Politics, Policy, Economics - Since 2010

Adapted from Chad Hagan's presentation at Skytop Strategies  Impact Investment Conference; Boston, Massachusetts,  September 17, 2019 ...

Adapted from Chad Hagan's presentation at Skytop Strategies Impact Investment Conference; Boston, Massachusetts, September 17, 2019

Electric Cars: The Impact of Changing Societal Values on the Auto Industry

The impact of changing societal values on the auto industry is one we are all well aware of and I will attempt to point out a few bits of insight I see in the market from my research.

The recent attacks on multiple Saudi Arabian petroleum processing facilities has shaken up what is roughly 5% of global supply. 

While there are long term oil reserves, they are largely strategic, and the recent unlocking of US reserves helps illuminate how dependent we are on global oil.

Our daily burn rate of oil is staggering around 90 - 100 million barrels per day. 

“The total worldwide oil consumption was 93 million barrels per day (bbl/day) 2015” - International Energy Agency (IEA)

While changing values in society have created a market for EV’s - this has come after a period of deep neglect. 

One of the central issues with automobiles is their dependency on oil and the carbon footprint from such heavy industry.

Electric vehicles are better but the manufacturing of electric automobiles is far from carbon free. From plastics to textiles and electronics; not to mention the constant roll out of new models, ad campaigns and marketing spends - there is a massive amount of cultural and environmental waste. 

The US is the second largest polluter behind China, and China has been active a third the amount of time. If this were thirty years ago, the US would surely be the largest. 

I had a great talk about this in London last week, and sadly if you add in California with the fires and earthquakes, the US simply tops the charts. Despite the green revolution in California, one must admit the state creates a staggering amount of carbon organically, let alone from their mega cities.

Automobile manufacturing is a form of great pride to many families, nations and empires. FIAT heir Gianni Agnelli said it best in the 1970’s when he spoke about building the cars first, giving cars to the consumer and then watching policy follow suit by building roads, and entrepreneurs developing destinations and so forth and so forth. Think of Citronen, Porsche, Ford, Fiat, Delorean, and Tesla - but no matter the destination, the United States did it best.

The US defined the automobile way of life - numerous regions had deep car cultures with subsets and segments like drag racing and surfing; the family station wagon or perhaps a Jeep for camping and hunting. Cars in America guaranteed part of the American dream, they even promised teenage independence. Even Hollywood stepped in. Hollywood helped make the idea of a road trip common place. At a broader level an extended domestic rail system for the commuter and traveler in the States never happened. 

We exported that way of life. Look only to South Korea to confirm the example of heavy industry American style. The South Koreans have in turn exported our model back to us in the form of foreign direct investment and employment base. They are intertwined in the southeast, specifically in Georgia and Alabama where they have holdings which provides thousands of local high paying jobs 

A bit of history:
It wasn’t always this easy. For some time the horse and carriage ruled the road, especially here in Boston. When automobiles first arrived, they came in the promise of a horseless carriage. One had to compete with the horse and the horse drawn carriage so a motorized carriage was the centralized promise. 

The first promise was delivered in the 1700s. The year was 1769. The 1st steam-powered auto, able to carry humans is built by Nicolas-Joseph Cugnot. It was basically a “mechanical land-vehicle” - the vehicle was huge, and only went 2 miles an hour. Still, it sold reasonably well. In 1771 an incident occurred where the driver of one of Cugnot's land-vehicles lost control and ran into a wall. This mishap is often credited as being the world's first automobile accident. 

The market slowly moved away from steam and into combustion. 

In 1808, Fran├žois Isaac de Rivaz designed the first car powered by an internal combustion engine fueled by hydrogen. 
In 1870 Siegfried Marcus built the gas combustion engine;
In 1885 Karl Benz opens shop;
In 1899 FIAT is formed in Italy;
In 1899 The Detroit Automobile Co. was founded, I believe Henry Ford’s first commercial automobile company;

Electric vehicles on the other hand were largely neglected but they had a legitimate presence. EV’s are not from last century, but as far back as the 1800s. In the 1830s Scottish inventor Robert Anderson invented the first carriage powered by non-rechargeable primary cells - so this would be the first electric carriage. Electric vehicles were produced commercially in the United States until the Model T, powered on gasoline, came to dominate. Gasoline won out for a number of reasons, including it being readily available and capable of fueling longer ranges. 

In the United States it wasn't until the 1960s and 70s that consumers began requesting EV’s in some capacity.  This was largely after the oil crisis in the 1973 oil crisis (October 1973 – March 1974); 

I guess we can claim that between 1975 and 1990 we were back in the throw of big oil and the mentioning of EV’s was just novelty.  

However, in 1990 California passed a Zero Emission Vehicle (ZEV) Mandate. The program was landmark and proved to be highly influential. 
Since 2010, more than 500,000 zero-emission vehicles and plug-in hybrids have been registered in California. I imagine a great deal more since that is a figure from a decade ago. 

The ZEV mandate likely nudged GM to produce their EV, entitled the EV1, it was produced from 1996 - 1999 and sold through their Saturn subsidiary. At 100% electric and the range was about 100 miles. 

What is clear is that electricity - or alternative fuels from non-fossil sources - could have been used to power autos - instead of gasoline - over 100 hundred years ago. Perhaps electric autos lacked the technology and power to fuel transportation initially, but they certainly fell behind by attrition, negligence and devotion to the oil barons. 

In the US from 1920 - 1970 the market and powers that be turned their backs on the idea of EV’s in the marketplace. 

This has caused other movements in the energy world: wind, hydro, nuclear and also clean powered vehicles for all types of transportation. Clearly, apart from batteries, Eventually we will see 100% clean fuel, or at least renewable fuels, and this will allow airplane and container ships to travel around the world without the associate pollutants - to some regard. 

It is estimated in London that emissions permits will be on of the most traded securities in the next ten years. However, it is still hard to add up the market share for forecasting at my office.

We have a lot of questions about the free market mechanics behind permits and trading and well as how it all adds up. 

The move away from carbon comes after a minimum fifty year run for carbon producers who effectively had a monopoly from gasoline. Where are we now in the US with the major automobile manufacturers rolling back sedans and coupes to center on heavy trucks and SUVs? How will those be efficient powered to be effective in the market place when a bigger emphasis is being put on size and that regards added weight? 

From a family office investment perspective, we kicked the tires on a deal in 2018 - it was a roll up consisting of numerous dealerships - and from what we could see, the sales, services and supply chain could easily support the mass introduction of EV, so long as EV charging times continue to develop, and maintenance expands.  

EV’s will eclipse the internal combustion engine—one day. Before this happens, in order for it to happen we need a tighter framework of regulation and better incentives for innovation - much like what I see in London and Europe. 

Numbers & Markets:
Despite the intense fever and furor for electric vehicles, they are quite rare. 
At this moment EV’s account for a minuscule percentage of annual auto sales. 

Market leaders at this moment are Tesla in the US and BYD in China. A decent product, Tesla has attracted intense emotional response, fandom and devotion; at the same time foes and enemies. However, because of Tesla electric vehicles have entered the consumer market place indefinity. 

BYD Auto, short for Build Your Dreams, was established in 2003 and markets the brand in China. It specializes in electric vehicles and has a joint venture with Daimler. 

As far as market share, Norway leads (46% in 2018), followed by Iceland (17%) and Sweden (8%).

Estimated 2018 EV sales:
China (1M+) 
Europe (385K) 
United States (361K) 
These three regions accounted for 90% of all sales in 2018. 

Peak passenger vehicle oil demand is forecasted for 2028; commercial vehicle peak oil demand peaks in 2035. By 2040 over 50% of all passenger vehicle sales will be electric vehicles, with the commercial fleet and e-buses following - Bloomberg NEF.

Note: Facts and figures came from Bloomberg NEF, EIA & Zermatt Research.

While the spike in repo and other short-term rates can be attributed to a confluence of events that resulted in a large swing in the US Trea...

While the spike in repo and other short-term rates can be attributed to a confluence of events that resulted in a large swing in the US Treasury’s cash balances, the extent of the move suggests either that reserves may be closer to their “terminal level” than previously thought, and/or that intermediation is currently constrained. The stress could persist in the near term without Fed intervention, but is not a “systemic risk” issue in our view.

Our projections for reserve balances and recent price action suggest that reserve injection on the order of $100-$150bn may be necessary over the next few weeks to keep the policy rate within the target range. While we expect a pick-up in reserve balances in late October/early November, this pick-up is likely to prove temporary. Therefore, rather than engage in temporary OMOs over long periods, the Fed may choose to expand its balance sheet by an amount offsetting non-reserve liability growth as early as October, when it announces its next round of Treasury reinvestment purchases.

- Goldman Sachs Research

Uncertainty over Saudi oil – ICE Brent prices settled yesterday with a gain of around 15%, the largest one-day price increase in at lea...

Uncertainty over Saudi oil – ICE Brent prices settled yesterday with a gain of around 15%, the largest one-day price increase in at least two decades, after Saudi Arabia reported a supply loss of nearly 5.7MMbbls/d. Saudi Aramco is still reported to be assessing the damage on the plants; however, a quick restoration of full capacity can probably be ruled out. The latest market reports suggest that the company may restore some of the capacity quickly (within a matter of days) but a significant part of the impacted capacity could take weeks or even months to repair and restore completely. Saudi Arabia said that it will use existing inventories to fill the supply gap; however, as we discussed earlier, inventories have already been depleted this year due to output cuts and the supply gap could be overwhelming if the current output disruptions are prolonged.

- ING Economics 

I am writing this post after a return from London, where you have a great many of smokers and smoking culture. There is also a lot of v...

I am writing this post after a return from London, where you have a great many of smokers and smoking culture. There is also a lot of vaping and vape shops. The EU is in favor of a broader distribution of vaping devices but they take a common sense approach to regulation. Nicotine, for instance, and nicotine amounts per milligram are regulated. A question we must ask ourselves in America is: "is vaping better than combustible cigarettes and should it be regulated". Off the cuff the answer seems obvious. However, from a medical standpoint:

"E-cigarettes heat nicotine (extracted from tobacco), flavorings and other chemicals to create a water vapor that you inhale. Regular tobacco cigarettes contain 7,000 chemicals, many of which are toxic. While we don’t know exactly what chemicals are in e-cigarettes, Blaha says “there’s almost no doubt that they expose you to fewer toxic chemicals than traditional cigarettes. - Johns Hopkins”

On this, vaping is bad for you. Smoking cigs is bad for you. Vaping is a healthier option but it still bad for you.  Also, vaping is still addictive. Let us look at cigars and cigarettes. Cigars are not terribly bad for you in moderation, but if you smoke them daily and if you inhale them, they are seriously bad for you.

Switching from cigarette smoking to cigar smoking can be particularly harmful because you might inhale cigar smoke the way you inhaled cigarette smoke. The more cigars you smoke and the deeper you inhale, the greater the risks. Although the health effects of occasional cigar smoking aren't as clear, the only safe level of cigar smoking is none at all. Instead of trying to choose between cigarette smoking and cigar smoking, try to quit tobacco entirely. There is no safe form of tobacco. J. Taylor Hays, M.D.

What can I say about this US? Well, the United States typically believes that the state level market dictates issues that then merit federal intervention. They are very hands off. In the world we live in today there is a loophole which allows for bad actors and greedy players to flood the market with their quasi-safe or not-safe-at-all product and it goes straight into the population where they are treated like guinea pigs in a consumer product experiment. At an extreme example is Heroin, OxyContin and Fentanyl. As for marijuana and THC, the absolute lack of regulation has put many buyers at the risk of the ethics of the manufacturers. Essentially, drug dealers who are squeezing out products and adding in extenders, or "cutting the drug" with whatever they deem appropriate, almost never attached to a scientific process.

The filled cartridges are not by definition a health risk. However, Mr. Downs, along with executives from legal THC companies and health officials, say that the illicit operations are using a tactic common to other illegal drug operations: cutting their product with other substances, including some that can be dangerous. - NYT

The US needs to set standards for nicotine, CBD, THC and other marketable smokeable vape cartridges and oils.  - Chad

Links & Sources:

1) Global Tobacco Laws:

2) Johns Hopkins 5 Vaping Facts You Need To Know:

3) The Walter White of Vape Cartridges:

+ Disclosure:
I am an investor in companies that manufacturer smoking devices and import Cuban tobacco.

What happened? Early Saturday saw the use of drones to attack crude oil processing plants in Saudi Arabia, with the 7MMbbls/d Abqaiq plant h...

What happened?

Early Saturday saw the use of drones to attack crude oil processing plants in Saudi Arabia, with the 7MMbbls/d Abqaiq plant hit, whilst the 1.45MMbbls/d Khurais oilfield was also hit. The Saudi energy ministry has said as a result of the attacks, 5.7MMbbls/d of crude oil output has been affected, along with 2bcf/d of natural gas production.

The Iranian-backed Houthis in Yemen have claimed responsibility for the attack, and follows the attacks we saw on Saudi oil infrastructure earlier this summer. However, this time around it has been significantly more disruptive, with 58% of Saudi oil output affected. Fortunately, reports suggest that there were no casualties with this latest incident.

What now for the oil market?

Clearly these latest developments are bullish for the oil market. In recent months, market participants have failed to price in a risk premium around Middle East tensions, despite a number of incidents over the summer. Instead, the market has been focused on trade developments and the broader macro environment. However now with almost 20% of OPEC production taken offline over the weekend, this is likely to change. How bullish will really depend on how long the outage lasts. There have been reports that production could return to normal in a matter of days, which if the case means the upside would reflect more of a risk premium, rather than a significant tightening in the market. However, we believe any indication or confirmation from the Saudis of a prolonged outage, would see Brent trading back above US$70/bbl in the near term.

It is not just the flat price that is poised to move higher, nearby time spreads are also likely to move deeper into backwardation, reflecting the tightening in the prompt physical market. OPEC+ production cuts in recent months have already been supportive for spreads, and this latest development will likely only give them a further boost higher. 

However looking beyond the supply lost from this incident, the attack does highlight the vulnerability of the Saudi oil infrastructure. Whilst many have been worried about disruptions to oil flows through the Strait of Hormuz, this latest incident does suggest that such attacks can prove even more disruptive. Furthermore, is the uncertainty of how the Saudis will respond to the attack, but what is certain is that the market needs to price in a risk premium for the simmering tension in the region.

Finally, the exit of John Bolton as the National Security Advisor to President Trump suggested that we could see the US relax its stance with Iran when it comes to sanctions. However, this latest incident means that it is an unlikely scenario now. Following the attack, US Secretary of State Mike Pompeo was not shy to put the blame on Iran.

Can the market manage with this lost supply?

The Saudis have said that they will use inventories to meet exports. If we see a disruption of only several days, then the market should be able to absorb these losses fairly easily. However, if outages start to run into weeks, this would leave the market increasingly tight. Looking at the Joint Organisations Data Initiative data, Saudi crude oil inventories have been in steady decline since 2015, and this is no surprise with ongoing production cuts. At the end of June, crude oil inventories stood at almost 188MMbbls - down from around 205MMbbls at the end of 2018. This is equivalent to around 26 days of crude oil exports. Current levels are likely to be even lower, with the continued deep production cuts that we see from Saudi Arabia.

The US Department of Energy has also said that it would act if needed, by turning to its strategic petroleum reserves, which stand at 645MMbbls. The International Energy Agency also said that is was following current developments closely, but for now believes that there are adequate commercial stocks to absorb production losses. 

Finally, a prolonged outage could mean that OPEC+ relaxes production cuts. However whilst this may help, it would not be enough to make up for the full Saudi shortfall. There are only a handful of OPEC+ members that can bring a meaningful amount of output onto the market. Between Russia, UAE, Kuwait and Iraq, we could see them bring in the region of 800-900Mbbls/d of production online, which is significantly less than the outage in Saudi. The issue for the market is that more than 70% of OPEC spare capacity sits in Saudi Arabia.

Link to PDF of article from ING Economics 

Friday the 13th Consumer News USA: Retail Sales Rise Further in August; Import Prices Decline in August. Headline retail sales increased by ...

Friday the 13th Consumer News

USA: Retail Sales Rise Further in August; Import Prices Decline in August. Headline retail sales increased by more than expected in August. Core retail sales increased by 0.3%, in line with consensus expectations, but revisions to prior months were somewhat negative. Import prices declined in August, in line with consensus expectations, and non-petroleum import prices were flat for the second consecutive month. Today’s import price data had a modest downward impact on our August core PCE estimates, and we lowered our month-over month and year-over-year forecasts by 0.01pp to +0.14% and 0.02pp to +1.70%, respectively. Today’s retail sales report suggested upside risk to our GDP tracking estimates, which we will finalize after the mid-morning data. 

Research from GS