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. 

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.

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.

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. 

Update 1 (20.12.2021)

This article examines the politics and economics of extracting Lithium, used in Lithium-ion batteries for electric vehicles, from the giant brine sea high up in the Bolivian Andes. 

The Indigenous Quechua people revere the Salar de Uyuni, 4,000 square miles of salt flats that their forebears believed were the mixture of a goddess’s breast milk and the salty tears of her baby... With a quarter of the world’s known lithium, this nation of 12 million people potentially finds itself among the newly anointed winners in the global hunt for the raw materials needed to move the world away from oil, natural gas and coal in the fight against climate change.

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.

Update 1 (08.01.2022)

Merryn Somerset Webb attributes the ongoing natural gas price rises in Europe to a decarbonisation shock,

The Bank of America reckons that the average European household spent about €1,200 on electricity and gas in 2020, a number that, based on current wholesale prices, will rise to €1,850 by the end of 2022 — up 55 per cent. Next year is unlikely to be much better. Energy prices will keep on rising. Why? Because too many governments have jumped the gun on renewables — thinking that we can phase out fossil fuels in favour of deeply unreliable renewable energy significantly faster than we actually can — if indeed we ever can. This is a decarbonisation shock — which one fund manager tells me could even end up causing as much pain as the Opec-driven oil shocks of the 1970s...

It is, say analysts at JPMorgan, a simple matter of supply and demand — as ever . . .  There has been a collapse in investment in oil and gas production — capital spending on new projects is 75 per cent down from its peak. But at the same time global demand for thermal energy sources as a whole has “barely declined” — and the demand for oil just keeps rising. JPM expects global oil demand to grow by 3.5m barrels per day in 2022, ending the year both slightly above 2019 levels and at a record high. There will be a new record high in 2023 — there are a lot of record highs in today’s column — more unwanted inflation I’m afraid. JPMorgan’s various research teams forecast oil prices in 2022 to range from $80 to $125 a barrel. The world’s efforts to energy transition are obviously well intentioned. But good intentions often come at an unexpectedly high price.

Weekend reading links

1. Fascinating account of the social debates taking place in Canada's Atlantic coast areas like villages and towns in New Foundland,

Until recently, Canada’s Atlantic provinces were suffering from so much outward migration that some towns started offering free land to lure workers. But as urban life across the world has been upended by the coronavirus, with lockdowns, shuttered bars and socially distanced gyms, the picturesque region is experiencing the largest inward migration in nearly 50 years. Desperate to escape pandemic doldrums and soaring housing prices, and energized by a global shift to remote working, the newcomers are flocking to Atlantic Canada, where they have been largely welcomed. But in the distinctive coastal region — shaped by the traditional values of its Indigenous peoples and Irish, Scottish, English and French settlers — the migration of moneyed urbanites is also fanning some tensions.

Though housing prices remain low compared with bigger urban centers, in Bonavista, population 3,752, they are exploding, and some local residents bemoan the higher property taxes that come with them. The social fabric of the town has also been changing. Traditional craft shops and restaurants offering fish and brewis, a starchy local dish of cod and bread, have been gradually giving way to designer sea salt companies and to purveyors of cumin kombucha and iceberg-infused soap...

According to Statistics Canada, about 33,000 people from other provinces migrated to the region of 2.5 million people in the first half of this year alone, compared with about 18,500 in the same period in 2005. Many of the new arrivals are millennials... Reg Butler, a crab fisherman, whose family has been in Bonavista for five generations, credited the newcomers for rejuvenating the local economy after the town emptied in the 1990s following a moratorium on cod fishing. But he said a housing shortage was stoking some resentment.

2.  South Korea hallyu facts of the day,

In the last few years alone, South Korea shocked the world with “Parasite,” the first foreign language film to win best picture at the Academy Awards. It has one of the biggest, if not the biggest, band in the world with BTS. Netflix has introduced 80 Korean movies and TV shows in the last few years, far more than it had imagined when it started its service in South Korea in 2016, according to the company. Three of the 10 most popular TV shows on Netflix as of Monday were South Korean... In September, the Oxford English Dictionary added 26 new words of Korean origin, including “hallyu,” or Korean wave... It wasn’t until last year when “Parasite,” a film highlighting the yawning gap between rich and poor, won the Oscar that international audiences truly began to pay attention, even though South Korea had been producing similar work for years.

3. Upshot has this summary of how the pandemic stimuluses have benefited American labour,

Workers have seized the upper hand in the labor market, attaining the largest raises in decades and quitting their jobs at record rates. The unemployment rate is 4.6 percent and has been falling rapidly. Cumulatively, Americans are sitting on piles of cash; they have accumulated $2.3 trillion more in savings in the last 19 months than would have been expected in the prepandemic path. The median household’s checking account balance was 50 percent higher in July of this year than in 2019, according to the JPMorgan Chase Institute... Over the 12 months that ended in September, those in the top quarter of earners experienced 2.7 percent gains in hourly earnings, compared with 4.8 percent for the lowest quarter of earners. For lower earners, that follows years leading up to the pandemic in which pay gains exceeded inflation rates.

4. Barry Eichengreen and Poonam Gupta, along with another, have a reprise of their earlier paper comparing emerging economies during the taper tantrum. Their headline finding on EM vulnerability is on the public debt and fiscal deficit fronts, and India leads on both.

Where emerging markets are weaker is in terms of public-sector indebtedness... interest rates in the U.S. are poised to begin moving up, which will make for higher interest rates in India, as we have shown above. Even without these unfavorable growth and interest-rate developments, it would have been necessary to cut the government’s primary budget deficit to prevent the debt-to-GDP ratio from moving higher. With these developments, larger cuts will be required... What happens when public debt relative to the resources that the government is able to mobilize rises even higher? Either taxes have to be raised or public spending must be cut to generate additional revenues for debt service. If this proves politically impossible, governments have responded, historically, in two ways. When the debt is held externally, they restructure. When it is held internally, they inflate.

The paper is full of graphs comparing EM economies on various indicators. This one is the most disturbing one from India's perspective, even though most government debt is internal (external is just 4% of GDP).

It draws attention to the differential between real interest rate and real GDP growth. 

Since the turn of the century, the real-growth-rate-real-interest rate differential has averaged around 5 percentage points. This means that India can run a primary deficit of 4.5 percent of GDP without seeing its debt/GDP ratio move higher...This follows from the standard equation for debt dynamics: Δb = d + (r – g)b, where the change in the debt b is the sum of the primary budget deficit d and the existing debt multiplied by the difference in the real interest rate r and the real GDP growth rate g. With a value for r-g of 5, as posited in the text, and value for b of 0.9, the product yields a value for d of 4.5 percent of GDP in a steady state... if interest rates now go up owing to global factors, the real-interest- rate-real-growth-rate differential could turn even less favorable... yields on the Indian government’s 10-year securities co-move with US 10-year Treasury yields. The elasticity with respect to U.S. rates approaches unity; this is true in both nominal and real terms. If U.S. yields are now going up, this suggests that even stronger steps will be needed to stabilize the debt/GDP ratio. With a growth rate of 6 percent and a real interest rate of 2 percent, the deficit would have to be cut to roughly 3.6 percent of GDP to stabilize the debt/GDP ratio.

5. The Ken has an investigative report on abusive practices by baby food manufacturers,

On 18 October, Union health Secretary Rajesh Bhushan received an unusual letter. It was a complaint penned by an employee of Nutricia International, the Indian arm of French food-products conglomerate Danone. The employee, one of 216 sales executives tasked with pushing the company’s infant milk substitutes and baby food, accused Danone India of a host of illegal and unethical practices in order to garner better sales in the baby food category. Danone had, according to the letter, sponsored overseas trips for doctors under the garb of an education grant, hosted liquor-fuelled parties for them, arranged for their transport, and even offered them financial inducements and gifts. If true, Danone would be in blatant contravention of India’s Infant Milk Substitutes (IMS) Act. The Act prohibits companies involved in manufacturing baby milk formula and food for babies upto two years of age from indulging in promotional activities. The allegations against Danone are damning... between January 2019 and May 2021, the Ministry of Health and Family Welfare (MoHFW) received 33 complaints about violations of the IMS Act. That’s more than one complaint a month. The alleged offenders included baby food manufacturers such as Nestle, Abbott, Mead Johnson, Danone, and Amul, but also extended to Apollo Pharmacy, Amazon, and even YouTube.

6. The surge in tech IPOs in Indian equity market - tech listings in India has so far raised $2.6 bn in 2021, a jump of 550% compared to last year's total! 

From an FT long read about the Chinese crackdown benefiting India,

For every dollar invested in Chinese tech in the quarter that ended September, $1.50 went into India, according to the Asian Venture Capital Journal.

This is a good indicator of the growth potential of Indian markets,

While listed “new economy” companies account for 60 per cent of China’s MSCI index, they make up only 5 per cent of India’s, according to Goldman Sachs.

And this about what's happening now,

Analytics platform Venture Intelligence says 35 Indian start-ups have become “unicorns” worth over $1bn this year, more than every year since 2013 combined.

7. Scott Galloway has a stunning graphic which shows that the middle 60% of Americans now own less wealth than the top 1%.

In 1989, the middle class in the US owned 36% of wealth, compared to just 17% for the top 1%. 

8. The recent break-ups of GE, Toshiba, and Johnson&Johnson have triggered a debate on the demise of the conglomerate model. In the context of India, Shyamal Majumdar writes

Though the aggregate financial ratios of some of the conglomerates still look respectable, that’s primarily because one company usually makes up for all the other underperforming businesses in the group. For example, Tata Consultancy Services accounts for 67 per cent of the combined market capitalisation of all listed Tata group companies and over 90 per cent of the group holding company Tata Sons’ dividend income. TCS has virtually funded the group’s growth for over a decade now. Similarly, Aditya Birla group’s financial ratios would look less impressive if Ultratech Cement and its parent Grasim Industries are excluded.

9. Putting the PayTm fiasco in perspective,

10. Are low valuations of industrial companies a cause for inflation? Merryn Somerset Webb writes,

In a letter to investors last year, David Einhorn of Greenlight Capital suggested that the low valuations of industrial companies might in themselves be inflationary. If traditional industrial companies have low valuations, and hence an implicitly high cost of equity, it makes sense for holders of the stock to demand that dividend payouts and share buybacks take priority over capacity expansion: if the market attributes little value to your business, why expand it? That leads to continued under-investment and, due to lack of new supply, to “sustained higher prices in a number of industries”, wrote Einhorn.

11. The rise and rise of private equity giants,

12. John Authers points to the poor performance of emerging economy equity markets. 

The BRIC markets are still below their Halloween 2007 peak.

Since 2011, the fates of equity markets of BRIC and developed markets have decoupled.

Authers points to the possibility of an interesting trend - decoupling of EM equity markets from that of China.

13. The ASER 2021 is out. An interesting graphic is the sharp rise in student enrolment in government schools, shifting away from private schools. 

The share of private schools has been rising for a long period, and now the trend appears to have reversed. It's hard to believe that the quality of government schools have improved across India and that of private schools have similarly declined across to warrant this near universal trend since 2018. Is it a proxy for economic distress translating into parents forced to exit private schools and fall back on government schools.

This is the full report.

14. Finally, on Udaan, a B2B online retailer which may be more sensible bet for investors than the other inflated unicorns,

Currently Udaan has 35 lakh installed customers on the platform and as many as 25 lakh undertake regular transactions. From an average 10 per cent of their total transactions going through the Udaan platform two years ago, that share has gone up to 40 per cent. “There are 30 million retailers in the country but three to four million of them account for 85-90 per cent of the trade. So while the number of retailers on our platform might go up slowly to 40-45 lakh, we are targeting the most relevant of them in the ecosystem and ensuring that they source the bulk of their products from us,’ said co-founder Sujeet Kumar. To do so, Udaan will also focus on the availability of those stock keeping units (SKUs) which sell the most for a retailer. For instance, in the FMCG and food space, Kumar says the top 200 SKUs account for 80 per cent of the sales. “We want the retailer to source 90 per cent of these items from us,” he said.

Law of unintended consequences - Delhi air pollution

Air pollution due to paddy stubble burning in North India in October-November envelopes Delhi in a thick blanket of smog. It has several contributors. 

Livemint has an article discussing the issue. The article has a good example of how well-intended policy actions can rebound,

In 2009, in a bid to save its rapidly declining groundwater levels, the Punjab government made a law that barred farmers from planting paddy before the dates notified in late May or early June. This was done to time plantings to the arrival of the annual monsoon. This enforced delay in planting pushed the date of harvest to November, which meant farmers had to quickly clear their fields to plant wheat. A delay means lower yields. Due to this short window— of just two weeks between the two crops—farmers took to burning the crop residue in larger numbers. The delay in harvest also meant that the stubble is burnt just when the wind direction changes in late October-mid November, which carries the smoke all over the northern Gangetic plains.

And also this,

“After the introduction of the subsidy, the cost of machines used to manage stubble has increased significantly (a super-seeder now costs ₹2,40,000, compared to ₹1,80,000 a year back)," said Ravneet Brar, a farmer from Muktsar, Punjab, and spokesperson of Bhartiya Kisan Union, Kadian... Under the central scheme of agri-mechanization for managing crop residues, over ₹2,200 crore has been spent in the past four years. The subsidies range between 50-80% for the purchase of new machines.

As to the problem itself, I don't think there are any innovative or unknown solutions to the problem of smog and air pollution in Delhi in the winter months. It requires deploying the well known set of actions, co-ordinating among various implementation partners, and implementing them with high fidelity in a focussed manner. Searching for innovations when faced with such problems is a human failing though it'll do little to solve the problem. 

Genaralizability problem with investment models

A common topic in this blog has been about the problems with drawing inferences with field experiments in development. Economists refer to the generalisability or external validity of the findings of field experiments. This post will examine the problem in Finance.

This has a more wider resonance in the form of what has been called a "replication crisis" even in the world of hard sciences. The seminal work has been that of John Ioannidis who has shown that the results of many medical research papers could not be replicated by other researchers, a trend exposed by researchers in other fields too. I have blogged here about the work Eva Vivalt whose meta analysis of nearly 600 impact evaluation studies of 20 development interventions shows a remarkable level of non-replicability and inconclusiveness. 

This has an even wider relevance in the context of the debate around the narrative of superior wisdom of experts. The Covid 19 has been only the latest demonstration of the perils of relying on expert wisdom. Philip Tetlock has done extensive research to show how experts perform even worse than outsiders in predicting future events in their respective fields. 

Robin Wigglesworth has a good article in FT which points to the problem in Finance, citing the work of renowned finance guru and Duke University Professor Campbell Harvey. Before getting to Harvey's work,  let's read Wigglesworth's excellent description of the problem, 

The heart of the issue is a phenomenon that researchers call “p-hacking”... P-hacking is when researchers overtly or subconsciously twist the data to find a superficially compelling but ultimately spurious relationship between variables. It can be done by cherry-picking what metrics to measure, or subtly changing the time period used. Just because something is narrowly statistically significant, does not mean it is actually meaningful. A trading strategy that looks golden on paper might turn up nothing but lumps of coal when actually implemented. Harvey attributes the scourge of p-hacking to incentives in academia. Getting a paper with a sensational finding published in a prestigious journal can earn an ambitious young professor the ultimate prize — tenure. Wasting months of work on a theory that does not hold up to scrutiny would frustrate anyone. It is therefore tempting to torture the data until it yields something interesting, even if other researchers are later unable to duplicate the results.

Campbell Harvey claims a replication crisis with market beating investment strategies identified in top financial journals. He feels at least half of them are bogus and that his fellow academics are in denial on this. The paper is a short 6 page read. It starts with the provocative statement,

About 90% of the articles published in academic journals in the field of finance provide evidence in “support” of the hypothesis being tested. Indeed, my research shows that over 400 factors (strategies that are supposed to beat the market) have been published in top journals. How is that possible? Finding alpha is very difficult.

He then outlines the incentive structure facing researchers and journals,

Academic journals compete with impact factors, which measure the number of times an article in a particular journal is cited by others. Research with a “positive” result (evidence supportive of the hypothesis being tested) garners far more citations than a paper with non-results. Authors need to publish to be promoted (and tenured) and to be paid more. They realize they need to deliver positive results.

To obtain positive outcomes, researchers often resort to extensive data mining. While in principle nothing is wrong with data mining if done in a highly disciplined way, often it is not. Researchers frequently achieve statistical significance (or a low p-value) by making choices. For example, many variables might be considered and the best ones are cherry picked for reporting. Different sample starting dates might be considered to generate the highest level of significance. Certain influential episodes in the data, such as the global financial crisis or COVID- 19, might be censored because they diminish the strength of the results. More generally, a wide range of choices for excluding outliers is possible as well as different winsorization rules. Variables might be transformed—for example, log levels, volatility scaling, and so forth—to get the best possible fit. The estimation method used is also a choice. For example, a researcher might find that a weighted least squares model produces a “better” outcome than a regular regression.

These are just a sample of the possible choices researchers can make that all fall under the rubric of “p-hacking.” Many of these research practices qualify as research misconduct, but are hard for editors, peer reviewers, readers, and investors to detect. For example, if a researcher tries 100 variables and only reports the one that works, that is research misconduct. If a reader knew 100 variables were tried, they would also know that about five would appear to be “significant” purely by chance. Showing that a single variable works would not be viewed as a credible finding. 

His conclusion is what matters, 

The incentive problem, along with the misapplication of statistical methods, leads to the unfortunate conclusion that likely half of the empirical research findings in finance are likely false.

However, he feels that backtest-overfitted strategies (p-hacking) is less of a problem in asset management industry than in academia due to the need for replication and protect reputations in the former. 

UK's HS2 project and implications for large infrastructure projects

Time and cost overruns are a feature of infrastructure projects in particular and large projects in general. This post is about couple of recent reports from UK which points to some takeaways to address the problem. 

The High Speed 2 (HS2) is arguably the most high profile infrastructure project in UK, whose formal construction approval was given in April 2020. The project which has been years in the works, is a high speed rail connecting London with the north of England and the Midlands, and its construction has been split into three phases. A recent report by the UK's Institute for Government examined the evolution of HS2 and consolidated the takeaways. 

Like other such large projects, HS2's estimated cost has tripled even before construction has started. 

Equally important, its benefits-cost ratio (BCR) assessment has declined from 2.5 in 2012 to 1.5 by 2020.

The report makes several suggestions to address time and cost overruns - improving the analysis underpinning initial decisions (better quality DPRs, range of BCRs, alternative options), political commitments are not made before feasibility and cost-effectiveness are demonstrated, greater scrutiny of cost estimates, transparency in evolution of project cost, independent evidence checks, improving project delivery by understanding project better, flexible approach to planning, and systematic and rigorous oversight. 

Another report, by the UK's National Audit Office (NAO) offers some suggestions on more effective management of mega projects like those in transport, energy, and defence. It has this to offer as learnings on cost and schedule estimates,

Estimates made at the concept stage will necessarily be based on high-level information, which becomes more detailed as the scope of the programme is developed. The relative lack of information at a programme’s early stages means that any estimate will be highly uncertain and contain many areas of potential risk. For example, assumptions will need to be made about elements such as ground conditions, which cannot be known until detailed surveying takes place, and knowing how something will be built might require a certain level of detailed design to understand. Early costs will also likely lack input from suppliers... In addition, the use of early estimates as delivery targets can incentivise delivery bodies and suppliers to attempt to meet unrealistic expectations, which then drive behaviours that are detrimental to the successful delivery of the programme. These behaviours include overambitious attempts to find savings and meet risky schedule targets...

An estimate produced from early high-level information is unlikely to be suitable for setting a programme budget and schedule. Any early estimate of programme cost and schedule should be seen as provisional, should clearly recognise limitations and uncertainties, and be used only in an indicative fashion to guide long-term planning until a detailed design supported by industry pricing is available. Previous practice in government has been to publish cost and schedule estimates as single point figures, and it is now moving to the use of ranges to better reflect risks and uncertainties. While we welcome this development, decision-makers must understand what these ranges represent and how much confidence they can put in them. Bodies should work to understand what risks and scenarios might cause the programme to exceed these ranges, and revisit this analysis as the programme progresses...

Senior decision-makers should be alert to behaviours that suggest a schedule is becoming increasingly challenging. Persistent schedule replanning, the removal of scope and /or benefits, previously unplanned staging of a programme and excessive focus on individual project risks are signs that they need to examine closely the feasibility of the schedule. Organisations should consider early in a programme’s lifecycle what needs to be in place to meet their schedule targets, and periodically assess the likelihood of these requirements being in place. The assessment should include historical performance and productivity and should feed into an assessment of whether the benefits of meeting a deadline under pressure outweigh the risks.

The report consolidates several actionable recommendations which can easily be reduced to a checklist and integrated with the project planning, approval, and execution processes. In fact, the checklist could be made part of the Cabinet Note or the relevant approval Note, and officials should be held accountable for deviations from its adherence without satisfactory enough explanation. Further, any deviation from the original checklist should be brought to the notice of the project approving authority for revised approval.  

There is nothing innovative or new with the recommendations. But the report consolidates all of them into one place. The challenge is to integrate them into the project processes in a manner that maximises the likelihood of compliance and makes deviation personally very costly for those responsible. Having done that, it's a matter of executing the processes and hoping that an associated culture takes hold in the organisation. There are no substitutes for such systemic solutions. 

Weekend reading links

1. What drives "hot-streaks"? Derek Thompson points to the findings of a new study,

Northwestern University economist Dashun Wang... found that artists and scientists tend to experiment with diverse styles or topics before their hot streak begins. This period of exploration is followed by a period of creatively productive focus. “Our data shows that people ought to explore a bunch of things at work, deliberate about the best fit for their skills, and then exploit what they’ve learned,” Wang said. This precise sequence—exploration, followed by exploitation—was the single best predictor of the onset of a hot streak... At least for artists, film directors, and scientists, neither exploration nor exploitation does much good on its own. “When exploitation occurs by itself,” Wang and his co-authors wrote, “the chance that such episodes coincide with a hot streak is significantly lower than expected, not higher, across all three domains.” Only when periods of trial and error are followed right away by periods of deliberate focus does the probability of a hot streak increase significantly.

The research suggests something fundamentally hopeful: that periods of failure can be periods of growth, but only if we understand when to shift our work from exploration to exploitation. If you look around you at this very moment, you will see people in your field who seem wayward and unfocused, and you might assume they’ll always be that way. You will also see people in your field who seem extremely focused and highly successful, and you might make the same assumption. But Wang’s paper asks us to consider the possibility that many of today’s wanderers are also tomorrow’s superstars, just a few months or years away from their own personal hot streak. Periods of exploration can be like winter farming; nothing is visibly growing, but a subterranean process is at work and will in time yield a bounty... Today’s best exploiters were yesterday’s best explorers.

2. In the context of departure of Jes Staley as Chief Executive of Barclays, Brooke Masters has a list of such departures for personal misconduct in leading UK and European banks in recent times. Makes you realise that the high pay comes despite these common place misdemeanours. Or more appropriately, the high pay (and associated stakes) distorts incentives and makes chief executives cut corners to keep the show going. 

It also emerges that Staley had close connections with the late serial sexual offender Jeffrey Epstein. 

3. In the aftermath of CoP 26 FT has an informative story on the sources of global climate financing. 

This from multilateral agencies

And this from bilateral donors

In this context, as another FT article writes, any illusions that the private sector can take leadership in addressing climate change is plain nonsense. Private companies can only be instrumental in the process if governments back up with appropriate policy mandates. 

This is a good example of fluff by a group with a proven track record of hypocrisy,

The Business Roundtable, for example, argued in September that the country had made significant progress towards reducing emissions “in part because of corporate leadership in the absence of a smart, national climate policy”.

This is a more accurate assessment of the private sector's role,  

Joachim Wenning, chief executive of reinsurance giant Munich Re, feel a growing sense of unease. “Very often I’ve heard things like ‘in the absence of governments doing their job . . . we the private sector, we the economic leaders, have to take care of combating climate change’. It’s almost: ‘Then we have to replace the governments,’” Wenning said. “I think it’s an illusion. It’s not only that we don’t have the mandate. We don’t have the means, honestly.”

The measurement difficulties and lack of standards associated with net zero claims makes any suggestions of private sector leadership deeply questionable. 

4. Brooke Masters on the rise and fall and rise of conglomerates. 

The history of conglomerates is a tug of war, not a straight line. Observers announced the “decline and fall of the conglomerate” in 1994 and declared “conglomerates are dead” in 2007. The 1980s wave of corporate break-ups cut the share of large US groups operating in three or more sectors from half to 30 per cent. ITT split in 1995 and Tyco broke up after a scandal in 2006. Yet each had become big enough by 2011 to split themselves up again. “It becomes the conventional wisdom that conglomerates are no good and need to be broken up. Then we end up with companies that are so specialised that somebody decides that there is merit in vertical and horizontal integration,” says Alexander Pepper, a London School of Economics professor of management. “Ten years later you end up with a conglomerate.” The conglomerate’s resurgent appeal lies in the normal ambition to improve coupled with a hubristic assumption that good managers can manage anything. Entering new business lines seems attractive when competition rules prevent dominance in a single sector. Cynics note that chief executive pay and influence expands along with company size.

5. From the Bank of America's equity derivatives team early this week, via FT, a set of facts which captures the times,

“The S&P has (i) reached new highs each of the past eight trading days, tying the longest streak since 1964; (ii) risen 17 of the last 19 trading days, a feat surpassed only once in 90-plus years, and (iii) for only the second time since 1950, taken less than a month to rebound from twin fragility shocks.”

6. The Economist questions the commercial viability of the ride-hailing and delivery sector. This is a remarkable snippet,

A pizzeria could make money by ordering its own food for a discounted price on DoorDash (which then paid back the regular amount).

The financials of the ride-sharing and delivery apps,

The nine firms that have gone public so far—Uber and its American rival Lyft;Didi, a Chinese ride-sharing app; and six delivery firms, from DoorDash and Delivery Hero, which is based in Berlin, to China’s Meituan and India’s Zomato—collectively raised more than $100bn... the nine listed flywheel firms are still growing nicely—at 103% on average in their latest reporting period compared to the same period the previous year. This explains why they are collectively worth nearly $500bn. But self-levitating they are not. Nor are they profitable. Sales for the group amounted to $75bn over the past year and the operating loss to nearly $11.5bn.

And there may be signs that the ride-hailing sector may be the drag on the sector,

What is more, the company, which has a market capitalisation of $85bn, is now more of a delivery service than a ride-hailing app: Uber Eats generates more than half of sales. DoorDash’s own punchy valuation, of $65bn, rests on revenue that has grown more than fourfold since the last quarter of 2019, albeit during a time when people dined at home more often. But it also bakes in success in new markets that it has recently entered, including groceries and pet food.

7. Livemint has a comparison of the valuations of internet companies with brick-and-mortar companies in the same sector in India. 

8. T N Hari has a good article on the talent crunch facing Indian economy. The frenzy of capital flowing into startups has driven up employee attrition rates and salaries (on the aggregate both by at least 30% each, he claims) and squeezed businesses everywhere. It is a good proxy for the limited depth of good quality talent in India that $20 bn or so funds that have flown into start-ups over the last couple of years has drained talent off from an entire continental sized economy. 

9. A feature of the financial market landscape in India is the belief that government entities cannot fail. This implicit guarantee has created several distortions. One such distortion is the propensity of power sector companies being able to access debt from banks despite severe indebtedness. 

In an important and welcome development, it appears that the power ministry in Delhi has lifted the bankruptcy protections on government power companies. It has said that these entities do not fall under the category of government companies as defined under Section 2(45) of Companies Act 2013 which prohibit insolvency of such companies.

The Supreme Court in a case involving Hindustan Construction Company Ltd and Union of India in the context of the NHAI held that IBC cannot be used on a statutory body which functions as an "extended limb" of the government since no resolution can take over the management of a body which performs a sovereign function. The Power Ministry has rightly taken the view that the Electricity Act allows for state of private ownership of electricity utilities. 

If public sector banks, and more importantly the power finance DFIs PFC and REC, can take defaulting state utilities to the NCLT that would do more than any UDAY to set right incentives and create conditions for sustainable and genuine reforms in the power sector. 

10. As the curtain comes down on GE's century long existence (it split into three units - health care, energy and digital, and aviation), FT writes that Wall Street investment banking firms made more than $7 bn offering services to GE since 2000 despite its value falling about 75% during the same time. 

GE spent $2.3bn on mergers and acquisition advice alone, according to figures from Refinitiv, as it built a sprawling empire through hundreds of deals... The rise and fall of the GE conglomerate has resulted in a windfall for Wall Street with the Boston-based group spending another $3.3bn on fees related to bonds, according to Refinitiv. It spent a further $800m and $792m, on loan and equity fees, respectively. Since 2000, the company has shelled out more on investment banking fees than any other US business, according to the Refinitiv figures... the outsized fees are indicative of how bankers — who have profited despite GE’s market value falling about 75 per cent since 2000 — care more about completing lucrative transactions than acting in the best interests of their clients.