Category Archives: On the cover

On the cover

The Oil Sector Underperformance Goes Beyond Oil Prices

Energy, Global Economy, On the cover, Sin categoría

So far this year, the European energy sector (SXEP Index) is the worst performing one in the European stock market. Same with Energy vs the US all-time-high levels.

The fact that this situation happens while oil prices remain within the range of $ 50-55 a barrel, shows that the sector is very far from regaining momentum after a rather technical rebound seen in 2016.

We should not forget that the oil sector was already one of the worst performers in the stock market way before the oil price collapse. The reasons were obvious. Monstrous investment plans with very poor returns, disappointing growth, weak profitability and missing companies’ own targets, added to an unsustainable dividend yield even at $ 100 a barrel.

No, the problems of the oil sector do not come only from the price of oil or natural gas. It comes from the atrocious allocation of capital and the inexorable destruction of value of many conglomerates that hide under the “long-term strategy” excuse, and the detestable “integrated model” to mask a very low competitiveness and a poor identity of objectives with the suffering shareholder who, year after year, looks to the sky and hopes that “in the long-term” things will improve.

When prices are high, the sector embarks on questionable acquisitions and, when oil prices fall, it is the shareholder who suffers.

It all started many years ago. Already in the late 1990s, the vast majority of integrated oil companies forgot the historical principles of the sector.  They forgot ROCE (return on capital employed) as a fundamental measure to analyze investments, launched “diversification” strategies that have destroyed billions of market capitalization, began to relax their investment criteria … And the disaster was slowly brewing. A sector that generated 12% ROCE at $ 14 a barrel … went on to generate a lower profitability, 11%, at $ 130 (SXEP Index).

When I started working in the oil sector, planning was made using commodity prices that were much lower than the curve. Today, oil companies’ strategy departments are semi-religious centers dedicated to praying for the price of oil to rise, resorting to conspiracy theories and hopes of OPEC cuts, instead of planning at the low-end of the cycle, as the sector always did.

US companies learned this lesson years ago when they made strategic mistakes because they thought the price of natural gas “could not fall.” Acquisitions were made in the US that required $ 6/mmbtu. But natural gas prices plummeted to $ 2/mmbtu. A reality slap in the face that led companies to go back to basics. Put ROCE in the forefront of strategies and forget the mirage of high debt. Massive capital increases, cuts in capex and restructurings ensued.

Meanwhile, in Europe, big oil companies were launching a strategy of running to stand still. Adding debt, and investing in power and renewables.

To think that the problem of the European oil sector, of its lack of investment rigor and poor shareholder return, is going to be solved with higher crude prices, is to deny reality. Investments have already started to increase – an annualized 8% – even though balance sheets remain damaged and the enormous overcapacity created in the bubble period has not been reduced.

There are opportunities in the oil sector, but I fear they are not clearly defined in Europe. Any hint of hope in European conglomerate valuations requires an act of faith, while in the US, at least the investor has managers who are aligned with investors’ interests and better fundamentals.

If investors believe that oil prices will rise, there are better options in service companies that benefit from the return of investment plans or focused exploration and production companies, where one does not have to take believe in conglomerates. In any case, despite the OPEC “agreement”, crude oil does not easily move out of its lateral range, due to the obvious excess of supply.

The high dividend yield of integrated conglomerates is an indicator that should be carefully analyzed. When those dividends are unsustainable, paid with debt or, worse, with shares, a high dividend yield could be misleading.

I do not like oil conglomerates. They are value traps by the book. They always seem optically “cheap”, but their low multiples are justified by the atrocious profitability, lack of investment rigor and megalomaniac strategic decisions.

The two trends that do interest me are the return of capex, which benefits service companies, and the energy independence of the US, which benefits the focused North American producers. The rest, with all due respect, need to stop hiding under the long-term excuse, do their homework and carry out an exercise of self-criticism and restructuring after decades of empire-building with shareholders’ money. The electricity sector did it. The integrated oil sector, like many banks, continues to believe in unicorns.

Daniel Lacalle. PhD in Economics and author of “Life in the Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.

Image courtesy Google.

 

Greece : In front of a challenging 2017

Europe, Global Economy, On the cover, Sin categoría

Can an economy after a long period of recession to achieve high primary surpluses in order to service a debt that has climbed close to 180% of GDP? Is it preferable to continue a restrictive policy instead of an expansive strategy for possible accelerated growth of the National Product? And finally, what is best for the interests of the creditors themselves? The development or high primary surpluses? After seven years of recession and three memoranda, opinions regarding the fundamental questions remain divided. Europe, at least as regards the Greek issue management insists on a restrictive policy setting as primary objective to achieve the budgetary targets in order to ensure and debt service. Already the IMF formulates different position whereas a country like Greece cannot in the long term to achieve surpluses of 3.5%. It requests directly to a settlement of the debt. So where is the truth?

Greece’s economy grew by 0.8% q-o-q (1.8% y-o-y) in 2016-Q3 in seasonally adjusted terms following 0.4% (q-o-q) in 2016-Q2. Growth was mainly driven by private consumption, investment, and exports. While part of these increases is explained by base effects, short-term indicators overall point towards positive growth in 2016.

Economic activity is up in industry, the retail sector, and tourism, while exports have also regained strength since the shock in 2015. Real GDP growth is projected to have reached 0.3% in 2016 reflecting the improvement in business and consumer confidence since the conclusion of the first review of the ESM program and the good progress that has been made in clearing public sector arrears, which has led to higher liquidity in the corporate sector.

Contingent upon the timely completion of the second review of the ESM program, Greece’s economic recovery is expected to gather pace in 2017 with a growth of 2.7%, on the back of improving financial conditions amid a gradual relaxation of capital controls. Private consumption and investment are projected to accelerate and the contribution of net exports to become positive. Real GDP is expected to continue recovering at a robust pace in 2018, with a growth rate of 3.1%. The labour market has been improving for the last two years. Employment grew by 2.4% on average in the first 10 months of 2016, and is projected to grow at a stable average rate of 2.2% until 2018.

 

Unemployment is projected to have fallen to 23.4% in 2016, down from an annual average of 24.9% in 2015. Unemployment is set to decrease steadily over the forecast horizon, backed by the impact of labour market reforms supporting flexible forms of employment and wage setting. The contribution of net exports to growth was likely still negative in 2016, since imports rose faster than exports amid higher domestic demand.

 

Going ahead, net exports are expected to turn positive, as improved competitiveness and higher investment in the tradable sector spur exports. The decrease in the price level halted in 2016 on the back of higher indirect taxation and rising oil prices. These factors are also expected to underpin a moderate rebound of inflation in 2017 and 2018, along with strengthening domestic demand. Over the forecast horizon, wages are expected to increase along with recovering labor productivity.

Downward risks mainly relate to uncertainties over the completion of the second review of the ESM program and external factors such as international and regional geopolitical and economic tensions, as well as the refugee crisis.

Greece is forecast to reach a general government balance of -1.1% of GDP in 2016. Having overachieved its primary targets of the ESM program for 2015, Greece is set to significantly – by about 1½% of GDP – over-perform the primary surplus target of 0.5% of GDP for 2016 according to the ESM program definition. The composition of the fiscal adjustment is tilted to the revenue side amidst restrained expenditure growth. It follows the adoption of a major fiscal package in the context of the first review projected to yield 3% of GDP through 2018, bringing total fiscal consolidation since the ESM program was launched to 4.2% of GDP. The stronger-than-forecast revenue primarily stems from dynamic growth in underlying tax bases, particularly for indirect taxes and the corporate income tax, but also several one-off factors related to clearing tax liabilities from previous years and stock-piling effects in view of the 2017 hike in the tobacco tax.

Taking into account the adopted measures (in particular personal income tax and pension reforms) and the 2017 Budget, Greece is projected to achieve the ESM program primary balance target of 1.75% of GDP in 2017, even after allowing for the national roll-out of the Guaranteed Minimum Income scheme. The strong revenue performance observed thus far especially in 2016, supported by the ongoing revenue administration reforms, implies considerable upside risks to the forecast which augurs well for the achievement of the target also in 2018. Downside risks include the possibility that the 2017 fiscal reforms could yield less than expected due to implementation risks and the effects of uncertainties over the completion of the second review of the ESM program.

The authorities are expected to adopt the Medium Term Fiscal Strategy for 2018-2021, including any adjustments in fiscal policies needed, to ensure the achievement of the 2018 program primary balance target of 3.5% of GDP.

Overall, the general government balance is projected to reach -1.1% of GDP in 2017 before improving to 0.7% of GDP in 2018. In structural terms, given the still-large output gap, the general government balance is forecast to reach 2⅓% of GDP in 2017 and 2½% of GDP in 2018. On the back of the fiscal outturn projected for 2016 and the stock-flow adjustment related to the clearance of arrears, Greece’s debt-to-GDP ratio is expected to increase from 177.4% in 2015 to 179.7% in 2016. The improved fiscal position and stronger GDP growth are expected to put the debt-to- GDP ratio on a declining path starting in 2017.

Interest expenditure is projected to decrease over the forecast years because old loans are replaced with new financial assistance loans with lower interest rates. The implementation of short-term debt measures in 2017 and 2018 will increase interest expenditure in the short run but will lower it in the long term and smoothen the debt repayment schedule.

By Thanos Niforos, Economist & Investments’ Advisor*
Thanos is an experienced investor & government relations practitioner with wealth management, corporate & project finance transactions in Greece, UK, Belgium, Chile and USA.

Face It, Technology Does Not Destroy Jobs

Global Economy, On the cover, Sin categoría

If you read some newspapers and politicians’ comments, it seems that technology companies are a threat and robots will take your job . The idea is interesting, and has populated hundreds of pages of science fiction books that feed on a dystopic view of the future where humans are only an annecdote.

It’s an interesting idea, there’s only one problem. It is a fallacy.  

The idea that technology will destroy jobs starts with exagerated estimates – as always – with the objective of presenting a world in which there must be an intervention – fiscal, of course – from governments, in order to save you from a future that has always been wrongly predicted … But this time it’s different.

The empirical evidence of more than 140 years is that technology creates more jobs than it destroys (read here ) and that there is nothing to fear  of artificial intelligence. Randstad studies  show that technology will create more than 1.25 million jobs in Spain alone over the next five years.

The empirical evidence of more than 140 years is that technology creates more employment than it destroys

Evidence shows us that if technology really destroyed jobs, there would be no work today for anyone. The technological revolution we have seen in the past 30 years has been unparalleled and exponential, and there are more jobs, better salaries. The best example is the German region of Baviera, one of the parts of the world with a higher degree of technification and robotization, and with a 2.6% unemployment. An all-time low. The same can be said about South Korea, and the world in general.

When I started to work in 1991, they told us that machines would take our jobs. Today, there is a lower unemployment and the workforce has grown massively. Today, they tell us the same thing. If 47% of jobs are going to disappear in 20 years, many more will be created .

Most of the jobs we know today did not exist ten years ago. Technology does not destroy employment, what it does is free capital from obsolete sectors to new sectors and, thereby, improve the quality of life of all and, in addition , create many more direct and indirect employment.

Technology only destroys jobs we do not want anyway

In fact, technology only destroys the jobs we do not want anyway. What society, all of us, must do is to create the conditions for us to be prepared for the new world. To be prepared does not mean to make us all computer engineers, but to understand that our capabilities are not just our decree or tasks, but a whole set of skills that have enormous value in a modern society. “Low skilled workers” are only viewed as unemployable because our analysis of valuable skills is based on obsolete views of jobs as tasks, instead of the inmense possibilities of many other high-value characteristics that those citizens possess apart from the specific labour they have conducted. A construction worker can be a terrific salesman or a great customer service consultant.

Technology does not destroy jobs, politicians do.

What does not work, nor has it ever worked, is to try to put barriers to technoligy, penalize the efficient, try to stop progress, with the objective of perpetuating obsolete sectors under the excuse of “employment”. It neither defends the existing jobs nor solves the problem.

If politicians want to defend the job, why not ban tractors and put the whole world to work in fields, like Pol Pot?. You may say this is an exaggeration, but this nonsense is the same fallacy as placing barriers to technology to perpetuate obsolete jobs.

Interestingly, those same people who “predicted” the end of oil, water scarcity, massive food shortages, the end of pensions, hyperinflation and slavery to machines, all wrong, are the ones who say “this time is different “, today.

Let us be clear. All that is sought by promoting scaremonging estimates is to find an excuse to increase your tax burden . Not for jobs. If politicians really cared about employment, they would be giving tax breaks to technology companies and start-ups to train workers on high-added value jobs and helping them adapt to change, not squandering funds in useless subsidies. Less basic income and more basic knowledge .

The problem is not artificial intelligence, but natural stupidity.

The tax assault on technology companies is not a coincidence. It seeks to perpetuate obsolete industrial conglomerates, which in Europe have turned into covert social security systems and, instead of seeing high-tech companies as guarantors and leaders of the change of the growth pattern, that create jobs and improve our quality of life Of all, it seeks to prevent change . The aim is to have citizens as hostage clients, addicted to Huxley’s Soma of State subsidies via welfare. It is more comfortable to subsidize idle capacity than promote progress.

Instead of making it possible for technology companies to grow and develop in Europe, politicians seem to prefer to subsidize low-added value sectors that generate sub-employment … and if a company buys a machine, a bureaucrat will decide how many jobs it is supplanting, only to pass the tax bill. Can you imagine if the hat manufacturers would have succeeded when they went on strike against Ford’s evil new automobile? Today, we would have all paid much more for cars and, above all, the hat industry would have succumbed anyway. Because putting barriers to progress is useless, and very expensive .

The technological debate cannot be addressed from dystopian estimates that have proven to be false time and time again since Malthus. But it is even worse when it is viewed from a fiscal repression point of view. You and I already know that there is a huge perverse incentive to present apocalyptic predictions because the trick is that you will pay the tax bill.

If politicians truly believed the apocalyptic scenario they paint, and really cared about jobs, they would do everything and more to attract investment and technology companies, not try to support their dinosaur telecommunications conglomerates via subsidies and entry barriers. And, of course, they would not attack those who lead change and generate innovation. They would be more like Ireland and less like Greece.

The probability that technology and the democratization of information generate more prosperity, employment and well-being is almost 100%.

If politicians were truly concerned about technology and digitization, they would not focus on whether taxes should be paid in profits centers or in customer locations. The benefits of technological multinationals comes from their intellectual capital (technology, software, algorithms) that makes services efficient and inexpensive. If interventionists were concerned about robotization and employment, politicians would be facilitating the creation of thousands of technology companies, not putting fiscal and regulatory barriers . They would be encouraging technological investment, not subsidizing idle capacity.

What politicians and those who make flawed 50 year predictions know is that the probability that technology and the democratization of information will generate more prosperity, employment and well-being for all is almost 100 percent.

What they also know is that it jeopardizes a rent-seeking revenue system that feeds many cronyist networks.

Technology does not destroy jobs. Politicians do. Never bet against human ingenuity.

 

Daniel Lacalle. PhD in Economics and author of “Life in the Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.

Image courtesy Google.

Video: Explaining the divergence between US and Europe markets

Global Economy, Media, On the cover, Sin categoría

While the US market reached new all-time highs, Europe remains weak, despite a positive earnings season and slightly improved guidance.

In this short video we explain some of the reasons for this divergence, that continues to widen despite the calls from analysts to switch out of US and into EU stocks.

 

Daniel Lacalle. PhD in Economics and author of “Life in the Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.

Image courtesy Tressis.