Saturday, December 4, 2021

Weekend reading links

1. WSJ points to different ways in which businesses raise prices by stealth,

The average domestic airline ticket price is about the same today as 25 years ago, $260, versus $284 in 1996. And that’s before adjusting for inflation. How is it possible that the airline industry hasn’t increased ticket prices in over two decades? It isn’t, really. Most of us are paying a lot more to fly today, thanks to a combination of three covert price increases. First, airlines have unbundled services so that fliers pay extra for checking luggage, boarding early, selecting a seat, having a meal and so on. The charges for these services don’t show up on the ticket price, but they are substantial. Second, the airplane seat’s quality, as measured by its pitch, width, seat material and heft, has declined considerably, meaning customers are getting far less value for the ticket price. And third, many airlines have steadily eroded the value of frequent-flier miles, increasing costs for today’s heavy fliers relative to those in 1996...

shrinkflation—the common practice in the grocery industry of reducing weight, quantity or volume of a package while maintaining price. It works effectively as a covert price increase, because consumers are far more likely to notice price increases than equivalent weight or quantity decreases. Less well known is a little psychological trick companies use with larger packages. Many shoppers assume that such packages with labels like “Party Size” or “Jumbo” will be cheaper on a per-unit basis. This is often not the case. Brands routinely exploit this common consumer belief by marking up larger packages more, and earning a greater margin on them. Researchers call this a “quantity surcharge.”

Another article writes about airline prices.  

2. Douglas Irwin of the Peterson Institute for International Economics has a paper that examines the reasons for South Korea's spectacular export success in the sixties. Its share of exports surged from about 1% of GDP in 1960 to more than 10% of GPD by end of the decade, and 20% by early seventies. The export liberalisation was introduced overcoming strong domestic opposition by the US whose aid financed most of the country's imports amounting to 10% of GDP. The US pushed hard for an export promotion strategy that devalued the currency and liberalised foreign exchange controls. 

The turning point was the reforms introduced in 1964-65 by the government of President Park Chung- hee. 

A slew of regulations and previous policies of import repression, all motivated by the need to conserve foreign exchange, were swept away or relaxed in moving toward a more open (if still restricted) system related to foreign exchange... Under the new system, exporters could retain or sell all of their foreign exchange earnings at a competitive exchange rate. The move marked a big change from the export-import linkage in which only exporters had access to a limited amount of foreign exchange at an overvalued rate. Henceforth, exports were to be promoted by indirect policies, including easy access to credit, duty free imported raw materials, and tax exemptions rather than export subsidies or preferential access to foreign exchange, both of which were abolished. As a result, the government no longer regulated imports by controlling the allocation of foreign exchange; the quarterly foreign exchange budgets, which made allocations to particular importers for particular products and amounted to specific quantitative restrictions on imports, were no longer necessary... 
The cornerstone of the new export promotion stance was maintaining a realistic exchange rate, a policy augmented by low-interest loans and reduced taxes for exporters, easy importation of raw materials, intermediate goods, and machinery needed to produce exports, and the removal of many bureaucratic obstacles to exporting. These incentives were not selectively applied to targeted industries but generalized to all exporters as long as they proved capable of selling abroad and earning foreign exchange. However, it was not a liberalization in the sense of removing all controls and price distortions or allowing foreign firms to compete in Korea’s domestic market. 

3. Robin Wigglesworth has a profile of Larry Fink and BlackRock, the world's biggest asset manager with a portfolio kissing $10 trillion. 

An interesting snippet is that BlackRock was founded in the late eighties with a $5 million loan from private equity firm Blackstone, which in turn took at 50% stake. In fact, its initial name was Blackstone Financial Management (BFM). It soon developed its iconic market leading bond trading service called Aladdin (Asset, Liability, Debt and Derivative Investment Network). Its split from Blackstone and naming was interesting,

All BFM’s funds had tickers — a code that identifies investment vehicles in regulatory filings and data providers — that started with the letter B. But an agreement with Blackstone stipulated that the new name could not include the words “black” or “stone”. Bedrock was considered, but made too many people think about The Flintstones. However, the founders loved the name “BlackRock”. They appealed to Schwarzman and Peterson, pointing out that Morgan Stanley’s 1930s split from JPMorgan burnished both firms. Peterson and Schwarzman were tickled by the idea of BlackRock as an homage to Blackstone, and blessed the new name. In 1994, Blackstone finally sold its stake in BlackRock for $240m to PNC Bank in Pittsburgh, which folded all its own money management operations into BlackRock and eventually listed it on the stock market. A long-mooted initial public offering finally arrived on October 1 1999, by which time BlackRock’s assets under management had vaulted to a hefty $165bn.

This about the outsized influence wielded by BlackRock and Larry Fink,

BlackRock, Vanguard and State Street are by some distance the world’s biggest purveyors of passive, index-tracking investment vehicles, whether traditional benchmark-hugging mutual funds or ETFs that can be bought and sold throughout the day. The inexorable shift towards such funds has handed the industry’s so-called Big Three enormous sway in many corporate boardrooms. Lucian Bebchuk of Harvard Law School and Scott Hirst of Boston University estimated in a 2019 paper titled “The Spectre of the Giant Three” that the trio’s combined average stakes in the 500 biggest listed US companies had vaulted from about 5 per cent in 1998 to over 20 per cent. Their real power is even greater — and growing. Given that many shareholders don’t actually bother to vote at annual meetings, BlackRock, Vanguard and State Street now account for about a quarter of all votes cast on average, which will rise to 41 per cent over the next two decades, the academics estimated... In reality, calling it the Big Three is a misnomer. State Street’s inclusion is the legacy of its invention of the ETF, and its size and growth rate is far more modest than BlackRock or Vanguard’s. In practice, there is an emerging duopoly, and BlackRock’s pole position — and Fink’s willingness to throw its heft around more than Vanguard — has made it a target across the political spectrum... A host of former government officials work at BlackRock, and others have departed for plum jobs in the Biden administration. To some critics, BlackRock is the new Goldman Sachs.

4. Sometime back I blogged that India's economic weakness of recent times has its roots in pursuing economic orthodoxy. Shang Jin-wei appear to think that the same may be true with China's impending economic slowdown,

Some of the reduction in growth stems from China’s zero-tolerance policy toward COVID-19, which calls for more frequent lockdowns than in most other countries... But the pandemic is not the only factor behind the slowdown. The government’s green industrial policy, tighter regulation of the property sector, and blacklists of online platforms also have collectively curtailed growth. Following its pledge to halt the rise in China’s carbon-dioxide emissions before 2030 and achieve net zero by 2060, the government has forcefully and often abruptly reduced electricity generation in coal-fired power plants, sometimes by 20%... In addition, the “three red lines” policy, initiated in August 2020 and intensified this year, sets ceilings on property developers’ debt-to-asset ratio, debt-to-equity ratio, and debt-to-cash ratio. Because many of these firms could not meet one or more of the red lines, and banks and capital markets are reluctant to provide new financing, they must sell assets, scale down operations, or both... Lastly, the authorities’ decisions to blacklist online-education companies, ratchet up antitrust enforcement, and enact a broadly worded data-protection law have helped to halve the stock prices of many listed digital-economy companies over the last 12 months. And falling equity valuations are merely the tip of the iceberg, as many digital firms and their suppliers have had to scale back their ambitions and plans.

5. One of the surprisingly less used instruments in infrastructure financing is credit guarantees. It's an instrument that can help unlock domestic lending to risky projects.

In this context, the FT reports that the European Union intends to mobilise upto 300 billion euros by 2027 for infrastructure projects for a Global Gateway that responds to China's Belt and Road Initiative. 

The draft says... the plans also hinge on the use of “innovative financial instruments to crowd-in private capital”, including guarantees to cut the risks of private sector investments. About €135bn of investments will be enabled by guarantees from the EU’s new European Fund for Sustainable Development Plus programme. The Luxembourg-based European Investment Bank would also be involved. Grant financing of up to €18bn will come from other EU programmes. Half of the targeted spending of up to €300bn will come from European financial and development finance institutions, according to the draft.

6. Tamal Bandopadhyay points to the process of bank's market share being taken over by mutual funds and insurance, 

The credit deposit ratio of the Indian banking industry in the fortnight ending November 5 was 69.56 per cent. This means for every Rs 100 worth of deposit, the banking system has lent just Rs 69.56. This is the lowest since the fortnight ending December 9, 2016, when it had dropped to 69.29 per cent. Barring this aberration, in the past decade, the CD ratio roughly varied between 72 and 78 per cent. You have not mentioned this but the fact is the banks have already started losing the working capital business to the mutual fund industry whose assets under management in October were Rs 37.33 trillion, having grown more than five-fold in the past decade. During this time, bank deposits have grown around three times, to Rs 160.49 trillion. For long-term financing, the insurance industry, with a money bag of around Rs 45.5 trillion, is stepping in.

7. Pratik Datta makes important observations on the implications of using the IBC on discoms,

The US bankruptcy code explicitly preserves the regulatory agencies’ rate-setting authority under a plan of reorganisation. There is no similar provision in the IBC. Therefore, clarity is needed on the NCLT’s power to approve a discom resolution plan that proposes a tariff change. If the NCLT could do so, tariff changes through resolution plans would be binding on the State Electricity Regulatory Commission (SERC). The policy on this issue may have significant implications for discom resolution. 

Insolvency of such utility service providers may need special treatment to ensure continuity of supply. Wide-scale disruption of such services could have disastrous consequences for an economy. For this reason, the UK restricts the rights of energy suppliers and their creditors to initiate insolvency proceedings. They must first notify the financial distress to the Secretary of State and Ofgem, the energy regulator. Ofgem assesses whether a supplier of last resort could be appointed to take over the responsibility of the failed supplier. If that is not feasible, Ofgem or the Secretary of State may apply to the court to initiate a special administration regime that ensures continuity of supply.

Even assuming the PPAs being outside the scope of NCLT (and therefore the risks of governments remaining saddled with the high cost PPAs), any haircuts on debt will translate into lower debt servicing costs which, in turn, will have to be passed on to consumers thereby implicitly revising the current tariffs.

8. On wealth creation by India's pharmaceuticals industry,

Of India’s estimated 237 billionaires, 40 have made their fortunes from pharmaceutical companies, according to the latest Hurun India Rich List, released in September. Of the 1,000 or so Indians on Hurun’s list — for which the cut-off is assets of about $140m — 130 are in pharmaceuticals, highlighting the depth of the sector. Other Indian healthcare entrepreneurs have prospered in the pandemic, as demand for their services surged. According to Hurun, India has seven billionaires who founded hospital chains, diagnostics labs or other healthcare services.

9. Business Standard writes about grade inflation in Class XII marks,

While there has been a consistent 8 per cent increase in students appearing for the Class XII exam every year, the number of students scoring over 95 per cent has jumped 58 times for the Central Board of Secondary Education (CBSE) examinations held between 2010 and 2021. In 2010, only 1,202 students appearing for CBSE Class XII had secured over 95 per cent. This year, the number was 70,004. While students scoring over 95 per cent had increased 118.7 per cent in 2020, the increase in 2021 was 80 per cent... This has also resulted in colleges posting near-perfect cut-offs for their courses. In 2010, the average cut-off for BCom (Hons) and BA (Hons) Economics at Shri Ram College of Commerce — a top-ranked Delhi University college — was 91.75 per cent and 91 per cent, respectively. This year, the college put out a near-perfect cut-off of 99.5 per cent and 99 per cent, respectively, for the courses.

In response, the Government of India is planning to have a SAT-style centralised Common University Entrance Test (CUCET) for all undergraduate and graduate courses for all the 45 central universities to start with. 

10. India digital advertising fact of the day,

At Rs 23,213 crore, their (Facebook and Google) combined ad revenues is higher than the combined ad revenues of the top 10 listed traditional media companies at Rs 8,396 crore... Together, Facebook India and Google India corner up to 80 per cent of the domestic digital advertisement revenues... For the last financial year, Zee Entertainment Enterprises, which has the largest market capitalisation among listed media entities, reported total revenues of Rs 7,729 crore. Of this, revenue from advertisements were 48 per cent, or roughly Rs 3,710 crore. In comparison, Facebook India alone reported gross advertisement revenues of Rs 9,326 crore for financial year 2020-21, while for Google the same was Rs 13,887 crore.

But this is important in terms of tax avoidance,

Both Facebook India and Google India, however, lag on aspects such as net revenue and net profit, when compared to traditional media companies. For example, while Facebook India reported a net revenue of Rs 1,481 crore, and Google India reported a net revenue of Rs 6,386 crore, Zee Entertainment Enterprises reported a net revenue of Rs 7,729 crore. The main reason for this is that Facebook India and Google India operate on an advertisement reseller model in India, which means that they buy inventory from a global subsidiary of the firm’s US headquarters and then re-sell that ad space to their client in India. For this, they pay a share of their gross advertisement revenue to the global subsidiary from whom they purchase the ad space... Industry sources said that while Facebook India pays up to 90 per cent of their gross advertisement revenues to the global subsidiary, Google India pays up to 87 per cent.

11. The Economist has an excellent primer on the Omicron variant of SARS CoV 2 virus. 

In the simplest terms, this is what makes it dangerous,

It might be better at getting into human cells than its relatives were. It might also be better at avoiding the attentions of antibodies from vaccination or an earlier infection. Virologists had long thought that a variant which combined both those advantages “would be a pretty dangerous thing”, according to Noubar Afeyan, a co-founder of Moderna... Now “Omicron is exactly that”, Mr Afeyan says... The most worrying of Omicron’s mutations are in the gene that describes the spike protein. This is the tool the virus uses to bind itself to cells and enter them. Delta probably owes its greater transmissibility in part to the fact that it sticks better to cells. Its mutations produce a spike in which nine of the amino acids in the 1,273-amino-acid-long chain from which the protein is made are distinctively different. The mutations in an unnamed variant called C.1.2, which boasted one of the most mutated spike ever seen until the past few weeks, changed 14 of the amino acids. Omicron’s mutations change 35; ten of the mutations have never been seen in any of the variants of concern to date. Almost half of the 35 changes are in the receptor-binding domain, the business end of the protein when it comes to entering cells and also the part targeted by the most effective antibodies. By changing the shape of this part of the protein, the mutations could make Omicron better at getting into cells and also less easily recognised by antibodies that work against a different version of the spike.

This about the uncertainty of the impact of mutant versions,

The reasons a variant spreads in one place and not another are, like much of the rest of evolution, thought to be largely environmental. For SARS-CoV-2 a crucial part of the environment is the immune system, and immune systems are different all over the world. How different genes, endemic infections, general levels of health, microbiomes and more end up stopping one variant from displacing another is largely uncharted territory.

The good news,

Western countries where double vaccination is common are providing more booster shots. That makes sense even if it turns out that the antibodies the immune system generates in response to existing vaccines are not as well-tailored to Omicron as they were to earlier variants. The boosters will not make better antibodies, but they will spur the body into making more of them, at least for a while. Studies have found that the quantity of antibodies against sars-cov-2 matters even if the antibodies are not specific to the variant... Because the vaccines get cells to make spike proteins according to the recipe used in the earliest genomes to be sequenced, the neutralising effect of vaccine-elicited antibodies will be lower for Omicron. But... it is not clear how great the reduction will be... immunological protection is not provided by antibodies alone. Vaccines engage the immune system’s T-cells as well. These are lymphocytes that respond not just to finished proteins, as antibodies do; they also recognise protein fragments. Because 97% of Omicron sequences are identical to the original virus found in Wuhan... these T-cell responses should still work... most fully vaccinated people with boosters should at worst fall only moderately ill if infected with Omicron. Alessandro Sette, an immunologist at the La Jolla Institute for Immunology and his colleagues have shown that T-cells preserve 93-97% of their targeting capacity when faced with a new variant.

The most impressive outcome from the Covid 19 pandemic has been the remarkable speed of lab to market translations,

BioNTech is working on a vaccine using mRNA that describes the Omicron spike. So is Moderna. Both companies have been down this road before, developing tailored vaccines against Beta and Delta. They did not go into production because they did not, in the end, prove necessary; the original vaccines held up well... Morgan Stanley, a bank, reckons that both firms could make about 6bn booster shots next year. When studying vaccines against Beta and Delta, both firms worked to develop procedures that would allow modified versions of their jabs to be approved quickly by regulators. Ugur Sahin, the boss of BioNTech says that if a new vaccine does turn out to be needed, his firm could deliver it within 100 days: the estimate includes regulatory approval.

12. Finally, Interpol capacity fact of the day,

Interpol's annual budget is just €145m ($164m)—less than that of the New Orleans police department.

Thursday, December 2, 2021

Profit seeking in Covid 19 vaccine - Pfizer edition

This will have to be one of the long reads of the year. FT has an excellent investigative report on how its Covid 19 vaccine has enabled Pfizer to dominate the global discourse on the pandemic. It's remarkable that it's covered on a mainstream and largely liberal free market newspaper like FT and not some niche website. 

The power wielded by Pfizer is truly remarkable,

The spectacular effectiveness of Pfizer’s Covid-19 shot has given the company the key to saving lives and economies... By email, text or phone, global leaders have pleaded with Albert Bourla (its Chief Executive) for orders, in some cases hoping that it might rescue political careers... While western leaders had Bourla on speed dial, the first challenge for some nations was getting his — or anyone at Pfizer’s — ear... The pandemic has ushered in a massive expansion in the power of the state — from the war-footing in economic policy to forcing people to stay in their own homes. But when it has come to medical solutions to the pandemic, governments have been almost completely dependent on private companies...
The vaccine has transformed Pfizer’s political influence... For years, its most famous product was Viagra for erectile dysfunction. Now, the US drugmaker is behind the pharmaceutical product with the record for sales in a single year. Pfizer forecasts sales of the vaccine will hit $36bn in 2021, at least double those of its closest rival Moderna. Pfizer’s ability to dramatically expand production has made it by far the most dominant vaccine maker. In October, Pfizer had 80 per cent market share for Covid vaccines in the EU and 74 per cent in the US.

This is the really scary part, 

Since the vaccine’s approval at the end of last year, Pfizer’s decisions have helped shape the course of the pandemic. It has the power to set prices and to choose which country comes first in an opaque queueing system, including for the booster programmes that rich countries are now scrambling to accelerate. Depending on its decisions, countries, regions and even whole continents can open up their economies or risk falling behind in the race to control the virus. Although supplies of vaccines to poorer countries have ramped up since September, the global disparities are stark. So far, 66 per cent of people living in G7 countries have had two vaccine doses; in Africa, only 6 per cent. The number of people in high income countries who have had booster shots is almost double the number in low income countries who have received first and second doses... How Pfizer wields this newfound power — and what it plans to do next — is treated as top secret, as the vaccine maker blacks out large chunks of contracts and binds even independent scientists with non-disclosure agreements.
And it cannot even claim to have invented the vaccine,
The vaccine Bourla has been fielding phone calls from world leaders about was actually invented in the labs of BioNTech, a pioneering company from the medieval German town of Mainz on the Rhine river. In late January 2020, BioNTech’s chief executive Ugur Sahin... marshalled BioNTech’s resources to invest in discovering a vaccine. But... he had to search for a partner who had the dollars he needed. His first stop was Pfizer because they had already worked together... The fact that it is now known universally as the Pfizer shot is “the biggest marketing coup in the history of American pharmaceuticals”. Unlike AstraZeneca and Johnson & Johnson, Pfizer never considered selling its Covid-19 shot without making a profit. BioNTech needed to make money from its first product to plough back into the business. BioNTech would pocket half the profits but Pfizer controlled commercialising the vaccine in every country except the founders’ home territories of Germany and Turkey, and China, where BioNTech had already signed a deal with Fosun Pharma. While BioNTech took up to €375m funding from the German government for development of the vaccine, Pfizer rejected US government money so it could keep complete control of the vaccine, including the crucial issue of pricing. So when Pfizer opened negotiations with the US government in early summer 2020, it took an uncompromising stance: the company demanded $100 a dose — $200 a course — according to people familiar with the matter... After Moderna, which had taken large US government grants, agreed a much lower price, Pfizer eventually settled on $19.50 a dose in the initial contract with the US, and equivalents in other western countries. But this was effectively four times the price of J&J’s single dose shot, and five times higher than a dose of AstraZeneca’s.

But its success lies in manufacturing and capacity expansion.

Pfizer’s strategy to keep more of its production in-house paid off. Along with BioNTech, they had nine of their own facilities, with the largest in Kalamazoo, Michigan and Puurs, Belgium, as well as 20 contract manufacturers. It went to extraordinary lengths to secure production. When Pfizer was unable to find appropriate ultra cold storage for its vaccines while in transit, it designed a thermal container itself. In order to secure dry ice to cool them, it built its own dry ice factory. This combination of control and expertise enabled a dramatic productivity leap. When Pfizer first began to supply the vaccine, it took an average of 110 days from the start to putting vaccine into a vial. Now, it takes an average of 31 days. In January, it said it could deliver 2bn doses this year but by August, it said it was on track to manufacture 3bn. Next year, it plans to make 4bn doses. In contrast, AstraZeneca struggled to scale up production. The Anglo-Swedish drug company, which had partnered with the University of Oxford, had planned to deliver 300m doses to the EU in the first six months of this year. But after a series of problems, it cut its deliveries dramatically, to just 100m... The problems were replicated at J&J, which at one stage paused its EU rollout.

This is also a teachable moment on the limits to the efficiency maximising approach of outsourcing production and relying only on branding and the merits of in-sourcing core functions. 

Given the near life-and-death nature of the demand, it was only natural that politicians balked at pushing back. 

“Politicians have been badly burnt. The few of them who have tried to negotiate on price or other forms of access have been politically hurt, particularly in the EU where after the early rollout there were enormous recriminations,” says Lawrence Gostin, a professor of global health law at Georgetown University. “People asked ‘Why didn’t you give companies what they are asking for?’” Ursula von der Leyen, president of the EU Commission, began... to negotiate a mega-deal of up to 1.8bn shots to be delivered all the way until 2023. “The member states wanted access to the vaccine for the next few years and to lock that down early,” says Sean Marett, BioNTech’s chief commercial officer, who adds that price was not the critical issue in the talks. “I think what was important was reliability and dependability. People were scared. You could feel it. Europe was worried about lockdowns and variants and wanted to reassure people.” The EU now expects five times more doses from Pfizer than its next biggest supplier, Moderna. Such a huge commitment would usually result in a price cut. But Pfizer raised the price by more than a quarter from the initial agreed level of €15.50 to €19.50 — and von der Leyen agreed. Pfizer also raised the price by a similar amount in its 2021 contracts with the US and the UK... negotiators feared that pushing back could delay the delivery of doses. Jonathan Cushing, head of global health at Transparency International, says: “It is effectively a race to the bottom: whoever signs over the most, will get the vaccines quickest”.

The academia, intelligentsia, and media failed to step up in creating the moral suasion to force good behaviour. Instead they spent their time on narrow academic debates and blaming governments for not doing enough. It's staggering that such profit gouging got such a free pass among the gatekeepers and opinion makers.

Worse still, with the Omicorn and other mutation threats, Pfizer's influence appears set to continue, as also the vaccine inequality,
The race to vaccinate the world has been complicated by rich countries’ booster programmes. Boosting is now well under way: Israel has already given a third dose to 44 per cent of its population, the UK has done 22 per cent, and the US just over 10 per cent. Even before the emergence of the Omicron variant on Thursday, these booster programmes looked set to cement Pfizer’s dominance of the Covid vaccine market because of the high efficacy of its shot and the company’s success at production.
Instead of claiming that it has "saved the world", a more appropriate description would be "saved the developed world". For Pfizer was not used by either China or India, and the share of Africa is tiny. Suffice to say Pfizer was practically unavailable for 70% of the global population!

This, and the likes of India's experience with private sector vaccine delivery (not to speak of market abuse by hospitals etc), should be a sobering reminder about the need to both use public policy and regulation to deliver vaccine mandates and also restrain private pharmaceutical industry price gouging in times of public health emergencies.

Monday, November 29, 2021

Market failure in residential property

An emerging trend across countries is that of private equity firms becoming large real estate landlords, including in housing. Blackstone is today the largest landlord in the world, including in America and several other countries like India

This trend has been accompanied by rising housing prices and rents, thereby posing questions about housing affordability. This, in turn, has generated strong backlash across countries, forcing governments to scramble with restrictions.

The White House wants to restrict the types of properties that large investors are allowed to buy. New Zealand has scrapped tax breaks for property investors, and Ireland has slapped a 10% tax on the bulk-buying of houses. Canada’s central bank says the role that big investors play in housing requires more scrutiny. In Germany Berlin’s residents voted in September to force their city’s biggest landlords to sell more than 200,000 flats to the state, though the referendum was non-binding and the constitutional court is expected to overturn the result if it becomes law. Spain’s left-wing government is the latest to unleash measures to deal with big landlords. Under new proposals, they will face rent controls, higher taxes on empty property and a ban on buying social housing.

And this,

Are real estate prices today the equivalent of bread prices? It’s a question that was recently asked by a trade union leader in Germany, where there has been a push to seize corporate-owned rental units and put them in public ownership. Many Dutch cities want to ban investors from buying cheap homes to rent out. South Korea’s ruling party took a beating in mayoral elections for failing to stop a 90 per cent hike in the average price of a Seoul apartment. China’s president Xi Jinping has made affordable housing a huge part of his common prosperity theme, saying that housing is “for living in, not speculation”.

Affordable housing is a complex issue. I have blogged here about the challenges associated with the issue. It's perhaps the most important problem facing the sustainability of cities, especially in developing countries. In developed countries, there is a case that housing markets in many large cities have become mature and resilient enough to evolve and regenerate constantly to prevent decay. 

Ultimately there is only one solution to addressing the issue of affordability, expansion of supply. Given the more or less fixed stock of land mass within a city, the solution has to involve both building on unused lands (extensive margin) and vertical development on existing properties (intensive margin). Further, there has to be a simultaneous expansion in supply of premium, middle-class, and low-income housing supply so that price transmission happens across the market. 

It's an empirically established reality that markets tend to concentrate the expansion of supply towards the rich and well-off. This is especially when the supply is constrained, as is the case in all urban areas. Besides, apart from being a dwelling unit, urban housing property is arguably the most important investment category

A McKinsey study, entitled “The Rise and Rise of the Global Balance Sheet”... found that two-thirds of net worth is stored in residential, corporate and government real estate as well as land... The authors believe that declining interest rates have played a decisive role in lifting asset prices of all sorts, but particularly real estate prices. Constrained land supply, zoning issues and over-regulated housing markets also helped push up values. The result is that home prices have tripled on average across the 10 countries.

The combined effect is a market failure to deliver affordable housing.  

Private investments in housing certainly has its benefits. As The Economist article illustrates,

Big investors there have been turning offices into homes for years. As a result, some 60,000 people live in Lower Manhattan today, up from just 14,000 in the mid-1990s. The City of London believes it has room for an extra 1,500 homes by 2030.

The article pooh poohs the critiques that private equity may be driving up property prices,

In fact, their share remains modest. In America investors own just 2% of rental homes. Across Europe, publicly listed funds own less than 5%. In Spain the criticism has focused on Blackstone, the country’s biggest residential landlord. After entering the market eight years ago, the private-equity giant now owns 30,000 homes. Yet this amounts to just 1% of the total stock.

But there are at least two issues with this critique. One, even if their share of housing stock is tiny, they are an increasingly important incremental contributor. 

By some estimates, they account for more than 6% of new homes in America each year. Across Britain, institutional investors are expected to supply a tenth of the government’s housing target in the next few years. Since 2018 they have built nearly a quarter of new homes in Liverpool, and more than 15% in Nottingham, Leicester and Sheffield.

Given that pricing happens at the margins, their increasingly high marginal share makes private equity a very important player in the housing market.  

A second more important issue is that of the nature of housing likely to be owned by private equity. Second homes and investment clients become the highest priority for private equity investors. All said and done, while generous tax breaks and other public support have made affordable housing somewhat attractive, the primary focus on private equity is on the high margin housing for the higher income residents.

Adding to the private equity headwind is that from sharing economy companies like AirBnB and Oyo. Even if their absolute share is small, it is a reality that they take out a non-trivial number of properties from the housing market each year, precisely at a time when its demand is rising. Besides, since the sharing economy market caters more to the middle-income and below clients, their impact is more likely to be felt in the affordable housing market. 

The aforesaid two factors mean that private equity is more likely to capture both the extensive and intensive margins with disproportionate focus on the higher income housing. At the extensive margin, vacant lands become too prohibitive except for the richest. At the intensive margin, gentrification drives out the poor and depletes affordable income stock. The net result is that the land footprint and total stock  shares of higher income housing rises, even as the real demand for affordable housing rises much faster than that for higher income housing.

In light of all the aforementioned, we have a market failure in affordable housing. The case for regulation of private equity investments in housing is therefore very compelling. The challenge is with getting it right. 

Sunday, November 28, 2021

Weekend reading links

1. Debashis Basu describes the 1993-93 equity market IPO deluge,

January 1995 saw 145 equity issues open for subscription. A spate of mega issues like Reliance Capital, Essar Oil, Jindal Vijaynagar, MS Shoes, and others hit the market in the first two months that year. In one frenzied week in February 1995, 78 companies went public, crowning a financial year of 1,400 IPOs. You begin to understand the farce of 1994-95 when you consider that between 1998 and 2001, only 219 companies raised public money.

2. As inflation looms large, FT article draws attention to the contrasting labour market trends in US/UK and elsewhere. 

In the US, where more than 4m workers have left the labour force since the start of the pandemic and the participation rate is still stubbornly 1.7 percentage points below its level in early 2020 — which is the equivalent to more than four million people. Similar pressures are visible in the UK, where the Institute for Employment Studies estimates that, due to a combination of population change and higher economic inactivity, there are now almost a million fewer people in the workforce than there would have been if pre-pandemic trends had continued... The Federal Reserve Bank of St Louis estimates that excess retirements — those that would not have happened through natural population ageing — totalled some 2.4m from the start of the pandemic up to August, accounting for more than half of those who left the labour force...
In the eurozone, in stark contrast, employment has almost regained its pre-pandemic level and labour force participation has rebounded rapidly — so that in France and Spain it is already higher than it was before the crisis... The EU has seen no wave of early retirements during the pandemic because in many countries this is already the norm... (in Australia) inflation could be less problematic there than in the US, because labour participation was returning towards record highs, in common with Japan and other countries in the region, with little pressure on wages.

Government policies may have played important role in this divergence. Specifically the nature of stimulus programs and restrictive migration policies in US/UK,

The difference was due to the high incidence of infection in the US, to school closures and to its policy of channelling income support directly to workers, rather than through schemes that preserved links between businesses and employees... In the UK, while labour shortages predate Brexit, they have undoubtedly been exacerbated by the sudden stop in inflows of EU workers. In the eurozone, labour shortages are most visible in Germany, which previously relied on a steady inflow of migrants to replace an ageing population. Diane Swonk, chief economist at the audit firm Grant Thornton, says the US is now “two million people short of where we should be” due to restrictive immigration policies in place since 2016, even before the pandemic closed borders. “It’s very hard to make up the gap in ageing demographics without a major catch-up in immigration,” she says.

Apart from this the wealth effect from rising asset prices and the general increase in household savings in the US too may have prompted people from exiting or not search for jobs.

3. Ruchir Sharma writes that the world is struck in a debt trap and therefore markets are pre-empting any rise in long-term rates,

Surging short-term rates are putting the world’s government bond markets on track for their worst year of returns since 1949. Yet the yield on 10-year government bonds is now well below the rate of inflation in every developed country. The market is likely intuiting that, no matter what happens in the near term to inflation and growth, in the long term interest rates can’t move higher because the world is far too indebted. As financial markets and total debts grow as a share of GDP, they become increasingly fragile. Asset prices and the cost of servicing the debt grow more sensitive to rate rises, and now represent a double threat to the global economy. In past tightening cycles, major central banks typically increased rates by about 400 to 700 basis points. Now, much milder tightening could tip many countries into economic trouble. The number of countries in which total debt amounts to more than 300 per cent of GDP has risen over the past two decades from a half dozen to two dozen, including the US. An aggressive rate rise could also deflate elevated asset prices, which is usually deflationary for the economy as well. Those vulnerabilities would explain why the market appears so focused on the “policy error” scenario, in which central banks are forced to raise rates sharply, tripping the economy and eventually pushing rates back down.

4. Dani Rodrik examines the adverse effects of globalisation with specific reference to the channel of trade and its distributive consequences. His summary,

Redistribution is the flip side of the gains from trade, and it becomes larger relative to net gains from trade in the advanced stages of globalization. Compensation is difficult for both economic and political reasons. International trade often differs from other market exchanges, raising fairness concerns in ways that domestic markets do not. The economic benefits of deep integration are generally ambiguous. Dynamic or growth gains from trade are uncertain.

5. Livemint points to the sharp rise in India's edible oil imports, 

India’s edible oil import bill shot up 63% to ₹1.17 trillion during oil year 2020-21 from ₹71,625 crore the year before. The volume of imports remained the same—at about 13 million tonnes—but the value rose sharply due to a spike in the international prices of palm and soy oil. The global price surge was driven by the pandemic-induced labour shortages, higher demand from China, and the diversion of oilseeds for biofuel production.

6. Much has been written about the PayTm fiasco. A less discussed factoid,

Of the Rs 18,300 crore raised by the company, Rs 10,000 crore was raised to allow an exit to existing investors, including the CEO Vijay Shekhar Sharma. In Paytm’s case, these investors happened to be Chinese.

From a Livemint article

Global brokerage firm Macquarie Research’s coverage of the company sums up the problem: “Paytm has a history of spinning off several business verticals without achieving market leadership or profitability. Paytm has been a cash burning machine, spinning off several business lines with no visibility on achieving profitability. Despite factoring in an aggressive ~50% CAGR increase over the next five years in non-payment business revenues led by distribution business, we expect Paytm to generate positive free cash flow only by FY30E."

PayTm is also a great example of how much damage one greedy company can do to a market as a whole.  

Ashneer Grover, the co-founder of fintech BharatPe, said Paytm had “spoiled” the Indian market. “Nothing can come in this market,” he told the website Moneycontrol.

This puts things in perspective of valuation,

An analysis by Goldman Sachs found that those Indian companies that are potential IPO candidates had an average price-to-sales ratio, one metric used to value companies, of 21 over the past three years, compared with three for groups across India’s benchmark Nifty index.

7. This is a stunning factoid about the nature of private capital markets today,

The IT services exporter Infosys took 12 years to go public. At the time of its IPO in 1993, it was a sub $100 million company. On the other hand, Zomato took almost the same time to list (13 years) but its market cap on listing was 130 times that of Infosys.

8. Never mind the perception of lack of objectivity with the opinion, former Chairman Coal India Parthasarathi Bhattacharya has some important home truths

If India has to develop it has to have more power, it has to generate that power, and that is not possible without depending on coal. Coal has to be there, particularly for the base load. Now tomorrow, let us say storage costs come down (a lot). And solar plus storage is the cheapest. Even in that situation, how much share of the total requirement can solar meet, even if the share increases, the power demand also increases faster? If you ask these questions I’m quite sure you will come to the conclusion that much of this will have to be borne by coal, and that’s the reason coal-based power will have to continue for quite some time in this country... you can’t shed away coal in the next 25, 30, 40 years.

9. John Thornhill writes about venture capital fund Tiger Global's capital spraying approach to investing,

In the third quarter, Tiger made 86 investments around the globe, about 1.3 deals every business day. Having raised a $6.7bn fund in March, it had invested most of it by June... While traditional VC funds can take weeks to agree term sheets, Tiger concludes deals in days. The fund mostly outsources its due diligence to management consultants, turning a fixed cost into a variable cost. It is extremely aggressive in winning deals and is happy to overpay because it is willing to accept lower returns. Tiger does not meddle with the management of start-ups or take seats on their boards.

10. From MoSPI data on time and cost over-runs for infrastructure projects

11. Snapshot of India's universe of intelligence agencies

12. Latest on profit concentration within corporate India.

India’s 20 most profitable companies accounted for nearly 65 per cent of all corporate profits in the listed space in the first half of 2021-22 (FY22)... reported a combined net profit of Rs 2.49 trillion in the first half of FY22, up 78 per cent from around Rs 1.4 trillion in the first half of FY21... Reliance Industries (RIL) was the most profitable company in the first half of FY22 with a net profit of around Rs 26,000 crore (adjusted for exceptional gains and losses). It was followed by Oil & Natural Gas Corporation (ONGC) at Rs 24,000 crore and State Bank of India at Rs 21,700 crore. In all, there were three public sector companies among the 10 most profitable companies in H1FY22, and seven PSUs among the top 20 profitable companies. RIL has been topping the profit chart every year since FY14.

Friday, November 26, 2021

Access to opportunity graphics of the day

Arguably the most important perpetuating factor in widening inequality is the barriers to equality of opportunity in accessing higher education. As Michael Sandel has written in his book, Tyranny of Merit, higher education has become the system by which modern societies "allocate opportunity".

I have blogged earlier pointing to the empirical reality of the higher quality higher education becoming the preserve of the richest people. This, this and this are posts about the Ovarian lottery that access to good higher education has become. 

Scott Galloway has two points. The first highlights the fact that undergraduate tuition in the US has risen three times as fast as consumer price inflation since 1980.

The second draws attention to its impact being much higher on the poor.

This conveys the point about both forced scarcity and galloping prices,

The greatest assault on middle-class America’s prosperity may be the relentless, four-decade-long inflation in higher education. Student loan debt ($1.7 trillion) is now greater than credit card debt... The number of Americans who have more than $100,000 in student debt is greater than the population of Utah.

The top 200 schools in America educate only 10% of college attendees. And these universities raise prices in perfect lockstep, miraculously, resulting in millions of kids who get arbitraged to mediocre universities but pay an elite price. It’s a cartel, enforced by the accreditation organizations, institutions who are as corrupt as the NCAA … minus the charm. Accreditation has teeth because it determines access to federally guaranteed student loans. And in the last 20 years, these organizations have blessed only 159 new institutions — most of them small and specialized schools — which have collectively grown total enrollment by less than 0.15% per year.

About costs and high salaries paid to senior leaderships in universities. This is mind boggling,

Nearly all of the 100 highest-paid civil servants in Massachusetts are employed by (wait for it) the University of Massachusetts.

Sandel has some stunning statistics about the access barriers,

More than 70% of students at the hundred or so most competitive colleges comes from the top quarter of the income scale, only 3% come from bottom quarter. At Ivy League colleges, Stanford, Duke, and other prestigious places, there are more students from the wealthiest 1% of families than from the entire bottom half of the country. At Yale and Princeton, only about one student in fifty comes from a poor family (bottom 20%). If you come from a rich family (top 1%), your chances of attending an Ivy League school are 77 times greater than if you come from a poor family (bottom 20%). The children of the working class and poor are as unlikely to attend Harvard, Princeton and Yale today as they were in 1954.

Leaving the last word to Sandel,

American higher education is like an elevator in a building that most people enter on the top floor.

Wednesday, November 24, 2021

Inside the struggle to control mineral resources

The NYT has a very good article that examines the China-US rivalry in the race to control Cobalt supplies from its largest producer, Democratic People's Republic of Congo (DRC). The article highlights the intersection of two important global issues - the control of minerals vital for emerging industries like electric vehicles and batteries, and destruction of rain forests to facilitate their mining. 

The setting is the Kisanfu Cobalt mines, the world's largest untapped cobalt reserves in a country which accounts for two-thirds of the global mineral production. A narrative abstract from the article. 

1. These minerals are scarce, available in only a few places, and critical for the emerging technologies.
A Tesla longer-range vehicle requires about 10 pounds of cobalt, more than 400 times the amount in a cellphone.

2. The scale of Chinese control is staggering. 

As of last year, 15 of the 19 cobalt-producing mines in Congo were owned or financed by Chinese companies, according to a data analysis by The Times and Benchmark Mineral Intelligence. The biggest alternative to Chinese operators is Glencore, a Switzerland-based company that runs two of the largest cobalt mines there.

Tenke Fungurume — a 24-hour operation that employs more than 7,000 across a landscape the size of Los Angeles marked by deep craters and dust kicked up by earth-moving vehicles... In August, China Molybdenum announced plans to spend $2.5 billion at Tenke Fungurume to double production over the next two years. When the expansion is complete, the mine will produce nearly 40,000 tons a year. Last year, the United States produced just 600 tons... The ground underneath the Kisanfu site contains enough cobalt, according to China Molybdenum’s estimates, to power hundreds of millions of long-range Teslas.
3. More than anything, the Chinese efforts have been bankrolled by deep pockets of its government. 

The five biggest Chinese companies in Congo had been given at least $124 billion in credit lines for their global operations. All of the companies are state-owned or have significant minority stakes held by various levels of the Chinese government.

4. And a standard playbook - control of minerals in exchange for infrastructure. This is a good example,

African countries for years have been turning to China for help building infrastructure with loans or trades involving their natural resources — deals that analysts warn provide far more benefit to the Chinese. A blueprint for those deals, now common across the continent, was sketched out in 2005 when Joseph Kabila walked into the Great Hall of the People in Beijing... Mr. Kabila’s wish list was long: He wanted new roads, schools and hospitals as part of a revival plan that, he hoped, would endear him back home to a nation exhausted and dispirited by years of conflict and corruption. In exchange, he was prepared to offer up his country’s vast mineral wealth — unparalleled in much of the world. In the imposing hall on Tiananmen Square, the two presidents outlined a deal that would change Central Africa’s balance of power... Mr. Hu Jintao explained that many people in China’s western provinces lived in deep poverty. Developing the area was a cornerstone of his domestic policy, and he needed minerals and metals to build out new industries. Congo was ready to help, Mr. Kabila assured him... 

The Chinese used the opportunity to begin formal talks with Mr. Kabila that would result in a $6 billion agreement: China would pay for roads, hospitals, rail lines, schools and projects to expand electricity, all in exchange for access to 10 million tons of copper and more than 600,000 tons of cobalt... “2,000 miles of roadway linking Orientale and Katanga provinces, 31 hospitals, 145 health centers, two large universities and 5,000 government housing units are pledged,” according to a cable in 2008 from the U.S. embassy in Kinshasa to members of the Central Intelligence Agency, the secretary of state and other officials.

5. Finally, the Chinese government's invisible hand has actively guided any diplomatic and other manoeuvres required to control these mines. Take this example, 

In April 2016, China Molybdenum, a company whose biggest shareholders are a government-owned company and a reclusive billionaire, made its $2.65 billion offer to buy Tenke Fungurume, an American-owned mine atop one of the biggest cobalt reserves in the world. There was one complication. Freeport-McMoRan had a Canadian partner that had the right of first offer to buy its stake. China Molybdenum’s solution was to have a Shanghai-based private equity firm buy out the partner, but even that deal relied on money from the Chinese government. None of the $1.14 billion raised to buy the partner’s share came from private investors, company filings show. Instead, it came from Chinese state-controlled entities, including from bank loans guaranteed by China Molybdenum as well as cash brought to the deal through obscure shell companies controlled by government-owned banks, according to the filings.

6. The Chinese strategic intent to control these emerging technology minerals has been matched by ineptitude, abdication, and greed on the side of American policy makers, corporates, and interest groups. For example, China Molybdenum acquired the Kisanfu site from American mining giant Freeport -McMoRan which, within five years, has moved from being one of the largest producers of Cobalt in Congo to leaving the country entirely. 

In fact, the Times reports that Hunter Biden, the son of the President no less, through the China-based private equity firm he founded, helped China Molybdenum buy Tenke Fungurume, a cobalt and copper mine, from Freeport-McMoRan in 2016. Clearly, mammon has swept aside any other consideration for American investors and businesses. 
The board of the private equity firm, commonly known as BHR, was dominated by Chinese members but also included three Americans: Devon Archer, a businessman who later was convicted of defrauding the Oglala Sioux tribe in a case still working through the legal system, and James Bulger, son of the former president of the Massachusetts State Senate. Another was Hunter Biden, whose father was vice president at the time. 
7. However, having come to control these mines, the actions of the Chinese companies themselves may be working against their interests and stirring up discontent, 
Dozens of janitor and driver jobs once held by Congolese citizens went to the Chinese... Employees were concerned that the mine was also becoming more dangerous, according to interviews with workers in communities surrounding the mine, current and former safety inspectors, Congolese government officials and mining executives. Workers climbed into acid tanks to conduct repairs without checking the air quality. Others drove bulldozers and other heavy equipment without training or did dangerous welding jobs without proper oversight... All of it was an extreme departure from the company’s American predecessor, which had “zero tolerance” for risky activities and safety violations. Freeport-McMoRan, which had built the mine, had learned some hard lessons years before at its copper and gold mine in Indonesia, facing international protest over its dumping toxic mine waste into a river in the rainforest as well as violent conflicts over its operations there... When safety inspectors discovered violations after China Molybdenum took over, they were sometimes told to overlook them, or offered bribes to do so, workers and supervisors said. And when they did try to enforce the rules, violence sometimes followed.
8. Now in the race to limit the damage and claw back some of the lost ground, the Americans are supporting efforts to get the Congolese government to exercise greater vigilance on the activities of the Chinese miners and also scrutinise whether they have fulfilled their contractual obligations. 
Congolese officials are carrying out a broad review of past mining contracts, work they are doing with financial help from the American government as part of its broader anti-corruption effort. They are examining whether companies are fulfilling their contractual obligations, including a 2008 commitment from China to deliver billions of dollars’ worth of new roads, bridges, power plants and other infrastructure... the Congolese government, with financial assistance from the United States, is examining numerous mining contracts to determine whether Congo has been shortchanged more broadly. While the Chinese-funded infrastructure projects got off to a flashy start, many have not been built... During a visit to the cobalt-mining region this year, the president Felix Tshisekedi said, “Some of our compatriots had badly negotiated the mining contracts. I’m very harsh on these investors who come to enrich themselves alone. They come with empty pockets and leave as billionaires.”

9. This underlines the enormous risks that China faces with these contracts,

Congo’s president, Felix Tshisekedi, in August named a commission to investigate allegations that China Molybdenum, the company that bought the two Freeport-McMoRan properties, might have cheated the Congolese government out of billions of dollars in royalty payments. The company risks being expelled from Congo.

10. These risks are amplified by the most important aspect, the displacement and damage inflicted on the native people by mining activities. Social tensions caused by the presence of outsiders, perceived as exploitative, are never far away. 

It's most likely that this will be only the latest version of western-style resource extraction colonialism, with China being the colonial expropriator this time. Like previous episodes, the colonial resource control desire of China and the US-China Cold War will certainly make it very hard for the DRC to benefit from its resources this time too. 

This is a good explainer of the issue. 

Monday, November 22, 2021

Some observations on the natural gas crisis

The sky rocketing natural gas prices have convulsed Europe. The blame game has pointed to a multitude of factors like increased demand, China's coal crisis forcing up its own gas imports, supply chain disruptions due to the pandemic, bungling on storage, domestic stockpile shortages in Russia, Russia trying to use the opportunity to gain approvals for Nordstream 2, unusual weather patterns, natural disasters, closures of generation capacity, and unfettered price competition at the downstream supply side. The crisis is also being posited as the first crisis of the energy transition, with the risk of slowing down the transition. 

This post will discuss two aspects of the energy transition - the decline in capital investments in the natural gas sector and the increasing reliance on short-term contracts. Both these trends in the context of a rising share of renewables pose serious threats to grid stability and reliable supply. 

Ariel Cohen writes in Forbes pointing to these two aspects,

The concerns of many energy experts (this author included) about Europe’s hasty transition away from traditional baseload powers sources (gas, coal, and nuclear) to intermittent renewable generation. Europe’s master plan for carbon neutrality has pushed the member states away from long-term purchase agreements and towards short-term pricing, making the crisis even more costly to energy utilities and other consumers who are now seeking alternative fuel sources...

As the EU sought to decarbonize their energy infrastructure, Brussels failed to establish a reliable baseline capacity for electricity generation. Today, without the ample nuclear, coal, and gas power stations, Europe would be a dark and cold place indeed. Moreover, they lack sources of energy for low renewable periods like the “windless summer” of this past year in the UK. Low wind speeds and cloud cover are becoming more unpredictable as climate change progresses, and the lack of baseload generation has resulted in the current crisis... Germany, despite all rationality, will decommissioned nearly all its reactors next year, while betting on wind and solar... Depending on Russia to fill the energy supply gap is a risky proposition. But perhaps even more short-sighted is Europe’s unwillingness to partner with the United States beyond short-term contracts. Refusal to engage in long-term purchase agreements has led Europe to fall behind Asia as America’s top destination for LNG... The main lesson is: one cannot will energy transformation into reality without building ample, reliable and economically viable baseline generation capacity.

The FT has a long read which highlights some of the problems with the energy transition,

The transition to cleaner energy such as wind and solar has had the effect of pushing up demand for gas — often viewed by the industry as a medium-term “bridging fuel” between the eras of hydrocarbons and renewables. But the long-term target of creating net zero economies in the UK and Europe has also sapped investors’ willingness to put money into developing supplies of a fossil fuel they believe could be largely obsolete in 30 years. Meanwhile, Europe’s domestic gas supplies, run low by decades of rapid development, have declined by 30 per cent in the past decade.

Adding to the problems from energy transition is the volatility associated with natural gas demand, 

The world’s oil consumption remains relatively stable throughout the year with only small fluctuations between the seasons. Gas demand, however, is far stronger each winter owing to its role in domestic heating. While there is a baseload of gas demand all year from electricity generation and industry, such as fertiliser and steel producers, the winter peaks can be far higher across the northern hemisphere. About 40 per cent of total gas consumption in the UK goes directly to heating homes, largely condensed into a period of five-six months. The industry manages these cycles in various ways. The chief one is storage — pumping gas underground during the low-demand summer months that can then be called on when the weather turns cold. The other is access to swing supplies that can rise or reduce as needed. One of the big problems the UK and Europe faces, however, is that the main sources of these supplies are not working as they once did, creating the conditions for more volatile gas prices.

European swing supplies, mainly its largest gasfield, Groningen in Netherlands, and storage facilities, like in UK (Rough storage facility off the east coast of England), have been shut down. 

The accompanying trend is the push for spot market purchases. For long natural gas supplies were governed by long-term contracts involving point-to-point pipelines. The rapid growth of the LNG market, with its liquefaction and regassification terminals, have not only integrated the global natural gas market but also led to the emergence of a rapidly growing short-term spot market similar to that for oil. An extended period of low natural gas prices lulled many market participants into the belief that the greater global natural gas market integration has resulted in a low price regime. 

In fact, in recent times, the EU has sought to shift away from long-term contracts linked to oil prices with Russia too. But with prices rising, "Gazprom has done little to help Europe refill, declining to ship additional supplies via Ukraine beyond what had been secured under long-term contracts."

However, this belief flies against the long history of price volatility with commodity prices in general. Given this, spot market reliance leaves buyers exposed to rapid demand spurts, like that now from Asian countries who are substituting away from coal towards gas. Also, when prices go up, LNG cargoes go towards those willing to pay top dollar, as the Chinese and East Asian countries are doing now to Qatari gas. 

The combined effect of these two, coupled with the stigma associated with fossil fuels and the buzz around renewables, have meant that domestic investments in natural gas infrastructure - exploration, extraction, storage etc - have declined sharply across the developed countries.

The rapidly increasing share of renewables and the simultaneous phasing out down of coal raises the question of grid stability. The only substitute for coal to serve as baseload generation is natural gas. This means that the demand for natural gas, even if mostly for baseload generation, will continue to rise for the foreseeable future even in the developed economies. This means that governments and society have to accept the reality of natural gas based generation and attract investments into the sector instead of scaring them away. Under-investment in natural gas generation at a time of rapidly increasing share of renewables is extremely short-sighted and will only create the conditions for gird breakdowns. Perversely, it could end up lowering public support for the energy transition and substitution with coal-based generation. 

These generation plants come with 25-30 year lifecycles. Given the variable fuel cost pass-throughs in utility contracts with consumers, this naturally calls for long-term contracts to hedge for short-term price volatility. It's often argued that a 10 year user requirement is best served with a 70-30 break-up between long-term and short-term contracts, and a 20 year requirement with a 80-20 break-up. In any case, the dominance of long-term contracts in any fuel sourcing contract is obvious. It would be short-sighted to ignore the long and rich history of commodity price volatility and get locked-up in a regime dominated by short-term contracts. 

Finally, on the Russia angle, I struggle to understand the reactions within mainstream media on Nordstream 2. The pipeline to pump 55 bcm of gas directly to Germany through a pipe under the Baltic Sea has been under construction for years. Irrespective of whether the gas comes through Nordstream 2 or the pipeline through Ukraine, Europe's dependence on Russia for natural gas supplies is a stark reality - just as that of US and Europe on Gulf oil was for decades. It's alternative option is LNG imports, which are more expensive and can only partially replace the Russian supplies.

Further, instead of saying no at the outset, the German government had gone along with the project for nearly a decade, including providing several permissions. Now holding up its approval may be just as repugnant as the alleged Russian attempts to starve Europe off gas supplies. Finally, the Russian intent to bypass Ukraine and deliver gas directly through Nordstream 2 is easily understandable given the geo-political significance following the 2014 Russian annexation of Crimea. Protecting Ukraine's interests is perhaps best served by other means than linking it with Nordstream 2.