US gas glut may dampen energy markets

Article first appeared at MacroBusiness

The US economy has shown some signs of stabilisation over the past few months.  For example, retail spending appears to be revisiting a growth path.  According to some commentators, the US economic green shoots appear robust and healthy, while I remain cautious about projecting anything more than muddling though, with a drawn-out grinding improvement in employment as the consumer debt burden is reduced by inflation, repayment and default.

The US ‘recovery’ is the result of many factors, including the relatively cheap US dollar (the US TWI is back at levels last seen in the mid 1990s), but importantly, and often overlooked in financial discussions, relatively cheap domestic energy fuel prices.  WTI crude is hovering around $100/barrel, still 25% down on the pre-crisis boom period.

But the key energy consideration for the US recovery, and future US political–economic trade policy, is the current domestic natural gas boom which has meant the US has shifted from gas net importer to net exporter.

Below we can see the recent rise in natural gas production, mostly as a result of the emergence of economical shale-gas extraction, for the past three years or so.  With natural gas comprising a quarter of domestic US energy needs, the scale of this boost in energy supply is significant.  Some have gone so far as to suggest that the natural gas boom, as a result of fracking and coal seam technology, is leading to a ‘new world energy order”.

We can also see that the US domestic spot price for natural gas has remained quite subdued in this period due to a combined of demand destruction, particularly during the financial crisis period between 2008 and 2010, and increased domestic supply.

The US government closely regulates natural gas exports, and any import or export of natural gas requires approval of the Department of Energy, as per Section 3 of the Natural Gas Ast 1938. (approvals in progress are here).

Debate is now brewing over the direction of US energy policy in the treatment of export approvals for the natural gas glut, given the significant profits to be made from liquefaction and export to Asian markets.

As the Wall Street Journal notes:

The U.S. already exports some natural gas, mostly via pipeline to Canada and Mexico. A recent wave of export proposals by energy firms seeks to liquefy gas and ship it overseas in tankers.
U.S. natural-gas prices have fallen below $3 per million British thermal units, pushed down by swelling production that became possible with the advent of new drilling technologies. With prices so low, U.S. producers are eager to reach customers in other parts of the world, such as Japan, that pay three to four times as much as U.S. users.
Collectively, they want to ship out about 14 billion cubic feet of natural gas a day, roughly 20% of current U.S. production.
But some lawmakers on Capitol Hill are opposed to increased exports and are urging the Department of Energy not to issue the required permits. The department will use the findings released Thursday in making its decision.
The administration is reviewing the export proposals “to ensure they are in the best interests of American taxpayers,” Energy Department spokeswoman Jen Stutsman said.

One argument is that maintaining a tight limit on exports will keep the domestic price low, and domestic energy intensive industry more globally competitive:

 The estimate by the Energy Information Administration, which compared gas-price projections in given years with and without higher exports, appeared to bolster assertions by U.S. manufacturers that they could face stiffer prices for natural gas and lose a competitive edge over companies abroad.
“Higher levels of exports would certainly impact the manufacturing recovery that has been revitalized in the U.S.,” said George Biltz, Dow Chemical Co.’s vice president for energy and climate change. “Exporting too much natural gas simply exports well-paying U.S. jobs.”

US Energy Information Administration (EIA) analysis of price impacts from increased exports shows that, under various scenarios, of high and low growth paths for shale-gas production, and rapid and slow scale up to exports, domestic price increases could be in the order of 15-35%, depending on the speed of development of export capacity.  See their chart of model results below.

As secondary concern has been whether exposing US domestic natural gas production to the global market will import price volatility due to global events.  If export capacity is high enough, this may be the case.  But if export capacity is limited by physical capital – the number and size of pipelines, and finite capacity of LNG conversion and loading facilities which would require a decade or so lead time to expand – then domestic prices will not capture global volatility, as high prices cannot be passed through to the domestic market.

The big question for US energy policy, is how best to share the benefits of this new energy supply.  The way I see it, maintaining tight control on export markets keeps prices for domestic gas users at a globally low level, making a diverse range of US industries more globally competitive.  However, this benefit comes at a cost to the gas industry that is being denied access and profits from global markets, such as Japan, Korea, China and India, where gas prices are significantly higher.

Indeed, allowing exports would in a way provide economic benefits to the destination countries, as the global price of LNG will be reduced as the increased supply comes on board.  For Australia, where the infant Coal Seam Gas (CSG) industry is being relied upon as a driver of economic growth, increased global competition in the gas market from US exporters may be cause to pull pack some of their price forecasts in the short term. Last week, Fitch placed the entire sector on negative watch for this reason among a growing list of other negatives.

The current US debate is interesting from the lens of an Australian resource State, where almost all energy resources are developed for export markets.  It is surely inconceivable that Australian authorities would consider such regulation to ensure competitiveness among our own industry. (Although, as mentioned earlier, the ability for export markets to compete with domestic energy markets is dependent on the interconnection of the supply chain.)

It is worth keeping a close eye on how US energy policy plays out in the treatment of the shale-gas boom, and the potential implications for LNG markets globally.

Tips, suggestions, comments and requests to rumplestatskin@gmail.com + follow me on Twitter@rumplestatskin

Why not adopt NZ’s no-fault national insurance

New Zealand is a beautiful country with great people and a relaxed attitude. One factor that supports a relaxed attitude is New Zealand’s national enduring no-fault accident insurance scheme, which eliminates some the perceived legal risks that can stifle innovation, new business, increase medical costs, and reduce private land utilisation.

I want to take the time to examine this important issue, by looking at the history and performance of the New Zealand scheme, in its various iterations, and compare this to the scope of State and national accident and health insurance provided in Australia. I will preface the discussion by noting that I am not a legal scholar, but an economist looking at the behavioural incentives provided by the legal framework.

So what is this no-fault insurance scheme I speak of?

As one of my Kiwi friends put it, imagine workers compensation for all accidents for all residents and guests in New Zealand. Yes, that includes Rugby World Cup players. In its latest incarnation, the scheme is governed by the Accident Compensation Act 2001, which created the Crown organisation the Accident Compensation Corporation (ACC) (although the legal structure is a little more complex than that).

Funding is provided through various payments, with accounts kept for different types of accidents, such as work injuries, non-work injuries, treatment injury (medical malpractice), and motor vehicle injuries – in all, a comprehensive national accident insurance scheme.

One key feature of the New Zealand scheme is that the legislation, by providing national insurance, removes the ability of accident victims to sue for damages even is such cases as fault could be determined (apart from strictly defined exemplary damages). The origins of this important provision include concerns over wasted legal effort, and sometimes impossibility, of proving fault in accident claims, and the lack of support of victims of no-fault accidents.

This is quite different from Australian tort law, where damages for negligence can be sought from those at fault, provided they meet a few criteria -

• A duty of care must be found to exist. 
• The duty of care must be breached. 
• Damage or injury, not too remote, must result from the breach. 

The legal profession uses the term the ‘public liability and professional indemnity insurance crisis’ to describe they way insurance markets responded to ever increasing claims for damages with higher prices and less availability in Australia around the turn of the millenium. This has serious implications for social clubs and sporting organisations, medical professionals, and private landholders who allow third parties to conduct activities on their land (an angle I will revisit later).

The Americans have been eyeing off New Zealand’s national no-fault insurance scheme because it appears so remarkably affordable. Regarding medical ‘misadventure’ not only are damages paid lower in New Zealand than under America’s tort system for claiming damages, but the administrative costs make up only around 10% of expenditure, compared to 50-60% under the US tort system. While some criticize a no-fault system as a no accountability system, the reforms to New Zealand’s scheme have included accountability for doctors and disciplinary hearings.

There is even regard for New Zealand’s scheme because it automatically provides accident insurance in the case of terrorist events.

Of course, some have criticised the scheme as inadequate. One argument often presented, that doesn’t seem to hold water, is that:

...the losses from the elimination of the tort system go further than just removal of incentives to minimise loss. They also remove the information base from which monitoring activities can be designed and upon which education to prevent future loss relies. Both of these are vitally important factors in a system that is heavily dependent on overt monitoring to achieve a socially optimal outcome. (here)

However, having a central agency, if structured well, would greatly enhance the information base about risks and risk education. A haphazard arrangement of private insurers, and unpredictable court decisions would be a maze to navigate if one wanted to get an appropriate estimation of risk levels.

The critics of such a scheme are those you might expect to benefit from its abolition – the business community who would take over insurance provision, and the legal profession.

While certainly a minority, there is a vocal constituency, comprised largely of individuals from the business community, who seek outright abolition of the no-fault system and a return to the common law tort system. Chief among these critics is the New Zealand Business Roundtable, which considers the accident compensation scheme to be an “unjustifiable intrusion by the state upon individual freedom and decision making” and would like to see it disappear altogether. In 1998, the Roundtable proved successful, if only temporarily, in its goal of dismantling the accident compensation system with the enactment of the Accident Insurance Act. Bolstered by substantial support from the Roundtable, the Act signaled a significant policy shift toward contraction of accident compensation coverage. By suspending the ACC’s statutory monopoly on the administration of benefits and beginning the process of privatizing the ACC, the Act ended most mandatory insurance coverage until the statutory re- institution of the ACC’s monopoly in 2000.

This temporary setback was the product of a clash of political ideals and a shift in political power.

Don’t get me wrong. New Zealand’s scheme is not perfect, and neither are any other national or State regulations for the provision of accident insurance, whether at work, in motor vehicles, or during domestic and recreation activities. New Zealand’s scheme has a checkered history of changing scope of coverage, cost blow-outs, and changes of government and direction.

Cost blow-outs were quite dramatic in the early decades of the scheme, with expenditure growing 8 fold in real per capita terms between 1974 and 2000. What this means in income adjusted terms I am not sure, since even with a set of identical claims and outcomes, the cost of the scheme is always going to at a rate closer to wage growth, than consumer price growth (since income compensation occurs are a proportion of previous incomes, and medical costs are closely linked to labour costs – see here for more explanation on this principle)

Other criticisms come in the form of questioning the moral hazard problem. Won’t everyone in New Zealand simply stop caring? Won’t business allow their patron to take extravagant risks? Will compensating behavior lead the outcomes from the scheme to be far from optimal?

The answers to the questions are all simply no. Studies have shown that risk of medical misadventure in New Zealand sits very close to the average of its peers (halfway between the UK and Australia by the way). In terms of serious injuries to workers, New Zealand outperforms all Australian States bar Victoria in terms of population adjusted workers compensation cases.

In fact, the ACC has a role to prevent injury and has adopted an approach of being a provider and safety information and regulatory advice.

New Zealand’s system, while it appears quite radical, is inherently similar to Australia’s public health care and welfare system from the point of view of an injured person, in terms of health care, rehabilitation, and lifetime income support (although income support in Australia is at subsistence welfare levels rather than a portion of previous income as in the New Zealand scheme).

In the realm of motor vehicle and workplace accidents, Australia has similar national or State insurance/compensations schemes in place (or compulsory private insurance), and it wouldn’t be such a great leap to expand our insurance systems to include all injuries. In fact, only about 25% of the serious injuries are not covered by statutory insurance requirements.

Data has shown that 61% of catastrophic injuries in Australia come under the motor vehicle scheme, 13% are part of workers’ compensation, 11% are due to medical negligence, and 15% fall under public liability. (here)

Some States in Australia have also reformed tort law to cap damages claims, and make scope for damages more narrow. This has gone some way to reducing civil matters that can clog our court systems to the advantage of the legal profession.

After all this rambling, will you now tell us why you are so interested in this scheme?

Yes, thanks for interrupting me.

In everyday life I see liability insurance as a great hindrance to social and economic activities. Local sporting competitions are often burdened by the costs of insurance, which are often directly attributable to legal costs under the tort system, and expectations of damages claims. Adventure sport and tourism, New Zealand’s great exports, would have a much more difficult time if they could not pool their liability insurance across all the diverse activities occurring in New Zealand.

Even if our current system does restrict liability, the uncertainty and difficulty in interpreting legal accountability, is itself a hindrance to emerging social and economic activities.

The NSW parliament has shown some interest in no-fault State accident insurance after the decision of the High Court to reinstate the award of $3.75million in damages to Guy Swain, a man rendered quadriplegic after diving into a wave and hitting a sandbank at Bondi Beach in 1997 (here). Waves of ‘insurance crises’ have led to continual tort reform, but in 2005, Bob Carr announced that the government was working on a no-fault scheme of insurance.

It is these types of legal and damages costs that Councils, community groups and landowners fear.

Doctors face hefty costs to start up their own practice, and often the risks involved from medical malpractice suits leads to over mediation, and excessive treatment. Since medical costs in the public system are already paid for by the public at large, wouldn’t any measure to reduce costs be beneficial? In the US, these so-called ‘defensive’ medical treatments are estimated to cost around $45billion per year.

Lastly, the liability of property owners for injuries from activities on their land does stifle economic activity. For example, would you allow an adventure sport race on your farm if you knew that there was a slight chance of being held liable for injuries to participants? Or would you allow campers on your land? What about paragliders launching and landing? I know from speaking with the paragliding community that liability concerns have made many landholders reluctant to continue to allow launching from sites on their property, and these same concerns extend to local Councils.

Removing the fear of legal action in the case of injury (whether real or perceived), by making all accident insurance compulsory and national, will help lubricate the economy by enabling those very small businesses and community groups to conduct activities they would otherwise fear to undertake.

Australia, and many other countries, are incrementally heading towards the basic principles of New Zealand’s national scheme, as the economic benefits from the elimination of the right to damages apart from in exemplary cases, provides society wide benefits.

I don’t see a sudden change in this direction, but with ongoing parliamentary interest, and recurring insurance crises, we may yet reach a point where the net effect of our complementary insurance scheme is much the same as New Zealand’s scheme, simply by default.

Any input from people who have been injured in New Zealand, or worked in this area of law would be greatly appreciated.

Living away from the tax man

This post originally published at MacroBusiness

The Commonwealth Treasury released a consultation paper last month on propose reforms to Fringe Benefits Tax (FBT), particularly, the tax treatment of Living Away From Home Allowances (LAFHA).

Apparently there are two major concerns leading to this reform.  The first, but unstated reason, is to increase tax revenue – which is more clearly articulated in the Treasurer’s statement:

LAHFA tax-free increased from $162 million in 2004-05 to $740 million in 2010-11.  The reform will raise taxes by $683.3million over the forward estimates.

The second reason is described as follows:

A particular concern is the growing use of the concession by employers (including through labour hire and contract management companies) to allow temporary resident workers coming to Australia to convert their taxable salary into a tax‐free allowance. This provides them with an unfair advantage over local Australian workers.
… An area of growing concern is the use of LAFHA by employers (including through labour hire and contract management companies) to attract temporary resident workers to Australia by including tax‐free LAFHA payments as part of their remuneration. These payments are effectively a re‐characterisation of taxable salary or wage income
…The changes will ensure a level playing field exists between hiring an Australian worker or a temporary resident worker living at home in Australia, in the same place, doing the same job.

Indeed, as the paper suggests,

The living‐away‐from‐home allowance is one of the most popular searched terms for workers on the 457 Visa.

So what are the changes?

Put simply, to claim accommodation costs and food expenses as a fringe benefits tax exempt LAFHA allowance, the employee must maintain a home in Australia they are living away from for work.   This is a change from the current treatment whereby there needs to be no evidence of actually living away from an Australian home for temporary visa holders (who, by definition, are living away from home, although not required to actually maintain a home).   They, and their employer, are simply enjoying a tax advantage compared to a local worker.

The second change involves tightening the qualifying criteria to ensure that any FBT exempt LAFHA reflects the actual costs incurred. The below table summarises the proposed new tax treatment.

We know that this will turn off a $683million tax loophole.  But just how many people could have their working conditions affected by the change? And what flow-on effects can be expected?

First, temporary residents on 457 visas are they key group able to access LAFHA tax advantages, and will be the main group affected by the reforms.  We can see in the table below that there has been a significant boom, and tapering in 457 visa numbers since the mid 2000s.

Currently, around 1% of the workforce is made up of the approximately 110,000 457 visa holders, but this is expected to grow over the coming years, as reforms implemented in November allow for a more streamlined visa approval process, and longer stays of six years.

I imagine the likely flow-on effects to be most acute in the real estate markets of mining-boom towns.  The new incentive means that domestic and foreign workers may prefer fly-in fly-out arrangements, as relocating becomes less attractive in after-tax terms, even if the cost of employment to the company is the same.

In terms of rental markets nationally, this will take tiny slice off demand at the margins, as this foreign workforce, occupying around 3% of rental homes, will be less enthusiastically spending tax-free income on accommodation.  The top end of the city markets will see much of this change.

The big question politically is whether this will have much of an impact on the demand for overseas skilled workers, and whether it will encourage the education and training of local workers by industry groups for their own future benefit.  I can’t say there being a major impact, but the uproar from the employment agent industry seems to suggest that the impact on the ease of attracting foreign workers may be significant.  At any rate, these reforms will provide a better set of incentives for local skill development.

Tips, suggestions, comments and requests to rumplestatskin@gmail.com + follow me on Twitter@rumplestatskin

BRICs can't hold the wall

This post first appeared at Macrobusiness

Not a day goes by when some economic commentator notes the ‘decoupling’ of economic growth of the developed and emerging economies. Europe looks almost certain to have a 2012 recession, and the US continues to have doggedly high unemployment with very soft conditions all around. Brazil, Russia, India and China, the BRICs, are meant to be taking up the slack, especially with domestic demand in China, to keep global growth on track.

But just as my suburb has a hard time decoupling from the rest of the city with which we trade our goods and services, the BRICs are nestled solidly in the layered courses of the integrated global economic masonry.

In the least reported economic news of the month, Brazil’s GDP was flat in the September quarter.  During 2010, Brazil’s economy grew 7.5%, while the year to September 2011 saw a mere 2.1% growth, with an obvious trend – down.  I am not sure what is on the horizon turn this around for Brazil, apart from a surprise boost in economic activity in Europe and the US (chart from here):

India was expected, much like China, to continue to grow at double-digit rates, but has just recorded its slowest GDP growth for two years, at 6.9%.  Particularly:

The manufacturing sector, which contributes nearly 16 percent of GDP, grew at a measly 2.7 percent, down from 7.8 percent a year ago. Agricultural output rose an annual 3.2 percent for the same period, down from5.4 percent a year ago.
The worst hit was mining, which showed a decline of 2.9 percent after growing by 8 percent in the same period last year.

Here is how Indian GDP growth has looked since 1990, with the September annual measure marked in addition to the annual measures:

The trend path for growth in India is looking to be heavily influenced by external factors.  Of course, exports make up about 20% of the Indian economy, so one must take external conditions into consideration.  Further, around 32% of the Indian economy is involved with capital investment, which can be easily scuttled should prevailing global market conditions render the financial returns unattractive.

Russia is bucking the trend a little, with GDP growth up from 3.4% annual in the second quarter, to 4.8% over the year to September 2011.  Currently this appears stable, but relatively slow.

Which brings us to China.  Well, I’m not sure what more I can add on China, but the image below shows that growth is remains high, but is doesn’t appear to be taking off in a hurry.  Annual growth has been steadily falling for the past 18 months, from 12% in early 2010, to 9.4% in the latest data:

I am not one to criticize a bit of economic stability, and the higher rates of growth on a lower base do mean that the share of economic expansion of the BRIC is relatively high.  But with these levels of growth I can’t see how the BRICs are meant to support the waning demand of the much larger western economies.  In terms ofshares of the global economy, Japan is 8.75%, US at 26%, the EU15 at 26%.  For the BRICs, Brazil is 2.4%, Russia is 1.9%, India is 2.3% and China is 7.5% – or 14.1% in total for the BRICs.

For some more perspective, the US military budget is about $1trillion pa, or half the size of the Brazilian economy, or two-thirds the size of the Russian economy.

Clearly, very strong growth rates from such a small economic base would be required to counteract even very moderate contractions in the developed world, and this is not visible in the trends we are seeing.  You can’t simply decouple the globally integrated economy while capital and goods are traded freely.

Tips, suggestions, comments and requests to rumplestatskin@gmail.com + follow me on Twitter@rumplestatskin

Economics of piracy

This post first appeared at Macrobusiness

Public debate over Internet piracy is riddled with contradictions and fingerprints of vested interests.  In the US, congress is considering the Stop Online Piracy Act (SOPA), while in Australia, an alliance of internet service providers had their proposal to crack down on piracy rejected by the Australian content Industry Group (group of music, software and games content owners).  The proposal:

…would see an ISP provide one education notice, three warning notices and one discovery notice to customers alleged to have infringed on copyright by the copyright holder, and, if a customer continued to infringe after this, the ISPs would tell the rights holder, which may then decide to apply for a subpoena to get access to the customer’s details for legal action.

Given that the application of knowledge is the engine of economic growth, one must intuitively consider copyright and patent laws as a significant burden on growth (China?).  Moves to curb piracy, as many economists are keen to point out, generally reduce consumer welfare, and in many cases reduce the profits of content owners who benefit from platform effects.

A key misapplied economic in the piracy debate is that greater incentives ‘bring about’ greater supply. That somehow, without a massive payoff, people would stop inventing and creating.  Imagine, people following their passions, even in something as obscure as blogging about economics, for their own rewards, rather than monetary payment.  History shows that creative contributions are independent of copyright and even patent protection.

Or, as The Economist magazine put it recently, “copyright theft robs artists and businesses of their livelihoods”.  Given that regulations create markets, and market actors play by the rules of the game, this point is partly true.  But is begs the question of whether markets provide better outcomes for both producers and consumers with or without copyright laws (or the evasion of the laws).

Consider the music industry.  Recent research suggests that music piracy can be beneficial to the music industry as a whole, but not those who are already superstars.

The effect of this is that piracy increases the diversity of music in the short run, and increases the supply of superstars in the longer run. In this sense, piracy is efficient, as it corrects a market imperfection.
…
This raises the possibility that opposition to file-sharing is strongest amongst those performerswhose success depends upon their fame more than their ability.

In software markets the ‘victims’ of piracy gain substantial benefits through platform effects (the result of strangely named two-sided markets).  The battle between mobile operating systems is demonstrating how platform effects work.  If Apples iOS is a platform for selling apps and music through online stores, Apple should be happy with piracy of its operating system, because the more ubiquitous their system, the more valuable their platform dependent inline retailing.  Microsoft, especially with its Office suite, shows that being ubiquitous means a cornering the market so that competitors cannot crack it.  Everyone insists on perfect compatibility with Office, because it is so common.  And it is partly so common because of the degree of piracy, rather than of sales.  Without piracy, these effects are greatly diminished.

Microsoft has even suggested that if you are going to pirate software, make sure it is theirs.

For some time, big software companies have tried to make the argument that a copy of pirated software is equivalent to a lost sale This is pretty ridiculous for a couple reasons. For one thing, there’s no reason to think that a given user of pirated software would have actually purchased a legitimate copy.
Furthermore, the argument ignores the fact that companies actually benefit in some ways from piracy, because a user of pirated software is likely to purchase software from the same maker at some point down the road. This latter point is something that even Bill Gates has admitted, even while Microsoft continues to talk tough about cracking down on piracy.
Now the company is stating more clearly that it knows there are some benefits to piracy. Jeff Raikes, head of the company’s business group, said at a recent investor conference that while the company is against piracy, if you are going to pirate software, it hopes you pirate Microsoft software. He cited the above reasoning, noting that users of pirated Microsoft software are likely to purchase from the company later on. He said the company wants to push for legal licensing, but doesn’t want to push so hard so as to destroy a valuable part of its user base.
The company recently got a stark reminder of this lesson when a school in Russia said it wouldswitch to Linux to avoid future hassles with the pirate police. Of course, this moderate stance seems at odds with the company’s recent hyper-aggressive anti-piracy push, which resulted in many mistaken piracy accusations. Either way, Raikes’ comments completely destroy the line about pirated software being equivalent to lost sales; if it actually were, Raikes would be telling people to pirate the software of Microsoft’s competitors.

Google is probably the best example of a platform business.  Their Chief Economist Hal Varian has been known to comment that whatever new software Google produces, if it increases the attraction of the Internet, then it is good for Google.

Content piracy has improved our lives, with some very minor costs to a small group of content owners whose lobbying efforts have already results in having the rules changed in their favour (thank Walt Disney). Whether this trend persists in the light of rapidly evolving content distribution methods I am not sure.

Tips, suggestions, comments and requests to rumplestatskin@gmail.com + follow me on Twitter@rumplestatskin

QLD CSG - the race for first gas

*I am now posting a daily column at Macrobusiness under the alias Rumplestatskin. This post first appeared at Macrobusiness on 18 Nov 2011.

While debate continues around land access and groundwater contamination, the coal seam gas industry in Queensland is powering ahead in a race for ‘first gas’. Which begs the question, why the rush?

It is no secret that government is a few steps behind the resource companies in terms of providing a solid regulatory framework for the industry to operate within. This is particularly the case for the management of CSG water in river catchments already plagued by their own water management issues (although DERM has released a CSG Water Management Policy and is investigating other beneficial use options).

Making substantial investments ahead of certain regulatory obligations appears a risky move on the part of the gas companies. After all, the gas will still be under your lease if you wait for some policy certainty, and sunk investments will provide substantial bargaining power to government to expand their wish-list as they finalise their policies. You won’t walk away from a billion dollar investment because the government makes you spend a little extra on over-the-top sweeteners to local communities.

The frantic pace of investment can be explained by the strategic first-mover advantages on offer to the winner of the race to produce ‘first gas’. British Gas’s Australian subsidiary QGC is a current favourite to win this race (to have their 'first gas' first), although Santos is a contender.

Stanford professors Lieberman and Montgomery published a defining article on first-mover advantage back in 1987 (ironically gaining a type of early-mover advantage on the study of first-mover advantages). They addressed the conditions under which such advantages are likely to exist, and we can use the ideas from their paper to better understand the advantages from winning the race for first gas.


Preemptive investment in plant and equipment
The first mover, or even second mover, to begin construction of pipeline and plant will gain a huge negotiating advantage during the expected consolidation of the sector; especially if the pipeline(s) is designed with surplus capacity. The owner of the first pipeline(s) can offer gas transport to other firms for less than the cost of constructing a their own pipeline. Once these first pipelines are operational, the sector will bargain a solution to avoid further uneconomical duplication, but there will be a balance of power in these negotiations to the pipeline owners.

QGC’s bargaining power was significantly enhanced by last year’s approved 15 year no-coverage declaration of its proposed pipeline from the Surat Basin to Curtis Island (see map below). This approval means that the pipeline cannot be declared for open access (which would oblige QGC to provide other gas companies access to the pipeline at a regulatory price) during this period, giving it the security to invest. QGC argued (quite rightly) that the pipeline would be economic to duplicate, and that access would not be in the public interest. But only two pipelines appear economical for the expected production of the area, so there will be second mover advantages as well.

But QGC’s no-coverage declaration also added significant extra time pressures, since the approval will lapse after three years if the pipeline is not constructed and in use. Santos noted in its submission to the National Competition Council in April 2010 that QGC is unlikely to meet that three year deadline, and hence their pipeline may not be protected from a regulatory access regime. The pressure is on for QGC:

Consolidation of the sector is also likely to occur in other parts of the production chain (see below), including upstream exploration and drilling, and in particular the liquefaction stage on Curtis Island where the industry is likely to negotiate a more efficient option than the four separate plants:





Overall, the sector may consolidate extraction rights themselves by a number of means. The first mover (to construct a pipeline and plant) may buy out other tenements from a strong bargaining position, or perhaps partnerships and joint ventures will emerge with other gas producers, or even straightforward private arrangements for utilising the first mover’s pipeline and plant.


If QGC and Santos build pipelines and plant with excess capacity, they can take a share of rents from other gas companies through these types of consolidations, which is publicly their intention:

“BG Group now has the strategic advantage of being the first to make a financial decision, with construction of its project to begin immediately.
Consolidation in the CSG and LNG sector in Queensland is widely expected, and as the “first mover”, BG will be one of the main players with whom other hopefuls will now want to talk.” (here)

Given this likely eventuality, other players have pushed through with plans of their own to stay in the race for the top two, given the payoff for success is so great:

The $35 billion Australia Pacific LNG (APLNG) joint venture will theoretically become neighbours with BG, Santos/Petronas and Shell, which have all announced plans to build separate plants on Curtis Island, off Gladstone, in Queensland.However, consolidation is expected in the sector.

Switching costs and buyer choice under uncertaintyFinally, the leaders of the race for first gas will have greater opportunity to monopolise contract negotiations, and develop strong buyer relationships. The typically long contracts in the gas market reinforce the dominant position of first movers. Santos, for example, currently has a 20 year contract with Petronas, while QGC has a 20 year contract to supply CNOOC, a Chinese state-controlled oil producer.

As a final note, the pace of development is important financially simply by bringing forward returns on a multi-billion dollar investment.

So how do you get a first-mover advantage? Lieberman and Montgomery suggest the following:

A firm gains first-mover opportunities through some combination of proficiency and luck. Various types of proficiency may be involved, including technological foresight, perceptive market research, or skillful product or process development.

I would add strong relationships with government officials, which can help push through approvals ahead of the pack, and often ahead of the formation of government policy.

This regulatory relationship is clearly a real concern. Santos has cautioned against regulatory interference in the expected industry consolidation process, through, for example, unpredictable outcomes of no-coverage applications, given the massive impact it will have on bargaining power between gas companies. Favourable treatment in such deliberations is a true source of industry power.

I am not a gas industry insider and there may very well be some subtle considerations I have overlooked. But on the surface, the evidence is strong that the pace of development, beyond the pace of development of environmental regulation for CSG production, is being primarily driven by the race for first gas.

This means there is a trade-off between the pace of development, and the quality of the development these environmental regulations. A slower pace of development may provide incentives to better optimise investment for the industry as a whole (rather than the first mover), and opportunities for the communities affected by the industry’s development to better understand what is happening before having their input into policy making.

This leads to another question, would eliminating advantages to the first-mover slow development to allow regulation to catch up?

This is not as simple as it might sound. The threat of open access declarations could have the exact reverse effect of completely rendering the pipeline unviable. Of course, government could simply build one and charge a fixed rate of return charge to all gas companies. I wouldn’t, however, expect the operation of this pipeline to be particularly efficient, and it would still lead to lobbying by the industry players over the operation of the government’s access regime.

A creative solution might be to regulate against exporting LNG from Curtis Island until a date sufficiently late for all companies to be contenders for completing their proposed pipeline and plant. Perhaps this will encourage consolidation of the sector prior to gas being delivered. But in all honesty, I can’t think of a way to eliminate the race, without eliminating some of the benefits of CSG development, and without picking winners.

Maybe the simple solution is for government to take a hard line when it matters, such as during assessment of environmental impact statements, and incur some delays at that point for the sake of nudging trade-offs in favour of the wider community. Delaying approvals at early stages may have provided the time to collect better data about the geology and underground hydrological effects of CSG extraction.

I personally believe CSG development can be a great benefit to Queensland and Australia over the next quarter of a century, but the political class being targeted by industry lobbying needs to be aware that their hard hat photo opportunities and premature approvals are inherently trading off benefits between external stakeholders and late entrants, and the industry’s first mover(s).

US observations

Two observations today.  The first is the graph below showing the median houshold income in the US since 2000 (ht.Felix Salmon).  Suprisingly the recovery from the 2008/09 recession has not resulted in an income boost, but in fact a dramatic continuation of the decline.

The second observation is that big banks on Wall Street are participating in a program to 'buy' their own police (ht.Yves Smith).  Which is all the more ironic this week as the Occupy Wall Street protestors rally against regulatory capture and the greed of the corporate world in seeking pursuing these ventures.  These officers are paid a token hourly rate by participating corporates, but their training and insurance is provided by the city.  Privatise profits, socialise losses.  That's not capitalism.

The fall out from the financial crisis is not over.

Media watch – cosleeping report

Within 24 hours of the Victorian Coroner’s Prevention Unit releasing a background report into infant deaths from co-sleeping (parents sharing beds with infants), no less than 31 media outlets have reproduced the media release beneath fear-inducing, but unrelated, headlines.

• Babies sleeping with adults at greater risk of death: study
• Landmark study reveals dangers of sharing bed with babies
• Fear as babies die in their sleep
• Cuddling Leading to Infant Deaths in Victoria Triggers Investigation
• Sharing Bed Could Lead To Death of Baby?

A credible journalist would have read the Coroner’s background study and found that its conclusions are nothing like what the headlines suggest (perhaps the subeditors need to pull their heads in). As the study itself notes -

The study was restricted to a case series of deaths, for which no comparison groups were available. Without being able to compare the proportion of co-sleeping among the fatal cases to the proportion of co-sleeping among non-fatal cases, it is not possible to provide an estimate of the increased risk of death attributable to co-sleeping.

In fact, the study is just an analysis of a selection of case-study data to inform an ongoing investigation, for which the Victorian Coroner is currently seeking input.  The investigation was triggered because the proportion of unexplained infant ‘sleep’ deaths associated with co-sleeping increased from 21 to 45% between 2008 and 2010 (7 deaths to 15 deaths).

Is it too much to ask that journalists actually read the source of their article before writing and offer an objective view, rather than induce fear in new mothers with unrelated headlines and loose presentation of the facts?

If any of these journalists had modicum of mathematical aptitude they would have realised that proportion of infant deaths from co-sleeping is meaningless without knowing the proportion of infants who co-sleep.  If 90% of infants co-sleep, but the only make up 45% of unexplained sleeping deaths, then that is some evidence to show it is probably not a factor.

And most bizarrely, if the rate of co-sleeping is constant, than some other factor MUST be to blame for the changing ratio (even if that factor is random variability).

Unfortunately the evidence on sleeping habits of infants during this period is limited.  This survey from 2008 shows that, in a sample of 6383 breastfeeding mothers with babies under 1 year old, about 37% of mothers co-sleep with their baby. If that ratio has increased since that time it may very well explain most of the data seen by the Coroner.  Other evidence suggests that breastfeeding mothers are three-times more likely to bed-share, and the ABS estimates that about 48% of babies under one year of age are breastfed (consistent between 1995 and 2001), although the proportion declines from about 85% to 30% over the period.  This gives a rough picture of co-sleeping habits in 2008 of about 29% - with co-sleeping deaths at 21% in this period.

Given the massive limitations of Coroner’s report, and the inherent variability in the year-to-year infant deaths statistics (the same debate occurs around pool fencing laws), the report itself seemed rather lacking with regard to the extensive existing literature on the topic.  For example, this research surveyed 4656 families internationally about sleeping arrangements and found that

Rates of bedsharing varied considerably (2–88%) and it appeared to be more common in the samples with a lower awareness of SIDS, but not necessarily a high SIDS rate.

A summary of the results is graphed below.

One major factor limiting the understanding of infant sleep death risks are omitted variables.  The ABS surveys on breastfeeding show strong trends between mother’s age and educational attainment and breastfeeding habit.  Also, the confounding factors of alcohol intake and smoking (and other health risk exposure) of the infant need to be taken into account to begin to point the finger at sleeping arrangements.  With this data available one can separate the impact of co-sleeping risks from the impact from other health risk on infant ‘sleep’ deaths. No doubt and the Coroner’s inquiry progresses these issues will be addressed in detail.

The creative destruction of retail

The great Australian retail adjustment is happening now at a store near you.

• Myer Managing Director Bernie Brookes recently announced the retailer’s plans for more serious efforts in online retailing, with $9million set aside to improve Myer’s online presence.
• Target yesterday sent a letter to suppliers explaining why they are going to pay 5% less for all their goods from now on – take it or leave it (ht: Adrian).
• Mark McInnes, head of Premier Investments, the owner of Dotti, Just Jeans, Portmans and Jay Jays outlets, has closed 19 stores and threatens to close more if he cannot bargain down the rents paid by his remaining stores.
• Masters, the hardware joint venture between Woolworths and Lowe’s Companies Inc, opened its first stores early this month to compete with Bunnings in the hardware and homewares market.
• Dick Smith has also had his say about the supermarket discounting wars and executive pay.

Not only are the retailers making some tough decisions, but shopping centre owner Stockland, whose CEO Matthew back in February noted the sunny outlook for their three Rs strategy – residential, retail and retirement – is finally coming to grips with reality and is rushing to offload a selection of retail property holdings.

Read full post at MacroBusiness...