David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Musings from the Oil Patch September 20th 2016

    Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB. Here is a section:

    So looking forward in a world of slow economic activity as experienced for the past decade, we can see VMT growth slowing and potentially a shift toward more fuel-efficient vehicle purchases – both not positive for gasoline demand. We then have the question of the impact of greater millennials in the population and the impact of the disruptive factors we enumerated earlier. 

    A Ford Motor Company (F-NYSE) senior executive told an analyst meeting recently that the company expected autonomous vehicles to represent 5% of the auto fleet sales in 2025, or potentially a million cars per year. Self-driving vehicle technology seems to be moving toward the mainstream faster than many anticipated. The City of Pittsburgh, Pennsylvania is now allowing Uber to test an autonomous vehicle taxi service. The cars are equipped with 20 cameras and seven sensors to help them navigate the city’s streets. The taxis will be required to have a human driver behind the wheel in case control of the vehicle needs to shift, along with an engineer in the front seat. Right now the service is free, and it has attracted many reporters who will publicize it. Will it attract many customers? Unless a taxi causes significant traffic disruptions or a life-threatening accident, we suspect the test will be declared a success. The industry, however, is still awaiting the federal government’s issuance of guidelines about how self-driving vehicle regulations should be constructed. Traffic laws are primarily under local control, but basic national standards are important for the regulatory process and the vehicle manufacturing process, including vehicle safety and emissions standards. Steering wheels and pedals, or not? 

    Self-driving technology’s primary benefit is to reduce and/or eliminate accidents and especially deaths. In 2014, according to data from the U.S. Department of Transportation, which is responsible for the Fatality Analysis Reporting System, there were 29,989 fatal motor vehicle crashes in which 32,675 deaths occurred. This represented 10.2 deaths per 100,000 people and 1.08 deaths per 100 million vehicle miles traveled. Some 38% of the deaths involved car accidents, while 25% related to pickup and SUV vehicle accidents. Only 2% of the deaths involved large trucks while the balance was accounted by motorcyclists, pedestrians and bicyclists. All deaths from large truck crashes were 12% of total vehicle deaths. 

    There remain a number of legal issues about self-driving cars that need to be resolved. Who is given a ticket for a self-driving car failing to heed traffic rules or becoming involved in an accident: the passenger, a driver in the vehicle, the owner of the vehicle, or the engineer who wrote the software? These issues will be overcome with time, but the impact on energy markets will likely come in dramatic fashion. Once auto companies feel comfortable that their self-driving cars will not be involved in accidents, they can begin designing vehicles for greater passenger comfort and entertainment, while using lighter materials since the heavy steel cages required now to protect passengers in accidents will no longer be needed. Reducing vehicle weight will make vehicles much more fuel-efficient and thus reduce future fuel consumption.

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    Guide to the 2016 Elections

    Thanks to a subscriber for this report from Wells Fargo offering a summary of potential outcomes to the upcoming elections. Here is a section:

    Some key risk seem clear: Higher budget deficits and trade restrictions are prominent risks in our scenarios. Limiting trade, widening deficits, and raising the public debt should be negative for the dollar and U.S. financial asset prices during the next four years.

    What it may mean for investors: We believe that the worst risks to the financial markets, discussed on page4s 6-10, have the lowest probabilities of occurring and advise investors not to allow the candidates’ broad unpopularity to drive fear of worse financial market impacts that are likely. In our view, investors should avoid large portfolio changes based on election fears or speculations. 

    Divided government obscures some potential opportunities but clarifies others: The strong cross-party ideological divide complicates the task of spotting investment opportunities from immigration, health care, trade, and regulation policies. Yet, sector opportunities seem clearer from prescription drug prices caps and, especially, fiscal policy, including tax reform and new infrastructure and defense outlays. 

    What it may mean for investors: The previous pages identify some potential investment opportunities, but clues about policy direction may emerging only slowly until January 2018 and possibility not until mid-2016. As the eventual policy priorities become more discernible to financial markets, investors might use this guide to identify the issues and the potential investment implications. 


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    UK Liberation From the EU Demands a Global Financial Investment Zone

    The June referendum result has galvanised thinking about the City of London’s future in a UK that will soon cease to be part of the European Union. While much of the recent discussion has centred on the potential negative consequences of Brexit, greater legislative independence will also mean that there may be new opportunities.

    One such possibility is the creation of a UK Global Financial Investing Zone. This would be a cross between a free trade zone and a tax jurisdiction. It would have the power to write local laws, be a tax authority unique in the UK tax system, and a governance authority making judicious use of data.

    The investing zone would have an entrepreneurial mission: to create an environment that was an attractive base for investment company vehicles – managing money for global investors and being deployed around the world.

    This simple sounding mission conceals an extraordinary level of opportunity. Financial services is the world’s largest industry and the UK has a particular strength in it. Britain’s ascent in the past 50 years has been supported by its international links, including a far-flung network of ex-imperial outposts, mainly in the West Indies. Entrepreneurs in the Cayman Islands, the British Virgin Islands, Bermuda and the Bahamas have created tax and governance regimes that have attracted trillions of dollars’ worth of funds.

    Of course, some of these appear to have the taint of tax avoidance or worse. But most investors use these regimes because they provide a stable and well-established legal framework, and avoid adverse tax consequences in the investor’s home jurisdiction.

    I have spent my life in the business of running global investment funds. These funds are established and run in the Caribbean, as well as Luxembourg, Ireland and Malta in the EU, Jersey, Guernsey and the Isle of Man in the UK, and Curacao and the Netherlands Antilles under Dutch oversight. All the legal, administration and accounting work tends to gravitate there. There seems to be no logical reason for this activity to take place offshore.

    Our investors are not trying to avoid tax, and the funds are not trying to avoid sensible regulation. Usually, investors are actually trying to avoid paying tax twice as a result of the tax regimes in different countries not dovetailing properly. Funds may be trying to avoid the restrictive effect of some anachronistic law or rule that no one in authority has had the competence to update. This is why successful governance regimes with a little motivation and entrepreneurial spirit have sprung up in multiple locations.

    The UK now has the opportunity to attract some of this business back “onshore”; an “offshore” regime in the heart of the City of London would benefit from the huge concentration of intellectual capital with expertise in the financial industry, IT and law.

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    Email of the day 1

    On what to do about debt:

    David, I feel that looming large and completely absent from the self-congratulatory stance of the Fed yesterday was the question of what to do with debt, private, public and corporate. We always talk about the USA because their economy is so large, and GDP consumer component has grown to 69%.. amazing, but this is probably true for the rest of the world.

    I just read an article which gave (in my opinion) a clear view of the debt situation and what eventually to do about it.:

    All this is far from new and Greece the 7th century BC was witnessing the same environment.

    Go to Solon on Wikipedia and then scroll down to "Moral reform" to see their solving of the debt situation. 

    I would be very appreciative if you could give your opinion on the potential of future destructive forces of the overall debt situation in the world today

    Many thanks, and all the best,

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    Hollande to Be Ousted in First Round of 2017 Vote, Poll Shows

    French President Francois Hollande won’t be able to make it past the first round in next year’s election regardless of the competitors he faces, a poll showed.

    Both former President Nicolas Sarkozy and former Prime Minister Alain Juppe would make it to the run-off vote against National Front leader Marine Le Pen if they win the nomination for France’s Republican party, according to the Elabe poll for Les Echos and Radio Classique.

    The findings show that Hollande is failing to gain traction with voters as Sarkozy and Juppe battle each other for their own camp’s nomination. With seven months to go until the first round of voting, the Socialist president wouldn’t even beat his former Economy Minister Emmanuel Macron, the survey showed.

    “Marine Le Pen will qualify for the second round no matter who runs,” Elabe pollster Yves-Marie Cann said in a note accompanying the poll. Macron “is showing himself a serious contender at this early stage of the campaign at a time when the electoral line up is very uncertain,” he added.

    The survey also showed Left Front candidate Jean-Luc Melenchon as making “significant” gains, Cann said. Melenchon would tie Hollande with a score of 15 percent in the first round if Juppe is the candidate on the right, according to the poll.

    The survey also shows that French voters see Le Pen as the candidate most able to reform France and ensure that it preserves its social security system. About 20 percent see her as the best-qualified on that issue, compared with 16 percent for Juppe and 13 percent for Sarkozy. Hollande scored 7 percent on that question.

    Elabe surveyed 922 voters on Sept. 20 and 21.

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    Email of the day 2

    On whether the USD (DXY) will provide some strength for commodities:

    Britain Has the Edge Over EU Nations in Trade Talks, Says Civitas

    Trade between Britain and the EU creates far more jobs on the continent than it creates in the UK, giving the remaining 27 nations a substantial incentive to strike a positive trade deal with Britain, according to researchers at the think tank Civitas.

    The new analysis estimates that 3.6m jobs in the UK are linked to trade with the EU, while 5.8m EU jobs are linked to trade with the UK.

    Every major EU economy is in the same position, according to Civitas, meaning that all of the biggest players have strong reasons to come to an open trading agreement with the UK rather than seeking to punish the leaving nation.

    Even among the smaller countries, each one has a higher proportion of jobs linked to the UK than the other way around.

    “Based on the potential impact on jobs, each EU country should be aware of the significant economic benefit in terms of jobs stemming from trade with the UK,” said Civitas.

    “The EU does arguably have to negotiate as a bloc. However, each of the 27 remaining national governments, with between 1.5 and 9.5pc of employment linked to UK trade, should be negotiating in the interests of those that democratically elected them.”

    The report, written by research fellow Justin Protts, also argues that the UK is in a sense in a stronger position that the other EU countries.

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    Fitch Reveals the $2Trillion Black Hole In China Economy That Heralds A Lost Decade

    Bad debts in the Chinese banking system are ten times higher than officially admitted, and rescue costs could reach a third of GDP within two years if the authorities let the crisis fester, Fitch Ratings has warned.

    The agency said the rate of non-performing loans (NPLs) has reached between 15pc and 21pc and is rising fast as the country delays serious reform, relying instead on a fresh burst of credit to put off the day of reckoning.

    It would cost up to $2.1 trillion to clean up this toxic legacy even if the state acted today, and much of this would inevitably land in the lap of the government.

    “There are already signs of stress that point to NPLs being much higher than official estimates (1.8pc), most obviously the increased frequency with which the banks are writing off or offloading loans,” it said.

    The banks have been shuffling losses off their balance sheets through wealth management vehicles or by classifying them as interbank credit, seemingly with the collusion of the regulators. Loans are past 90 days overdue are not always deemed bad debts.

    “The longer debt grows, the greater the risk of asset quality and liquidity shocks to the banking system,” said Fitch. Capital shortfalls are currently 11pc to 20pc of GDP, but this threatens to hit 33pc in a worst case scenario by the end of 2018.

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    UN Fears Third Leg of Global Financial Crisis With Prospect of Epic Debt Defaults

    Here is the opening of this mischievous report by Ambrose Evans-Pritchard for The Telegraph, perhaps best not read if standing near a ledge, busy traffic or other obvious hazards: 

    The third leg of the world's intractable depression is yet to come. If trade economists at the United Nations are right, the next traumatic episode may entail the greatest debt jubilee in history.

    It may also prove to be the definitive crisis of globalized capitalism, the demise of the liberal free-market orthodoxies promoted for almost forty years by the Bretton Woods institutions, the OECD, and the Davos fraternity.

    "Alarm bells have been ringing over the explosion of corporate debt levels in emerging economies, which now exceed $25 trillion. Damaging deflationary spirals cannot be ruled out," said the annual report of the UN Conference on Trade and Development (UNCTAD).

    We know already that the poisonous side-effect of zero rates and quantitative easing in the US, Europe, and Japan was to flood developing nations with cheap credit, upsetting their internal chemistry and drawing them into a snare. What is less understood is just how destructive this has been.

    Much of the money was wasted, skewed towards "highly cyclical and rent-based sectors of limited strategic importance for catching up," it said.

    Worse yet, these countries have imported the deformities of western finance before they are ready to cope with the consequences. This has undermined what UNCTAD calls the "profit-investment nexus" that ultimately drives growth and prosperity.

    The extraordinary result is that some countries are slipping backwards, victims of "premature deindustrialisation". Many of them have fallen further behind the rich world than they were in 1980 despite opening up their economies and following the global policy script diligently.

    The middle income trap closed in on Latin America and the non-oil states of the Middle East a long time ago, but now it is beginning to close in such countries as Malaysia and Thailand, and in some respects China. "The benefits of a rushed integration into international financial markets post-2008 are fast evaporating," it said.

    Yet the suffocating liabilities built up over the QE years remain. UNCTAD says corporate debt in emerging markets has risen from 57pc to 104pc of GDP since the end of 2008, and much of this may have to written off unless there is a world policy revolution.

    "If the global economy were to slow down more sharply, a significant share of developing-country debt incurred since 2008 could become unpayable and exert considerable pressure on the financial system," it said.

    "There remains a risk of deflationary spirals in which capital flight, currency devaluations and collapsing asset prices would stymie growth and shrink government revenues. As capital begins to flow out, there is now a real danger of entering a third phase of the financial crisis which began in the US housing market in late 2007 before spreading to the European bond market," it said. 

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