Friday, August 28, 2009

Going Green Goes Bust: Ethanol Businesses In Crisis

Back in late 2007, I wrote this post concerning Congress and energy policy. In that piece, I quoted an article which read, in part,

In its efforts to set the U.S. on the road toward energy independence, Congress may be constructing a detour.The House and Senate have passed separate energy bills and are now working on combining the two into final legislation that could come up for a vote by the end of the year.Both bills are designed to lessen American reliance on foreign oil, in part by mandating far greater use of corn-based ethanol and so-called cellulosic ethanol, which is made from biomass like grasses and wood chips. The Senate bill also calls for higher fuel-economy standards.Here's the catch: Anything that creates uncertainty about demand for gasoline over the long term means less incentive for refiners in the U.S. to expand their capacity. And that means greater reliance on gasoline imports in the near term, at least until ethanol becomes a mainstream fuel. And that, of course, is the opposite of energy independence."

It was thus with some amusement that I read an article in yesterday's Wall Street Journal entitled, "Turmoil in Biofuels Threatens Green Energy Revolution."

Without going into massive detail, the piece notes that several factors have recently coincided to derail the holy grail of replacing oil with ethanol-based fuels for transportation.

Specifically, oil's price decline to the neighborhood of $70/barrel, and a global recession, have completely changed the assumptions initially governing the US government's alternative energy subsidies.

Thus, many of the once-touted green energy initiatives are going bankrupt. Ethanol isn't being produced in the quantities imagined only two years ago.

One of the howlers is that the sanctimonious Silicon Valley mogul, Vinod Khosla, unwittingly backed a scam in which Cello Energy of Alabama produced fuel from conventional petroleum sources and claimed it was green-based. A rather damning passage in the Journal's piece states,

"This year, Khosla representatives took samples of diesel produced at the new Cello plant and sent them off for testing. The results showed no evidence of plant-based fuel: Carbon in the diesel was at least 50,000 years old, marking it as traditional fossil fuel. The EPA wasn't told about the test, and continued to rely on Mr. Boykin's original claims when it asserted in the Federal Register in May that Cello could produce 70% of the cellulosis fuel targets set by Congress that are due to take effect next year."

One other rather comic effect of the biofuel producers' sudden financial woes is the looming prospect of a government bailout of this new sector. Because the current administration made alternative energy such a showcase issue, it may be politically necessary for this third major bailout. It's ironic, of course, because it was thanks to government mandates and subsidies that anyone took this form of energy production seriously in the first place.

I love economics in part because it can't be fooled. Governments can subsidize and legislate to distort returns and costs. But even such actions have costs, and these, too, have to be borne by voters. Eventually, horrendously expensive, wasteful government programs become apparent.

Some, like the dairy and sugar industries' shameful subsidies, continue because the costs/consumer are so small, while the benefits/producer are so large.

But in the case of alternative energy, there are huge new investments and uncertain scaling up of new energy production technologies. And, of course, as the Journal article notes, we still have the distressing fact that if all current US vegetable and animal fat output were used to produce ethanol, it would provide only 7% of diesel fuel used in the country.

The economics are simply against long-term usage of large amounts of vegetable-based energy. It's not as powerful per unit of volume as petroleum, and never will be. You could more easily and efficiently liquefy coal than you can convert foodstuffs into transportation fuel.

Perhaps in this recent era of federal bailouts and massive deficits, the green energy sector will be one too many sectors to save. Especially as it may not be well-enough established to have the political clout on its own to sway federal legislators.

Thursday, August 27, 2009

Citigroup's Recent Performance

I recently witnessed a discussion of Citigroup's recent total return, and whether it was now a legitimate investment vehicle. I can't recall the exact timeframe, but the price change cited was something like +300% or more.
Being curious, I produced the nearby Yahoo-sourced price charts for the ailing, government-owned bank and the S&P500 Index prices for the past 6 months and 2 years.

For the former, Citi's return looks to have been about +150% since early April. From the 2-year chart, it's clear that the low was prior to that, in March, which would boost that return a bit.
But looking back only through early this year requires an investor to have been engaging in speculation and market-timing.
The 2-year chart, more to my preference in terms of duration, shows the S&P to be a far superior investment, with Citigroup losing between 70% and 80% of its value. Additionally, with a background of the prior two years, the last few months don't look quite so stunning.
To me, Citigroup's recent performance is all too typical of the many companies capable of beating the S&P by a wide margin for any single year. The causes of such returns can be many, but I learned years ago, from my proprietary performance research, that one year of outsized total return performance does not an investment make.
That's why I look over a longer term. It's just not statistically significant to look at one-year, or less-than-one-year returns and pronounce a company to be a desirable investment.
Between the government's continued ownership of much of Citigroup, and the overall weakness in both business and consumer lending, plus the largely-intact, dismal management team at Citigroup, I'd stay far away from the company as a candidate for consistently outperforming the S&P for the next few years.

Wednesday, August 26, 2009

Ben Keeps His Job!

The big news yesterday was that Ben Bernanke was nominated to a second term as Fed Chairman.

Of course, the pundits were running wild on air and, today, in print.

But it probably all boils down to what one observer noted in a discussion on CNBC yesterday morning.

Basically, he opined that if Obama had nominated Larry Summers, and the economy didn't straighten out flawlessly, or anything else unexpectedly bad occurred in the financial sector, then the administration would own the result. Period.

This way, the president can try to cling to some last vestige of the prior administration, blaming them and then-, and still-Fed Chairman Bernanke for the mess. The logic is that Ben can stay to clean up the mess that occurred on his watch, with no new problems interjected by the new administration via a new Chairman.

It's a sensible explanation. And, God knows, Bernanke has prostrated himself humbly, and reflated the economy massively, in order to secure that reappointment.

Personally, I'm of the opinion that, because it's a nomination for the Fed Chairman, whether a "renomination," or not, Obama will still own the results.

If bad, one could argue that he should have changed horses from the guy who let things spin so badly out of control through, at the very least, a failure of the Fed's bank oversight function.

But, the die is cast. It would be unlikely, and a very important signal, if a Democratic Senate doesn't confirm Bernanke to another term.

The wait is over. Now, perhaps we'll see the hard work begin- raising interest rates and draining excessive liquidity from the US and worldwide economies.

Tuesday, August 25, 2009

Martin Feldstein On Rationing Health Care

Martin Feldstein wrote a scathing piece in last Wednesday's Wall Street Journal concerning "ObamaCare."

I found Dr. Feldstein's piece particularly illuminating because he noted an important fact which I had heretofore not realized,

"Although administration officials are eager to deny it, rationing health care is central to President Barack Obama's health plan.

One reason the Obama administration is prepared to use rationing to limit health care is to rein in the government's exploding health-care budge. Government now pays for nearly half of all health care in the U.S., primarily through the Medicare and Medicaid programs. The White House predicts that the aging of the population and the current trend in health-care spending per beneficiary would cause government outlays for Medicare and Medicaid to rise to 15% of GDP by 2040 from 6% now. Paying those bills without raising taxes would require cutting other existing social spending programs and shelving the administration's plans for new government transfers and spending programs."

Thus, a flawed approach to government-sponsored medical care from the 1960s haunts us today.

Thank you, LBJ and the Democratic Congress of that era. Logically, Feldstein observes that this wouldn't be a problem, were government to reduce its role in health care funding,

"The rising cost of medical treatments would not be such a large burden on future budgets if the government reduced its share in the financing of health services. Raising the existing Medicare and Medicaid deductibles and coinsurance would slow the growth of these programs without resorting to rationing. Physicians and their patients would continue to decide which tests and other services they believe are worth the cost.

There is, of course, no reason why limiting outlays on Medicare and Medicaid requires cutting health services for the rest of the population. The idea that they must be cut in parallel is just an example of misplaced medical egalitarianism."

Again, Feldstein's logic is sharp and unerring. Why do all of us who pay for our own health insurance and medical care have to suffer just because government is bungling the management of health care for the poor and/or elderly?

Next, Dr. Feldstein attacks the tax-preferenced nature of privately-funded health care,

"While an extra $100 paid to someone who earns $45,000 a year will provide only about $60 of after-tax spendable cash, the employer could instead use that $100 to pay $100 of health-insurance premiums for that same individual. It is therefore not surprising that employers and employees have opted for very generous health insurance with very low copayment rates.
Since a typical 20% copayment rate means that an extra dollar of health services costs the patient only 20 cents at the time of care, patients and their doctors opt for excessive tests and other inappropriately expensive forms of care. The evidence on health-care demand implies that the current tax rules raise private health-care spending by as much as 35%.

The best solution to this problem of private overconsumption of health services would be to eliminate the tax rule that is causing the excessive insurance and the resulting rise in health spending. Alternatively, Congress could strengthen the incentives in the existing law for health savings accounts with high insurance copayments. Either way, the result would be more cost-conscious behavior that would lower health-care spending.

But unlike reductions in care achieved by government rationing, individuals with different preferences about health and about risk could buy the care that best suits their preferences. While we all want better health, the different choices that people make about such things as smoking, weight and exercise show that there are substantial differences in the priority that different people attach to health.

Rationing is bad policy. It forces individuals with different preferences to accept the same care. It also imposes an arbitrary cap on the future growth of spending instead of letting it evolve in response to changes in technology, tastes and income. In my judgment, rationing would be much worse than excessive care."

Thus, Feldstein provides a coherent, sensible, exhaustive economic basis for rejecting the proposed universal, single-payer health care system, and, instead, fixing the current mess by correcting tax-based biases, allowing those who can afford to buy their own health care to do so without suffering due to government funding problems for the poor.

Finally, he reminds us, as the good economist that he is, of the target which we should not fail to keep in sight,

"Those who worry about too much health care cite the Congressional Budget Office's prediction that health-care spending could rise to 30% of GDP in 2035 from 16% now. But during that 25-year period, GDP will rise to about $24 trillion from $14 trillion, implying that the GDP not spent on health will rise to $17 billion in 2035 from $12 billion now. So even if nothing else comes along to slow the growth of health spending during the next 25 years, there would still be a nearly 50% rise in income to spend on other things."

The national economy, if left to grow as it has in the past, will provide income to allow people to afford more health care, should they choose that as a spending option.

A key part of the solution, though, is to quite making government the ultimate payer for all health care, thus requiring rationing of public spending on private health matters, and allowing each person to choose their own health care options using their own money, or that which the public has decided to allot to them.

Monday, August 24, 2009

Bad Economics Disguised As Healthcare Reform

Several times in the past year or so, I've written critically of Boone Pickens and his ilk crying that Americans spend "too much" on imported oil.

How, may we ask, can Boone know what "too much" is? Price is the economic allocator of scarce resources. Ostensibly, those Americans who have bought petroleum products refined from imported oil did so because they had uses for the oil more valuable than its price.

It's the same with health care.

A recent Wall Street Journal editorial, Craig Karpel claimed we are spending too little on health care, not too much. Why? First, he notes some very sensible economic facts,

"Mr. Obama has said that "the cost of health care has weighed down our economy." No one thinks the 20% of our GDP that's attributable to manufacturing is weighing down the economy, because it's intuitively clear that one person's expenditure on widgets is another person's income. But the same is true of the health-care industry. The $2.4 trillion Americans spend each year for health care doesn't go up in smoke. It's paid to other Americans.

The basic material needs of human beings are food, clothing and shelter. The desire for food and clothing drove hunter-gatherer economies and, subsequently, agricultural economies, for millennia. The Industrial Revolution was driven by the desire for clothing. Thus Richard Arkwright's water frame, James Hargreaves's spinning jenny, Samuel Crompton's spinning mule, Eli Whitney's cotton gin and Elias Howe's sewing machine.

Though it hasn't been widely realized, the desire for shelter was a major driver of the U.S. economy during the second half of the 20th century and the first several years of the 21st. About one-third of the new jobs created during the latter period were directly or indirectly related to housing, as the stupendous ripple effect of the bursting housing bubble should make painfully obvious.

Once these material needs are substantially met, desire for health care—without which there can be no enjoyment of food, clothing or shelter—becomes a significant, perhaps a principal, driver of the economy."

These are important and reasonable statements. It's simply ludicrous for anyone, especially an economically illiterate, newly-elected, politically-immature president to state that any one sector has "too much" spent on it, when that spending is the result of consumer choice.

Then, for the first time in my memory, I actually read a cite of some economic research on the topic. Karpel continues,

"In a 2007 study, Stanford University economists Robert E. Hall (who will take office next year as president of the American Economic Association) and Charles I. Jones reported that modeling they've conducted has found that mid-21st century U.S. health-care expenditures would optimally amount to 30% of GDP or more. They wrote:

"We examine the allocation of resources that maximizes social welfare in our model. We abstract from the complicated institutions that shape spending in the United States and ask a more basic question: from a social welfare standpoint, how much should the nation spend on health care, and what is the time path of optimal health spending? . . .

"Viewed from every angle, our results support the proposition that both historical and future increases in the health spending share are desirable. . . . [W]e believe it likely that maximizing social welfare in the United States will require the development of institutions that are consistent with spending 30 percent or more of GDP on health by the middle of the century." "

As our life expectancy increases, is it not reasonable to expect that we, as a nation, will spend more of our increasing disposable income on health care? More people are more active at older ages than in decades past. Joint replacements are more common.

Why should our government unilaterally decide how much is "too much" health care for Americans to buy?