Nature of the Beast

I was in the middle of a very important ‘financial decision’ last few days. I was recently assigned on a project in a small town in Tennessee countryside, 50 miles north of Memphis. My earlier plan was to rent an apartment in the farthest suburb of Memphis and drive everyday. But as gas prices marched towards $ 4 / gallon, my plan began faltering. My other option was to rent an apartment in this small town, just across the street from my workplace. This plan would have definitely saved 10-15 bucks everyday, but my preference was to stay in Memphis. Also there is such a little visibility about the validity of gas prices; commodity market is so volatile right now.

In order to facilitate the decision process, I set-up a spreadsheet and developed a ‘complex’ financial model involving all the factors such as miles saved in daily commute, miles driven for leisure trips, incremental travel to airport and also other factors such incremental cost of auto insurance, tax difference, depreciated car value which would otherwise incur due to daily commute and so on. I ran this model for different scenarios of gas prices varying from $ 2.5 through $ 5 per gallon to account the volatility in the oil prices.

The financial model showed that renting apartment in this small town would be beneficial as long as the gas prices stay above $ 3.12 per gallon. If the gas prices start falling below this benchmark price, the benefits would also start diminishing. Based on the these results I decided to rent an apartment in the small town for 6 months, assuming that there will be major correction in the commodity market by the year end. Please note that this decision was purely based on the quantifiable benefits and I did not consider any intangible benefit on either side such as cutting daily commute or benefits of small town, city life etc.



My financial analysis would appear rather stupid, since there is low risk involved in either of two alternatives for a very short term. But if you amplify the scale of this project over million times, the risk will also amplify substantially. What I am trying to simulate is the decision process of investment in an alternative energy venture.

There are so many energy alternatives: some renewable such as solar, wind, bio-fuel, and some traditional such as offshore drilling. But viability of every alternative would depend on the same analysis I have just demonstrated. If the price of crude oil, which is the major source of energy today, stays elevated, these investments look particularly lucrative. On the other hand if the prices fall, these investments would go red. For example a major energy company recently started investigating viability of using oil-shale (mud-rock) for oil production, but only when crude oil crossed $100 mark. It would be difficult to justify the same investment when the crude oil is below $60.

Traditional energy companies are not necessarily evil as they have been portrayed whenever there is hike in energy prices. But they certainly have their first accountability towards their investors for every dollar invested in such projects. It is true that these decisions can not be based merely on the investment returns. These traditional energy sources will come to depletion at some point of time in the future. Such issues as greenhouse gas emissions and global warming must be addressed on highest priority. Thus it is the responsibility of the energy policymakers to create environment for attracting the investors towards renewable energy sources. Wind energy was once considered one of the ‘text-book energy sources’. Today it is one of the most profitable businesses worldwide. That became possible only when government subsidies and tax-breaks created a very conducive investment environment.

Well, soon after relocating to this small town, I was eating dinner with some of my friends. The topic of discussion directed towards gas prices. Everyone was complaining about the gas prices and started talking about green technologies. When it was my term, I said – “Today we are talking about all these green technologies because of the hurting gas prices. Tomorrow if the FED increases interest rate even by 25 basis points, the gas prices will start falling down and I bet you, we will stop talking about ‘green technologies’ at very same moment …” Apparently no one liked my statement !!

I don’t know what the energy future is. As far as I am concerned, I have tried to minimize my own ‘carbon footprint’ by relocating to this small town. But I am sure that this happened only when gas prices reached beyond the reach and unfortunately that’s the nature of the beast!

Protectionism Questioned

Recently there have been many concerns about the motives of multinationals and foreign investments, not in communist China but in United States, mother of capitalism and free trade. As a matter of fact, there is a growing sentiment of protectionism in United State: much of it can be attributed to the loss of manufacturing industry and high-paying blue collar jobs to foreign countries. The sentiment can be clearly heard on campaign trails of Democratic Party’s presidential candidates, production floors of few remaining manufacturing plants, TV and radio shows like Lou Dobb’s War on Middle Class, and most surprisingly on the recent cover page of the Business World, a leading business magazine!! Let’s try to address this with the case of Indian economy.

The early policymakers of independent India were highly influenced by the economic model established by socialist USSR as well as Gandhi’s philosophy of self-sufficiency and controlled spending. This helped to establish and develop the key road and railroad infrastructure, strategic industries like steel and cement, mammoth agricultural reforms to feed huge population, public rationing system and state-of -the-art technological institutions. Most of these enterprises were state-owned and funded with combination of domestic capital and foreign aid but not the foreign investment capital. The private industry was generally encourage but largely controlled with the system of quotas, permits and licenses lampooned as quota-license-permit raj (state of quotas, licenses and permits). The system allowed only state and few private industrial houses to control to most of the industry and market. Indian companies enjoyed a great protective environment without fear of competition.

But something changed in late eighties. Social and political instability was at the peak. The long-embraced socialist model collapsed with the collapse of socialist regimes in East Europe and USSR. The balance-of-payments came under severe liquidity crisis fuelled by rising fuel prices in the wake of first Gulf war. The foreign exchange reached bottom and the federal government had to use its gold reserve to obtain foreign exchange, widely viewed as national disgrace. Practically the nation was on the verge of bankruptcy and was forced to take massive economic reforms – ending quota-raj, opening several sectors for private sectors once reserved for private sector, easing import regulations and most importantly encouraging foreign direct investments and multinational companies.

Multinationals soon started investing India- setting manufacturing plants and launching superior products with very aggressive marketing. The Indian companies were not ready for the competitions in terms of products, technology, marketing and capital. Many multinational started acquiring Indian businesses thus taking advantages of established marketing and distribution networks and the brand loyalties. For instance, Coca-Cola acquired Parle, the largest player in soft drink in the market that virtually enjoyed monopoly since Coca-Cola’s exit from India in 1977. Hindustan Lever, a subsidiary of Unilever, acquired many Indian companies including Tata Oil Mills Co. (TOMCO), part of giant Tata group.

Most of the people didn’t like these reforms and tried to forge an unusual alliance of socialists, trade-unionists, Old Gandhians, and even right conservatives to oppose these ‘anti-national’ reforms. The acquisitions of Indian companies by giant multinationals were compared to the colonization of India by British East India Company. I was in mid-school that time. I remember the huge campaigns and rallies against multinational.

But again things changed in few years. Instead of getting into the uneven fight with giant multinationals, Indian companies changed their business model. Instead of producing everything they preferred to specialize on few. They concentrated to on IT, engineering, heavy industries leaving Fast Moving Consumer Goods sectors for multinationals. They innovated the new products and processes (e.g. outsourcing services) and refined business model (e.g. inexpensive products). Indian companies soon started acquiring foreign businesses once they feared of. Acquisition of Corus by Tata Steel, another Tata group company, may be seen much symbolic in the perspective of acquisition of Tata Oil Mills by Unilever in 1993.

This questions the validity of the original question -Does protectionism really help a nation’s economy?

Green Lining

Corporate World has always been reprimanded by the Socialist World and Liberal Media. It has been portrayed as an organization engaged in making profits by exploiting the consumers, employees, government and the environment. Issues like climate crisis and global warming have been closely associated with Corporate World thus stigmatizing it as Anti-Green. But is Corporate World really Anti-Environment? Is it not really ready to change? I decided to research this topic and here is a list of some of the Fortune 500 companies and their initiatives to make their operations Greener:

1. Wal-Mart: Probably the greatest bête noire of environmentalists and consumer advocates. But surprisingly Wal-Mart has ambitious green plans: Targets include spending $500 million a year to: increase fuel efficiency in Wal-Mart’s truck fleet by 25 percent over three years and doubling it within 10 years; reduce greenhouse gases by 20 percent in seven years; reduce energy use at stores by 30 percent; and cut solid waste from U.S. stores and Sam’s Clubs by 25 percent in three years.

2. DeltaAir: On Earth Day 2007, Delta announced to plant one tree for each of its 47,000 worldwide Delta employees. Delta customers now have the option to contribute toward the offset of carbon emissions through a donation to The Conservation Fund when they purchase a ticket at website of this once bankrupt company.

3. CitiGroup: CitiGroup is purchasing more than 56 million kilowatt-hours of green power, a 55% increase over its purchases in 2007. Citi is buying renewable energy certificates from Constellation NewEnergy. Purchase of certified green wind power will provide 100% of the energy load for the next five years at Citi's newest skyscraper, Two Court Square in Long Island City, New York, the building that has been acclaimed for its high energy efficiency. In addition Citi is achieving environmental certification globally for the construction of all new office buildings and operations centers and evaluation of existing larger facilities.

4. General Motors: In order to obliterate long reputation as makers of gas guzzlers, GM plans to introduce a hybrid full-size pickup. GM says the 2009 GMC Sierra hybrid will provide a 25 percent improvement in fuel economy without compromising performance.
Chevron: Most of the people don’t know that Chevron is also the largest private producer of geothermal energy in the world, accounting for more than half of all privately developed geothermal power. Since 2002, Chevron has invested approximately $2 billion in alternative and renewable energy technologies and energy efficiency services, and between 2007 and 2009, they expect to spend approximately $2.5 billion.

5. FedEx: FedEx Express has used Biodiesel (B5) in the Washington, D.C. area since Fall 2005 with over 1,000,000 miles of revenue service by April 2007. There are now 100 FedEx hybrid electric vehicles operating in locales including United States, Canada, Japan and Europe. FedEx hybrids have accumulated more than 1,000,000 miles in revenue service.

So what’s the truth? Is Corporate World really changing its mindset? Is it ready to face and address the energy and environmental challenges? Is it ready to invest in greener systems?

Unfortunately there is no one answer to these questions. The issue is really multi-dimensional and has numerous aspects:

1. Bottom Line: - Being green may be good for environment as well as for the company bottom line. Today every industry that has energy as primary input resource seems struggling to maintain the business profitable in the fierce global competition. Thus it makes lot sense to cut down the high energy use, and/ or increasing energy efficiency.

2. Sustaining in Market: Green products help company to maintain the market and even capture new market. For example, highly fuel efficient 787 Dreamliner grabbed much attentions and orders, even from some of the European airlines.

3. Government Regulations and Lawsuits: Corporations are trying to be ahead of the curve to avoid future environmental lawsuits and cope with government regulations.

4. Subsidies and Tax Exemptions: Green products have great amount of subsidies and tax exemptions that make these attractive investments.

5. It’s Good to be Green: Being green helps to build and improve the image. It’s certainly a strong marketing point.

So is it good for the common consumer? yes!!. It’s a sign that the mindset is shifting slowly but definitely surely. Even the smallest attempt is going to help the environment, whatever the intension may be! It should be welcome and at the same time be ensured that this momentum is conserved. After all every corporate cloud has the green lining !!

References:
1. “Is Wal-Mart going green? - CEO vows to be ‘good steward for the environment’ in announcing goals”, MSNBC News Services, 03/03/2008, http://www.msnbc.msn.com/id/9815727/

2. “The Conservation Fund”, 03/03/2008,
http://www.delta.com/about_delta/global_good/conservation_fund/

3. “EPA Recognizes Citi among Nation's Leading Green Power Purchasers”, 03/03/2008, http://news.moneycentral.msn.com/ticker/article.aspx?Feed=BW&Date=20080222&ID=8230748&Symbol=C

4. “GM introduces hybrid full-size pickup truck”,
http://www.iht.com/articles/2008/02/03/business/hybrid.php

5. “Geothermal - Creating Renewable Energy for Power Generation”, 03/02/2008,
http://www.chevron.com/deliveringenergy/geothermal/

6. FedEx Express, 03/02/2008, www.fedex.com

Outlook

I am not an economist, neither by profession nor by hobby. I don’t claim to be … Economists are in high demand especially during time what they call recessions. It is one of the professions that appears to be harmless to humanity. In a sense everyone is welcome to offer his or her free (well...mostly) opinions. You can pretend to be intelligent. And since no one is taking you seriously, world is safe! But I do like economics. So here are some of my predictions about the economy in near future.

1. Energy: Global oil markets will likely remain tight through 2008. Crude oil has already crossed $ 100 per barrel psychological mark. It will remain mostly above $ 90 unless supply and demand cycle changes dramatically. That means be ready to pay $ 3.5 to $ 4 per gallon at the gas station.

2. Consumer Debt – At the end of 2007, consumers held over 2.5 trillion dollars in debt not secured against real estate. For example, average household debt is estimated to be 6.34% of annual salary. On the other hand 3 out of 10 have ever been 60 or more days overdue on any credit obligation. Now good credit is always a good sign of economical health of individual as well as the economy but not outstanding debt!

3. Employment: Major issue of concern. Construction employment decreased by 27,000 in January 08 and has fallen by 284,000 in past 12 months. Manufacturing lost 28,000 jobs in January and over 269,000 jobs in the past 12 months. Since reaching a peak in December 2006, employment in financial activities has declined by 99,000. Statistics indicates the future trends.

4. Inflation: Mostly because of higher energy prices. But not a major issue, in my view. Escalating energy and food prices may shake home economics though.

5. Dollar Decline: Dollar is not likely to regain the historic strength in coming years and even may continue downfall. It may worsen energy prices. But I take is as an opportunity. This makes US attractive investment destination and accelerate the influx of foreign capital. On the other hand cheaper US dollar can boost exports and help to regain mostly lost manufacturing industry.

6. Housing: Not likely to improve and conditions may even worsen. Prices will continue falling, inventory will continue rising which will adversely affect construction industry, building material industry, banking sector and the common consumer.

Economy stimulus package: Most of the experts, on both demand and supply side, agree on the one single thing - putting extra dollars in the pockets of tax-payers will have a limited effect. It will mostly help low-end retailer chain such as Wal-Mart and of course the junk manufacturers across the pacific!

Again – I am not an expert, but everything seems so obvious, logical, realistic and horrific.

Next time - world economy outlook … it’s even easier.