Carl from Chicago

Business executive interested in history, economics, taxation and energy policy.

Natural Gas and Power Generation

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Power Generation:

The US power generation portfolio is primarily made up of nuclear power, coal, and natural gas. Hydroelectric can be significant in parts of the country (and in power coming from Canada) but no one is even thinking of adding new hydro assets (in fact they talk about tearing down the dams we have today). Despite all you read in the press, “alternative” energy including solar and wind energy makes up a minuscule portion of total US generation (and almost none of the critical “base load” generation which is reliable).

In many posts over the years I have written about the media myths about power – one of the most prevalent is that nuclear power is enjoying a “renaissance” – nothing could be further from the truth. You can click on the sidebar (here) to view my previous posts on this topic. Nothing of substance (i.e. shovels turning dirt, committed orders occurring) is happening in the US; even in Europe where the revolution is also occurring one of the few new Western nuclear plants under construction (in Finland) is plagued by cost overruns and difficulties – from this NY Times article:

Areva, a French nuclear construction company, said this week that its project to build the world’s most powerful reactor remained mired in delays and was over-budget by 2.3 billion euros, or about $3.3 billion. The price tag of the plant in Olkiluoto, Finland — the first of a fleet of so-called evolutionary power reactors that Areva foresees building in coming years — was about $4.3 billion in 2003 and costs have steadily increased. The reactor was meant to have gone online early this summer but Areva no longer is committing to any dates for its completion.

With all of these difficulties in building coal or nuclear plants, the industry has turned almost exclusively to natural gas in order to provide extra capacity for the US. Natural gas plants are relatively cheap to build and easy to site; they emit less greenhouse gases than coal plants – but their down side is that with the price of natural gas up near $10 – $14 / unit (as anyone who uses natural gas to heat their home can attest), these plants are much more expensive to run. In addition, US supplies of natural gas have been limited (by exploration constraints and lack of LNG facilities and pipelines to get the gas where it is needed).

Natural Gas Today:

Often in this blog I criticize journalists for their poor understanding of business concepts; but I need to instead praise the Wall Street Journal for an excellent and succinct article on natural gas on Monday, October 5th.

The article is titled “Natural-Gas Glut Posts Risks for Independents” and is about the impact of lower natural gas prices on independent power producers (traditionally known as IPP’s). This article is on the back page of the investing section, called “Heard on the Street”. The articles here assume that the reader has a pretty in depth knowledge level of what is being discussed and as such get right to the point.

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NY Times on Job Creation

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The Sunday editorial page of the New York Times has an article titled “Wanted – Leadership on Jobs“. This article describes the current unemployment situation as bleak and requests “leadership” from politicians to arrest this trend. The brief editorial is nine paragraphs long; 8 of them describe the problem, and then the 9th (summary) paragraph includes their recommendations:

If successful, ambitious goals like health care reform and energy legislation may generate jobs, but officials have not persuasively linked them to job growth. Congress and the administration also have not done enough to directly create jobs. That could be done with more stimulus to spur job creation, or a large federal jobs program, or tax credits for hiring, or all three. Or surprise us. Just don’t pretend that the deteriorating jobs picture will self-correct, or act as if it is tolerable.

Often times our debate with the NY Times is presented as a left / right political view issue. However, in this case, the differences are even more profound – the NY Times simply has no idea what the problem set is, so they can’t even fathom a solution.

Job Creation

The first and most profound misunderstanding is that jobs are not “created”. They don’t come about from a fiat by government and can’t be “willed” into existence.

Jobs are a by-product of:

– Either a successful (profitable) business or a business in growth mode
– That has a need for services or labor to meet a business requirement
– That they can profitably sell to a third party, or leverage as part of a broader business venture

The issue of whether or not to hire additional employees is an issue that all of the employers that I have worked with or consulted for over the last two decades have wrestled with continuously. If government or the NY Times wants to increase the number of jobs, they need to peer inside the head of a business executive and work to push the levers that would make them more likely than not to hire. Thus the first and most significant problem with the lack of understanding of the NY Times is that they don’t even frame the problem correctly – if they want to create jobs, they need to think like a business person.

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The FHA and Impact on Real Estate Values

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Today the FHA, the Federal Housing Administration, is a gigantic player in the residential mortgage business. The FHA guarantees mortgages against default, and allows purchases of homes with only a 3.5% down payment, and provides a rock bottom interest rate of near 5%. These lenient terms apply to virtually everyone, even those with poor credit scores and little equity in the home, which are highly correlated with default. This is in addition to the $8000 tax credit the US Government is issuing to first time buyers, which is boosting demand for these sorts of loans.

This article describes the measures that the agency is taking to reduce the odds of a bailout, but they don’t hit on the core issues of low down payments and not adjusting the interest rates to better reflect the risks on lower credit quality mortgages. These half-hearted measures require a tiny base of assets for mortgage originations (up to $1m from $250,000) and some changes to appraisals… the core issue here is that there were massive amounts of fraudulent mortgages that flooded into the system during the boom and when they went awry the brokers that backed them vanished into the night.

Many have pointed out that the FHA looms as a likely candidate for government bailout, such as this article from the Washington Post, titled “FHA’s Refusal to Seek Bailout Met With Skepticism”

FHA Commissioner David H. Stevens said Friday that the surplus fund set aside to cover unexpected losses on mortgages backed by the agency will fall below the 2 percent threshold required by Congress when the next fiscal year starts in October.

Although the reserves had remained well above the minimum required level during the housing boom, the audit last year showed they had shrunk to 3 percent as of Sept. 30, compared with 6.4 percent a year earlier. The fund’s value was estimated at $12.9 billion, down from $21.2 billion the previous year.

Many stories note that most of the loans that are being done today are backed by the FHA. From this article in the Wall Street Journal titled “No Easy Exit for Government as Housing Market’s Savior”

The Denver home lender sees every day how dependent the housing market has become on the government. At the height of the boom, just 20% of Universal’s mortgages were backed by the Federal Housing Administration, an arm of the government that guarantees loans to borrowers who can’t afford big down payments. Today, the FHA accounts for more than 80% of his business.

Also note that the US Government is buying most of the securities that are backed by the FHA. Private banks are not interested in purchasing securities with low returns and thus the government secures the loan on the front end, and then repurchases the securities on the other end.

At the Fed, the question of whether to start dismantling the scaffolding is a dominant one. Since the beginning of the year, the Fed has purchased $836 billion of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, the federal body that securitizes FHA loans. The purchases have helped push down interest rates on mortgages guaranteed by the firms from more than 6.5% last October to 5.15% today, according to HSH Associates, which tracks the mortgage market.

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One (Small) Good Item Out of the Health Care “Debate”

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I try to stay away from the non-fact maelstrom that is our current, utterly dysfunctional “debate” on health care reform (I put that in parenthesis because I don’t even know what the latest, half-baked plan du jour even is without an up to the minute scorecard).

However – the health care publicity did bring to light and start to quantify one item that could be useful in the future when this all dies down (and hopefully goes nowhere) – the high cost of health care for our governmental employees.

This article discusses “gold plated” health care plans and their cost, and the fact that under some proposals these plans would be subject to an excise tax. From the article:

“We don’t have Cadillac salaries”, said Robert Corner, a 63-year old who works for Nebraska’s department of roads in Lincoln and earns just over $50,000 a year. His parent union, the American Federation of State, County and Municipal Employees, estimates that it’s average health plan in Nebraska will be worth $31,000 in 2013, the year the new tax thresholds would take effect.

But Mr. Corner – you DO have a Cadillac salary when you take into account the health plan that taxpayers have given you, one likely with small co-pays and very few restrictions. Many of the union plans here in Illinois involve the workers paying almost NOTHING towards their care, and rumbles of a strike whenever they are asked to contribute a dime.

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