The ‘long-drop’ for BP and Shell as profit plunges

BP and Royal Dutch Shell have both announced declines in profit of 62 per cent within a day of each other. The oil price of less than $50 a barrel is to blame. But what will this drop mean over the long-term?

BP say they will rein in their $20 billion capital expenditure programme for this year instead of reducing dividends to shareholders. They plan to do so by carrying out the same work as planned for less than the $20 billion target. Shell will no doubt have to make a similar decision on spending very soon.

But on tighter budgets, both companies will find it very difficult to attain the oil exploration and infrastructure upgrades that will support future production and growth. Even one year of falling profits in the oil industry can have a lasting effect. In such a capital intensive sector, cash reserves are quickly eaten up for infrastructure expenditure when profits are low.

The oil industry has been through recession before, but this time round presents the greatest challenges. Oil supply is at its scarcest since production began. More money than ever is needed to find new oil fields, and those we know about are in remote, difficult to access areas where production and transport costs are very high. Without large sums of capital to fund these exploration and production costs, the industry is threatened with a growing funding gap. At some point that gap cannot be filled.

Shortly after the last serious recession in the UK – where both BP and Shell are partly headquarted – in the early-to-mid 1980s, North Sea oil and gas was discovered. Such a large field so close to industrialized Europe was a blessing for the industry. There is little chance of finding such a convenient stop-gap this time.

Rules of the game

Here are three statements which are true, but which were generally missed before Enron, the 2002 governance crisis, and all we are seeing unravel in the way banks and other businesses are being ruled today:

1) Every business is governed by a very small set of people compared with other types of institutions.

2) Each of these people can have a very significant effect on the welfare of society by exercising the powers they hold in a company.

3) One of the easiest ways to change how society works is to change the way these people hold power.

Of course there has always been regulation of corporate governance, but this has always been within the terms of the corporate world. Laws against fraud or insider trading, for example, are designed mostly to prevent dishonesty within business, or to stop some insiders gaining unfair advantage over others. They are not particularly concerned with those outside the corporate management and administration world – in other words, the consumers and suppliers (and even those who are too poor to be either: subsistence farmers would be one example). This whole group – the outsiders – are really just spectators on the sideline. But they are not disinterested spectators.

We have seen an improvement in corporate governance since the Enron scandal, as Dr Thomas Kirchmaier of the London School of Economics Corporate Governance institute points out here. But given that we, the populous, hold arguably as much of a stake in multinational corporations as we do in democratic governments, why do we not have more of a say in how they are run? Of course there are workability arguments, but these confuse efficiency with optimality. It is only one component of it, as democratic theorists know too painfully.    

The past decade or so has also seen a rise in grass-roots movements which operate on the paradigm that we do have a say in how corporations are run: namely, by the power we hold as consumers and the ways we choose to exercise our spending. This is a powerful and inspiring argument, but it breaks down when we think about assymetries of information. How many Icelandic consumers could have known what their banks were doing with their money, for example? Our responsibilities and choices as consumers are only small parts of a much larger nexus.

There were cries throughout the past ten years for more aid for the developing world, more fairness in trade, and greater protection of the environment. These global problems continue to dwarf those that were largely though not exclusively the concern of the developed world in the past decade: increasing wealth inequality and the attendant questions about the productivity and dignity-bestowing aspects of work, not to mention the larger question of what society might be for. But far too much of the outcry deafened us to the role corporate governance might have in dealing with these seeming leviathans.  

The debate now needs to turn even wider than bankers’ bonuses, or pay and competencies for directors: it needs to look at how every individual can exercise their stake in global business.

New order of crisis in Japan

There is always a tendency in finance to compare what is happening now to what went before. But  after a certain point such comparisons are too often spurious.

Many have been comparing today’s credit crunch with the Japanese banking crisis of the 1990s. Proof emerges today that we are dealing with something very different. Japan’s economy contracted in the fourth quarter at the fastest rate in 35 years. Japan, we might need to be reminded, is still the world’s second largest economy.

Worrying times for Ireland

The property market has collapsed and the main banks are edging closer to nationalization. It’s a familiar story in lots of countries at the moment, but Ireland looks closer to the precipice than many.

On Thursday the Irish government had to commit another 7 billion euro to bailout the country’s two largest banks, and now there is warning that the government could default on its sovereign debt.

Debt-market investors now rank Ireland as the most troubled economy in Europe.

Given that the European Central Bank is not a lender of last resort, a knock at the International Monetary Fund’s door might be expected soon.

Obituary: the efficient market hypothesis

So this is it. After two hundred-odd years of debate, the efficient market hypothesis is officially dead and is being buried up a Swiss mountain. A high-level discussion session at Davos yesterday pronounced the patient dead and conducted a post-mortem, which you can read about here. The future? Attempts at wider regulation, most likely. But it is difficult to overstate the difficulty of making such a concept work.

Bank of Spain lets banks ‘tune’ accounts to prevent future failures

At least a dozen Spanish banks do not meet solvency requirements and are locked in one-to-one negotiations with the Bank of Spain, according to reports from Spanish media.
 
The purpose of the negotiations is to “fine-tune” the 2008 accounts of the twelve retail and savings banks  in order to avoid catastrophic writedowns on troubled assets, which are believed to be loans to property developers rather than sub-prime products.
 
Sources close to the negotiations told the Spanish finance website Cotizalia that the central bank had agreed to let banks extend the repayment schedules on bad loans.
 
“What’s happening is a tuning of the accounts for the balance to clear more slowly,” said the source. “They’re negotiating the repayment schedule for the bad assets. No entity is going into bankruptcy.”
 
The report suggests that if the Bank of Spain’s central governor Miguel Angel Fernandez Ordonez forced the banks to recoup all of these assets on schedule, a few banks would face insolvency immediately.
 
A spokesman for the Spanish retail bank Caja Castilla-La Mancha said, “Nobody is going to publish their accounts without the approval of the Bank of Spain”.
 
Spain’s economy has suffered from a collapse in the property market in recent months as developers have seen entire blocks of new appartments left without either buyers or occupiers.

99p or Private Equity?

As most people know, the 99p (or whatever your local currency) stores that are a permanent feature of lower income city neighbourhoods do not live up to their image of timelessness or humble, traceless origins back in the formation of the urban habitat. These days, when it comes to the lexicon of urban myths and legends, the 99p store can’t quite compare with their cousins in the iconography of deprivation - the pawn shops. That is because most of the 99p stores that you see now are actually part of a single corporate chain – at least in the UK.

Add to that another swinging demolition ball to be used against the myth of Skid Row: 99p Stores Limited is part-owned by Barclays Venture, the private equity wing of the major retail bank, meaning even the vast wealth of private equity occupies a place in our poorest communities.  A counterpart of 99p Ltd is Poundland, which sells products assigned a fundamental value by our markets, in the efficiency of their invisible wisdom, 1 pence greater than that of their rivals. Poundland too is owned by private equity – the US-based firm Advent International.  

There must be few places other than a 99p or Poundland store where you can see the interests of the vastly wealthy classes mixing so closely with those of the economy’s least fortunate – maybe a church or other religious venue would see that same mingling, or a parliament (allegedly). Readers are invited to provide other examples.

‘We’re in a depression’

So says the North America economist at Merrill Lynch. This makes it the first mainstream invetsment bank to call it a depression.

More here.

Jon Snow’s outrageous report?

“Well now the nightmare is over, I think we can call it a nightmare without in anyway being anything other than objective.”

These were the words of Jon Snow, presenter of the UK’s Channel 4 News. He was talking about Zimbabwe.

Is it unfair journalistic bias to call the Zimbabwe of today a nightmare, as Daniel Finkelstein of The Times claims, saying it is ‘outrageous’ and that Jon Snow has confused his own opinion with objectivity?

An admission: Jon Snow’s comments weren’t really about Zimbabwe at all, but about George Bush’s term being the nightmare that is over. Yet would Daniel Finkelstein have had the same objection if the reference had been to Zim?

The wider question is can we accept that it is possible for there to be no breach of journalistic principle for a reporter to use the word ’nightmare’ in a piece?

Imagine, for example, a reporter sneaks into Harare, sees the cholera and starvation and turns to the camera and opens with ‘Harare is a nightmare’. No blame is attributed, no sides are taken. What the reporter is saying is not far from an ascription of fact – cholera and starvation are surely archetypal contents of a nightmare, or a vision of hell.

A Vision of our future selves?

Will the governments of the world print money? Zimbabwean central bank governor Gideon Gono hopes so. The man who will later this year oversee the printing of a trillion-dollar bill, would like to see everyone else join in on his policies.  Mr Gono told Newsweek in an interview that he feels vindicated now even the US looks like it will follow the strategy of quantitative easing that he has pursued for several years. 

“I’ve been condemned by traditional economists who said that printing money is responsible for inflation. Out of the necessity to exist, to ensure my people survive, I had to find myself printing money. I found myself doing extraordinary things that aren’t in the textbooks. Then the IMF asked the U.S. to please print money. I began to see the whole world now in a mode of practicing what they have been saying I should not. I decided that God had been on my side and had come to vindicate me.”

The maverick in Harare is no doubt smiling as cholera and poverty fill the streets around him, happy that soon the rest of us will be following his lead. What a vindication.

“I sit back and see the world today crying over the recent credit crunch, becoming hysterical about something which has not even lasted for a year, and I have been living with it for 10 years. My country has had to go for the past decade without credit.”