Commodity Crash

Remember, just few months back everyone was speculating over commodities - Analysts at Goldman-Sachs forecasted price of oil barrel could reach $ 200, even oil baron T. Boone Pickens forecasted $ 150 (Pickens also spent millions of dollar to promote his oil independence plan)

And today oil is below $ 75, and it’s not only oil. Copper dipped to $ 2.15, wheat neared $ 550.

Does it help the consumers? Well, at least for short term. Especially decline in energy prices brings tax cut effect estimated up to $ 100 billion. But as prices fall, conservation efforts also come to halt and so does alternative energy development projects. It is interesting to see how alternative energy index fund collapsed with crude price decline.

Bizarre Mechanism : Central banks all over the world are pouring liquidity in the market. That should increase the inflation. Then how the prices are coming down? 

The latest commodity price decline is another classical example of free market mechanism. For example as  oil prices peaked demand in developing markets reduced since governments can no longer afford subsidies. Even in United States demand reduced. On the other hand, supply increased to OPEC increased production. Decreased demand and increased supply brought prices down. 

© Rohit Deshpande

Citi never sleeps (?)

“Every time you sleep but your dreams are wide awake.  Because ambitions never sleep, aspirations neversleep, goals never sleep, hopes never sleep; opportunities never sleep; the world never sleeps. That’s why we work around the world. That’s why we work around the clock to turn dreams into realities. That’s why Citi never sleeps.”

 That’s the TV commercial CitiGroups has been airing for last many months. Citi, itself suffering financial crisis, last Monday announced buying commercial banking division of Wachovia, another mortgage security hit bank for $ 2.1 billion. The deal was backed by FDIC - Citi would have assumed $53 billion worth of debt and agreed to absorb up to $42 billion of losses from Wachovia's $312 billion loan portfolio. The FDIC agreed to cover any remaining losses in exchange for $12 billion in Citigroup preferred stock and warrants. The deal, referred as a forced acquisition, was almost done. But the dynamics changed since that – 

1. Liquidity crisis becomes severe even after central banks over the world poured liquidity. (LIBOR peaks to 5.3%). On the contrary, bank deposits provide easy stream of liquid cash.
2. On Tuesday, the Internal Revenue Service issued new guidance that would allow banks to take larger tax write-offs from the losses from loans and other bad debts held by other banks they acquire.
3. Hopes rise as the Congress come closer to the financial rescue plan

 And deposit rich banks like Wachovia become valuable assets. On Friday, in a surprise announcement Wachovia Corp. agreed to be acquired by San Francisco-based Wells Fargo & Co. in the all-stock deal for about $15 billion. The deal would not need assistance from government.

 These are not the everyday deals. JP Morgan Chase gets Bear Stearns and WAMU; Bank of America gets Countrywide and Merrill Lynch; Barclays gets Lehman Capital; Well Fargo would get Wachovia. As Warren Buffet says – “You buy a farm during drought”.

 

It is not the end of the world for Citi.  It has announced a legal action. It will try to get something from the deal. Or will buy a regional bank. But for now it looks like Citi did sleep for 48 hours. 

© Rohit Deshpande

Too big to let fail ; Too big to save - It's WAMU WAY

There is an interesting relationship between a bank's financial state and its deposit rates: IndyMac was offering 4.85 % just before it was put into conservatorship. WaMu is still offering 5% on 12 month CD when national average is 3.69% ! Here are some facts about WaMu:

• WAMU has lost 90% of its market value in last 12 months.

• Standard and Poor lowered credit ratings on WaMu to BBB- on long-term, just shy of the "junk bond" status.

• The bank has already lost over $ 6 billions in write-offs mainly in risky mortgages; many billions to come in near future.

• Despite of the its reduced market cap to $ 9.1 billion, the huge assets over $ 300 billions make it difficult to be acquired.

Would WaMu become 12^th bank to fail in 2008 ? I don't think so. The real question is WHO will save the bank ?

(By the way, small depositors are safe; FDIC has them covered. But the outlook doesn't look too promising” Berkshire Hathaway subsidiary's plan to stop insuring bank deposits above federal limits may reflects Warren Buffett's worries about future bank failures?)

Browser Wars III – Google Strikes Back !!

Today's biggest buzz in the tech world was the news that Google would soon be launching it's own open source web browser 'Chrome'. The news came exactly three days after Microsoft released newest version of its legendary web browser - IE 8 beta.

Who cares? Web browsers are free today – Microsoft made them free years back. Interestingly, the primary function a web browser have transformed in last 15 years - from a simple browsing tool to the machine to control the web searches and thus online ad revenues. Online ads is the biggest revenue stream for Google and thats where Microsoft struggling to make its way.

On the other hand, Microsoft is fighting back on different fronts to protect its market from Apple and Google. Both Apple and Google are targeting Microsoft's core businesses. (In my view, Microsoft is the most diversified technology company today with it's businesses and operations in operating systems, business solutions softwares, online services and entertainment devices vastly dodge the risk exposure). All of these three companies are well capitalized, have constantly demonstrated satisfactory financial earnings and led by some of the greatest visionary business leaders. (Though there is significant difference in the brand characters - Apple has kind of 'Cool' brand, Google is more 'anti-establishment and maverick' while Microsoft's brand style is rather 'serious and corporate' !)

The war is getting serious everyday...

1. http://www.marketshare.hitslink.com
2. http://www.attributor.com/blog/get-your-fair-share-of-the-ad-network-pie/


© Rohit Deshpande

Airline Industry – “High” and “Dry”

Recently I came across a very funny video on You Tube. In this video, flight attendance charges passengers fees for use of seat belts, reading material and even emergency oxygen masks. It seems that the parody is coming to reality. Just yesterday, in a letter to the Federal Aviation Administration, United Airlines' Pilot Union alleged that four recent engine failures or compressor stalls on United 737 aircraft may signal the "maintenance standards have deteriorated at United as operational decisions are increasingly driven by economic considerations." [WSJ]. Last Month US Airline Pilots Association complained that the airline was pressuring pilots to carry less fuel to reduce the weight of the plane. [Fox Business]

The sky-rocketing oil prices have clearly crippled the airline industry. Airlines are taking major decisions to keep operating costs low; ranging from consolidations, eliminating routes, and cutting jobs to charging for check-in baggage and in-flight services including food, beverages, blankets and pillows. There have many arguments from both sides of the fence. The critics criticize declining value of service while supporters argue pointing that the cost of air travel has not been increased significantly with the increased fuel prices.

In my opinion issue real problem is not oil price but the business model itself. 5 of “Big Six” airlines have gone through chapter 11; some of them have gone more than one time. There is an urgent need to refine the complete business model:

1. Demanding cutting edge technologies that will reduce the risk exposure to volatile energy market;


2. Building strategic partnerships with all the stakeholders, particularly with the customers;


3. Eliminating the non-value addition processes. They have done it well in recent days; But most importantly:


4. Defining the business as ‘transportation business’ instead of just ‘airline business’. This will open avenues to sustainable horizontal growth. (This is much analogues to railroad industry decline in “Marketing Myopia” by Theodore Levitt)

Few days back I got email letter signed by the CEOs of major airline companies urging to join campaign against speculation in oil futures market that allegedly drives oil prices. With 20% drop in oil prices in last few days, I hope they don’t take away the ‘complimentary’ seat belts.

Airline stock performance with compared Dow Jones Industrial average (last six months)

Airline stock performance with compared Dow Jones Industrial average (last one month)

Links:
Airline Video –
http://www.youtube.com/watch?v=Q-nX6g148mA

Airline CEOs sign joint letter to frequent fliers -http://www.stopoilspeculationnow.com/uploads/An_Open_letter_to_All_Airline_Customers.pdf

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?