – the centrepiece of Jokowi’s ambitious economic plans – has begun to pick up, but only after severe delays, and the programme remains well below its targets for this year.

Perhaps most damaging is a pervasive sense of disarray. Policies are announced and then scrapped, whether because of objections that should have been aired before, as with a law to force foreigners to pass a language test, or because they conflict with other plans, as happened with a proposed road tax. Ministries seem to pass rules independently, without consulting each other or the president. Decentralisation – meaning a huge devolution of power from the national government to the regional level – may have held the country together in the early 2000s, but today it impedes infrastructure development and hinders policy co-ordination. Poor communication from the president compounds these problems.

The good news is that Jokowi has come to an intersection and said, ‘I’ve got to do something different because what we’ve been doing isn’t working.’ Mr Lembong says that deregulation is “something the president intends to do every year he’s in office…The broad thrust is that we want to become less interventionist in the economy.” These bold words are welcome. But bold actions would be better still.

4. INTERESTING LINKS

Do we really need four hours sleep? [NY Times Blog]; Aircraft carrier catapults car into the ocean [YouTube]; Vietnam’s military put $1 billion into Tanzania [Quartz]; Advocating the decriminalisation of drug use [The United Nations]; An engineering theory of the VW scandal [The New Yorker]; Graham & Doddsville fall newsletter [Columbia Business School]; How shipping containers made distance irrelevant [Nautilus]; Should you be able invest in other people’s lawsuit? [NY Times]; The first mobile phone lane… for pedestrians [Thailand National].

5. JOKE OF THE WEEK