Category Archives: australia

Oil Prices on the Rise?

Prompted by an article entitled “Bust and Boom” in the current issue of The Economist, I have decided it is time to dust off a Stubborn Mule staple: the petrol price model. As The Economist notes, following last year’s precipitous fall, oil prices have been climing again over the last few months. The West Texas Intermediate oil price per barrel (bbl) has almost doubled in US dollar terms and, despite a stronger Australian dollar, the price in Austalian dollars is not far behind.

wti

West Texas Intermediate Oil Prices

Rising oil prices may seem odd in a world economy still under the influence of the Global Financial Crisis (aka the GFC), but The Economist points the finger at the collapse in investment in oil exploration and development of new fields. This raises the fear that, while oil inventories are currently in record excess, once these inventories are drained, digging up more oil is getting harder and, consequently more expensive.

So where does this leave Sydney motorists? The simple regression model I have used before is still showing a tight relationship between wholesale oil prices (in this case refined Singapore 97 oil prices) and prices at the bowser. If The Economist’s fears are justified, petrol prices will be reaching $1.30/L very soon and will be headed north from there. Updated Petrol Model

Data source: Bloomberg and the Australian Automobile Association.

Shoots Are Greener in Australia?

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The phrase de jour (or du mois in fact) in financial markets is “green shoots”. Optimists, world equity markets included, are seeing tentative signs of improvement in the world economy. Google trends saw a blip in searches for the phrase green shoots back in January when UK Government minister Baroness Vadera used the phrase and was lampooned for what was perceived as premature optimism. Moving forward a few months and searches have surged again, but this time consensus seems to be far more supportive of a positive outlook.

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Who is to Blame for BrisConnections?

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Bolton as The Dude In the latest instalment of the ongoing debacle that is BrisConnections, Nicholas Bolton shrugged off the mantle of hero to mum and dad shareholders in exchange for a secretly arranged $4.5 million dollars. I have to admit I would have enjoyed the Schadenfreude of seeing Bolton continue to stick it to Macquarie Bank, but whatever his shortcomings (which include a striking resemblance to the One.Tel dude—thanks to the friend who pointed this out to me and to Crikey!), and however tempting it is to blame him for not finishing the job, it was never his job to protect shareholders.

When it comes to assigning blame, it should fall fair and square on the ASX. If they were doing their job properly, they should never have allowed BrisConnections to be listed in the first place.

To explain why requires a (relatively) brief explanation of instalment receipts. Also known as partly paid shares, they are a means a of issuing shares in a company in stages. If a company was estimated to be worth around $200 million, rather than issuing 100 million shares at $2 each, this approach involves selling 100 million “instalment receipts” (rather than fully paid shares) at $1 each. At some point in the future, holders of these receipts would pay a further $1 and their receipts convert into ordinary shares. This means of raising capital is very well suited to construction projects where the company does not require all of the capital upfront and was, for example, used to finance the construction of the Sydney Olypmic Stadium prior to the 2000 Olympics.

So, using instalment receipts was a natural approach to raising capital for the construction of Brisbane’s Airport Link. However, there is a crucial difference between the approach Macquarie Bank used with BrisConnections and most previous projects such as the Olympic Stadium and the Telstra privatisation. In the earlier examples, payment of later instalments was optional. Holders of instalment receipts had the choice of paying the next instalment and converting their holdings to fully paid shares or simply walking away with nothing. However, in the case of BrisConnections, paying the instalment is not optional and this makes a big difference.

To see why, I’ll go back to the hypothetical example of the $200 million company. Imagine that, for some reason (project problems, global financial crisis, or whatever), the value of the company fell to $150 million and then to $100 million and finally to $60 million. If they had originally raised capital by issuing 100 million $2 shares, then the share price would fall to $1.50, then to $1 and finally to $0.60. Obviously investors would be disappointed to see their investment fall in value, but these things happen on the share market.

Now imagine that they had issued 100 million $1 instalment receipts with a compulsory instalment payment of $1 in the future. So, even though the original investors had only invested $1, they had effectively committed $2. Initially worth $1, these instalment receipts would fall in value to around $0.50 when the company fell to $150 million. This is because the overall value of a fully paid share is $1.50 and instalment receipt holders have committed to paying the final $1, so the balance is $0.50. It gets messier as the value of the company continues to fall. When the company is worth $100 million, the instalment receipts are essentially worth $0 and with the company worth $60 million they should be worth negative $0.40! What this means is that a holder of one of these receipts should be prepared to pay someone $0.40 per receipt to take them off their hands. Since a “buyer” of the receipts considers the company to be worth $0.60 per share but knows there is a commitment to pay $1, they would want to be compensated $0.40 per share to take on the commitment of paying the instalment.

This is where is gets problematic for the ASX. The way the stock exchange system is set up, it is impossible to trade on the exchange with negative prices. So, even though these hypothetical receipts have a negative value, they would have to trade at a positive price. And they are not worth that! This is exactly what happened with BrisConnections. It got to the point where it was trading at price of a fraction of a cent when the value of the instalments were in fact negative. As a result, investors unaware of the future instalment obligation thought they were snapping up large numbers of shares at a bargain price and instead are now faced with enormous liabilities that many will simply be unable to pay.

The ASX has responded by announcing new rules requiring better disclosure from brokers. This misses the point. No amount of disclosure will change the fact that BrisConnections instalments could not be traded at real, negative prices. Even if everyone had full disclosure and (assuming no-one was trying anything tricky like Bolton) so no-one bought any units at near zero prices, this would leave the problem that existing investors would be unable to sell their holdings at all.

When the BrisConnections receipts were first listed, everyone might have expected the value of the company to go up not down, but the possibility that it could have gone down was always there and this should have raised alarm bells with the ASX right from the start.

Put simply, if the ASX cannot cope with negative prices, they should never allow anything to be listed on the exchange that has the slightest chance of having a negative value.

Since instalment receipts are hardly new, why has this only come up now? The secret lies in the fact that the instalments for Telstra, the Olympic Stadium and so many others were optional. Since there would never be a committed liability for instalment holders, the prices of the receipts could certainly go down to very close to zero, but they could never be negative. Of course, if no-one paid the instalment this would create some difficulties for the company and they would have to raise fresh capital, but a debacle like BrisConnections could never happen. Why was BrisConnections structured with a committed instalment? I can only guess the certainty of future cashflows for BrisConnections made it much easier for Macquarie Bank to pull out fatter fees for structuring the deal in the first place, which is why I would not have been sorry to see it all collapse for them (and it still might). Even if I am right in my suspicions, this would hardly be surprising news about Macquarie. So, I don’t really blame them, I blame the ASX.

How Big Are Australian Banks?

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There is no doubt that the big four Australian banks have navigated the global financial crisis better than many banks around the world, particularly in the US and UK. However, there seems to be a pervasive tendency in Australia to overstate the success of the Australian banks.

A couple of weeks ago, Michael Duffy wrote in the Sydney Morning Herald that

There are only 15 banks in the world which now have a AAA credit rating. The four major Australian banks are among them.

It would be nice if it was true. However, no Australian bank has a AAA rating, they are all in the AA band. There are a few Government-owned or guaranteed banks around the world with a AAA and the only privately-owned bank with a AAA rating these days is the Dutch Rabobank.

More recently, Kerry O’Brien was interviewing the astute Morgan Stanley analyst Gerard Minack when he made the comment

Given that the big four banks in Australia are now in the top 12 around the world, what risk still applies to Australian banks as this scenario that you’ve described unfolds?

Gerard blinked for a moment before moving on, so I suspect he knew that Kerry did not have his facts straight here. By my reckoning (with a bit of assistance from Bloomberg),now that Westpac has taken over St George, it just scrapes in at number 12. ANZ, however, is all the way down at number 33 and the other two are somewhere in between. If I have missed any of the major world banks in my calculations, that would only push Australian banks further down.

The chart below shows data I have uploaded to Swivel giving the market capitalization for 40 of the biggest banks in the world in billions of US dollars. Figures are in thousands of millions (i.e. billions) of US dollars. While management of the big four Australian banks should be pleased with how they are faring, there is no need to blow their trumpets to the point of ignoring the facts.

One final point: it is interesting to note that the three biggest banks in the world today are Chinese banks.

For those who read my earlier Amazing Shrinking Banks post, you may notice that I have added a few more banks, including the large Chinese banks.

Time for States to Give Up Borrowing?

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It hasn’t been a very good few months for the Australian State Treasury Corporations. While the ongoing global financial crisis (GFC) has been challenging for everyone dealing in the financial markets, conditions really got difficult for the States when banks began issuing bonds with Commonwealth Government guarantees back in December 2008. Things got worse last week when Standard & Poor’s announced a downgrade of Queensland Treasury Corporation (QTC) from AAA to AA+. Many investors are concerned that New South Wales will be next. Perhaps the time has come for the States to give up their borrowing programs and move to a centralised Commonwealth borrowing model.

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Australian Prices Heading South

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Yesterday’s quarterly inflation release, which showed prices falling by 0.3% over the December quarter across Australia, cemented expectations of a 1% cut in interest rates in February. How things have changed! My very first Stubborn Mule post back in May 2008 examined the inflationary pressures that had so concerned the Reserve Bank and led them to keep interest rates high well into the financial crisis. In that post I used a heatmap to dig down into the drivers of inflation, and a quick comparison of the latest December inflation rate with inflation six months earlier gives a very clear illustration of where prices are falling.

Austalian Quarterly Inflation – Dec 2008
(click to enlarge)

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End of the Age of the Gatekeepers

Rudd, Carbon and the Price of Petrol

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Power Stack Australia’s Prime Minister, Kevin Rudd, triggered waves of protests from environmentalists this week when he annouced that Australia’s target for emissions for 2020 would be a mere 5% reduction from the levels in 2000. With substantial commitments to emission reductions from other countries around the world, this target would be increased to 15%. The Government was at pains to point out that Australia’s population growth makes this target more ambitious than it sounds. However, by world standards Australia’s emissions are very high, whether measured per capita or by gross domestic product. This means that Australia should have more scope for relatively inexpensive emissions reductions than many other countries.

So 5% does seem to be a very unsatisfactory target. If you are a climate-change skeptic, even a 5% target is a needless waste of time and money, while if you take forecasts of climate-change seriously it seems woefully inadequate. However, rather than focusing on the target itself, in this post I will look at the implications that the Government’s plan will have where consumers will see it most directly, on the price of petrol.

In their White Paper on the carbon reduction scheme, the Government proposes a cap on the price of carbon of $40 per tonne for the next 5 years while, for their financial impact modelling, a price of $25 per tonne has been assumed. In an earlier post I calculated the impact of the price of carbon on the price of petrol. Here are the results for a range of carbon prices.

Cost of Emissions ($/tonne)	Petrol Price Increase (cents/litre)
10	2.4
20	4.8
25	6.0
30	7.2
40	9.6

So, if the Government’s assumption is correct that the price of carbon will initially be around $25 per tonne, we can expect an increase in petrol prices of 6 cents per litre. Even if the price of carbon reaches the $40 cap, the impact on petrol prices will only be around 10 cents per litre. I say “only” because that 10 cents is small compared to extraordinary moves in petrol prices seen over the last year due to movements in the price of crude oil. From July to November, the price of petrol in Sydney fell by almost 40 cents per litre, according to prices published by the Australian Automobile Association, and based on my observations has fallen another 20 cents since then. Even compared to the 38 cents per litre fuel excise, 10 cents seems a modest figure. The chart below shows the dramatic moves in petrol prices along with projected prices based on the daily price of Singapore 95 refined oil, based on a regression model I have used in a number of posts in the past.

Petrol - Dec 2008

Introducing an emissions trading scheme for carbon will eventually affect a wide range of consumer prices, but based on the relatively small increase in petrol prices that it will produce, the scheme is not likely to have a significant impact on consumer behaviour. The scheme will do all its work on the behaviour of businesses and, given the dire financial straits we find ourselves in today, this is presumably why the Government has been so unambitious with their target. But this does also highlight that there is a lot more that the Government could be doing to reduce consumer carbon emissions beyond the trading scheme itself.

Photo Source: Foto43 on flickr (Creative Commons).

Auction Approaching

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Recently I bought a new house at auction and now I am in the process of selling the old house, which will also be by auction. As a result, I have spent a lot of time of late pondering the best way to approach an auction, both as a buyer and a seller.

There are a lot of different types of auction. In a Dutch auction, popular at wholesale fish markets and also known more prosaically as a descending price auction, the auctioneer starts with a high price, which is then reduced in increments until a buyer is prepared to pay that price for the fish (or whatever is being sold). Bond market tenders are closely related to Dutch auctions.

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Australia and the Global Financial Crisis

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Over the last few months I have written a lot about the global financial crisis. My posts have focused on specific events as news has broken, ranging from a programming bug by Moody’s to the enormous US bailout plan and Government guarantees from Ireland to Australia. Here I will instead take a broader perspective and provide an overview of how the crisis has unfolded and, more specifically, how Australia came to be caught up in the mess.

A year ago, many commentators were extolling the idea that Australia’s economy had “de-coupled” from the United States and Europe, and would continue to be powered by the rapid growth of China and other developing nations. Concerns about inflation meant that interest rates were rising and many felt Australia would escape the incipient economic slowdown in the developing world. Events have instead unfolded differently. The Federal Government has taken the extraordinary step of guaranteeing deposits held in all Australian banks, building societies and credit unions and the Reserve Bank of Australia has delivered an unexpected 1% cut in interest rates, citing heightened instability in financial markets and deteriorating prospects for global growth. This was an extraordinary turnaround. It is, of course, the result of Australia becoming ensnared in the global financial crisis that began in mid-2007 and has intensified ever since. But how and why did Australia get caught up in a mess that started with falling property prices in the US?

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