Carl from Chicago

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

Mistakes Right Before Your Eyes

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When I was a first year staff person a couple of decades ago there was a presentation to a major multi-national company and I was the lowest ranking person on the team by a country mile. The account team prepared a map of the world with the client’s locations listed.

I looked at the map for about 2 seconds and just shouted out

You have Scandinavia on there twice

When they printed the map, for some reason they had Norway there one time and then again out in the Atlantic. I noticed it immediately because, well, it was very obvious (to me).

The account team was cursing because there was no time to change anything and they alternatively were mad at me and just laughing that someone who was a kid just hit their major presentation that hard. I think the presentation went well (I wasn’t at the meeting) and probably the client hardly noticed, anyways.

As I walked down the street in River North I noticed a custom clothing store that took up their main window space with this advertisement. This is pretty important because they get a lot of sidewalk traffic.

In 2 seconds I noted that $2,550 – $1,550 doesn’t equal a $383 discount – that sounds like $1000 to me. How they even got to $383 is a question in and of itself.

Cross posted at LITGM

Nuclear Plant Delays

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While I am a big supporter of nuclear power, the insane regulatory framework in the US and our broken financial incentive mechanisms for utilities has doomed the promised nuclear “renaissance”. The only places where nuclear plants in the US are even being attempted have “old school” regulation with “cost of service” opportunities that basically mean that the utility will recover whatever they put into service and earn a return on that investment. These include 1) South Carolina, where SCANA (a relatively small utility) is building two 1,100 MW reactors and 2) Georgia, where Southern Company (and a variety of municipal entities) are building two 1,154 MW reactors. The oddest entity, the Tennessee Valley Authority (TVA), is a Federal entity, which allows it to move forward with completion of a unit that is 1,180MW.

No utility in a state with deregulation (partial regulation) can contemplate a nuclear plant, because of the high costs which must be recovered from an open market. The price of electricity is very volatile, driven by demand, weather, and the price of alternative fuels. The low price of natural gas today, not foreseen when these plants were considered back in the late 2000’s, would make high enough energy prices to recapture these costs (and earn a profit) on an open market impossible. The price of natural gas could rise and other factors (such as the impending retirement of much of the US’ coal fleet due to EPA strangulation) could also make them economically viable; but these factors are not present today.

Beyond the enormous (and likely fatal) financial risk that these mega-projects have, (SCANA’s market capitalization is $6B, and the 2 reactors are “planned” to cost $9B), these projects have historically been plagued with immense delays and catastrophic failures such as abandonment. When these projects started, optimistic dates and costs were trotted out, ignoring both the sad history of mega-overruns and the fact that today’s regulatory and legal climate are even MORE unfavorable than those in the 1970’s when the earlier failures occurred. I knew that delays were inevitable, and unfortunately, enough time has passed that the companies are starting to admit their failures (to date).

This article describes how Southern Company has begun to waver from their cost and schedule estimates.

Southern Co. has had a simple message for the past few years: The effort to build the country’s first new nuclear power plant in a generation was on time and on budget. Now, that message is changing. The $14 billion project to build two reactors at Plant Vogtle is trending hundreds of millions of dollars over budget and trailing more than a year behind schedule, according to a report from a state-hired construction watchdog.

TVA recently has begun acknowledging their delays and cost overruns, too, per this article.

Unit 2 at the Watts Bar Nuclear Plant in Spring City, Tenn., is up to $2 billion over budget and three years behind, according to the Tennessee Valley Authority. TVA blames its own management oversight and planning. Instead of basing a plan and estimates on the twin reactor already running at Watts Bar, the utility used as a model the only other reactor work that had ever been deemed on time, close to budget and a success: Unit 1 at Browns Ferry. The trouble was that Browns Ferry and Watts Bar are completely different types of reactors with different work spaces and work needs.

Not only is the TVA admitting the cost and schedule delays, their official in charge of the plant just left the organization.

SCANA too has been acknowledging delays and cost overruns. Per the first article cited above:

In Jenkinsville, S.C., the Scana Corp.’s $9 billion expansion of its Virgil Summer nuclear power station began with work on two new reactors in late March. The Summer reactors already are reported to be at least $300 million over budget because components did not meet shifting safety standards.

Here is a SCANA presentation to EEI from their investor relations web site. Go to page 8, which shows the rising costs and tail of their planned nuclear investment. Frame this page and come back to it 3-4 years out and if it looks anything like this it will be a huge win for SCANA and the US nuclear power industry. Sadly enough, the odds are likelier that the Cubs will win the world series than that the “real” spend will look close to that graph. Note that SCANA is a 55% owner of this plant so it only represents their portion of the spend (other utilities and municipalities foot the rest).

Thus in conclusion:

1. The entities that are embarking on the nuclear construction adventure are either virtually immune to market forces (TVA) or are under “old school” regulation that lets them recover the cost in customer rates regardless of whether or not it makes economic sense

2. While these entities went into the projects with optimism despite the dismal track record of delays and outright abandonment common to nuclear construction, their exhortations and optimism are starting to fade early on in the projects

3. The US has far more to do in the form of favorable “one permit” regulation and removal of potential lawsuits and other barriers, as well as additional financial incentives, before the US nuclear industry really has a chance

Cross posted at LITGM

Music for 2012 (Carl’s List)

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With Youtube it is easy to try out new music so I recommend that you check on some of these links and see what you think. iTunes is also just a couple of clicks away.

Bob Mould – The Silver Age – Album

Bob Mould was the lead singer and guitarist of Husker Du, the seminal punk (?) band. After they broke up he went solo, formed the great band Sugar, and then got weird. He’s back now, guitars blazing, and it sounds great. Here he is playing the lead single “The Descent” on Letterman.

Calvin Harris – Feel So Close – Single

This simple, hypnotic song with a very humanistic video is one of the best songs of the year (see it here). The sparse use of electronics in all the right places is what moves it into something great.

LCD Soundsystem – Shut Up and Play the Hits – DVD

The great electronic band LCD Soundsystem fronted by James Murphy disbanded this year and he had a farewell tour and DVD of their final shows in New York City. I had the privilege of seeing LCD Soundsystem three times and they put on a great show every time. Here is a clip of them playing “All My Friends” from the DVD.

Soundgarden – King Animal – Album

When Soundgarden came back to Lollapalooza I was amazed at how great Chris Cornell’s voice sounded. This is their first album in many years and it is as if they never left. Here is “Been Away Too Long” on Letterman.

M.I.A. – Bad Girls – Video

The video for MIA’s song “Bad Girls” was completely original and new. Talk about doing your own stunts… check it out here.

Afghan Whigs – “Lovecrimes” – Song

The Afghan Whigs were a great alternative band back in the day known for “Gentlemen” and other hits. Front man Greg Dulli is still out there making great music and he reformed the band – this is their cover of a Frank Ocean song “Lovecrimes” You can download it for free at their web site here.

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Energy Update

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In the US, our energy policies have been transformed by fracking, which has led to an abundance of natural gas and re-invigorated our domestic oil industry, to boot. When I first worked in the energy business they still talked about how the natural gas industry was forced to curtail new hookups of houses in the 1970’s because we believed that we were about to run out of the fuel, and the costs in the 1990’s were about $2 / unit. After a spike up to $14 / unit (which contributed to the bankruptcy of California), economic forces and not government intervention led to the innovation and today’s low prices in the $2 – $4 / unit range.

When natural gas first fell into this low price range, industry participants were basically “waiting it out” to see if prices would rise. The price of natural gas plays a huge part of the overall energy pricing market, since natural gas “peaking” plants are turned on during spikes and they set the marginal cost of power during those peak events. During times of peak usage coal, nuclear and hydro plants reap a windfall since their costs are (comparatively) fixed if the price spikes are set by high natural gas prices. These price spikes have been significantly lessened and now natural gas is used not only for peak plants but for base-unit capacity. If the price of natural gas ever rose near those peaks in the $10+ / unit range all those investments would be un-economical, but price spikes in those ranges don’t seem to be coming in the near future.

Last Hurrah For Wind Subsidies

The wind industry is basically a creation of government incentives worldwide. The Spanish market collapsed completely instantly when incentives evaporated. The US turbine market is about to collapse as well as soon as a governmental program providing subsidies in the form of tax credits to all wind installations in service by year end, as described in this Bloomberg article.

Wind-turbine installations are exceeding natural gas plants in the U.S. for the first time this year as developers rush to complete projects before the expiration of a tax credit for renewable energy. New wind capacity reached 6,519 megawatts by Nov. 30, beating the 6,335 megawatts of natural gas additions and more than double those of coal.

It isn’t known whether or not this tax credit will be renewed; if it isn’t the US turbine industry will likely grind to a halt since wind isn’t competitive in the US without large subsidies. Unlike natural gas, which can be found in areas connected to the gas pipeline grid, most of the best wind locations are not connected to the electricity transmission grid and the costs and barriers to installing these transmission lines are insurmountable under the current regulatory regime, dooming wind to a niche tax subsidized role. Our existing wind infrastructure will sit in place, earning the tax credit, with little or nothing added going forward without new incentives.

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Low Interest Rates and Side Effects

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I was recently at a bank as part of a non-profit (else I rarely step foot in a bank) when I was talking to the banker about setting up a new account and we started discussing the interest rates that each of the potential accounts would receive. After a bit of discussion I said

At these rates, it doesn’t matter

Basically interest rates on savings accounts and non CD accounts are effectively zero unless you have an immense amount of money in that account. For example, the Chase “savings” account offered .01% – which means that if you have $100,000 in the account all year long, you are going to make $100. That is the definition of negligible. Certainly you can shop around a little more and get a higher interest rate, but you aren’t going to get near 1% unless you buy some sort of vehicle with other conditions (i.e. locking up your money for a period of time). The woman at the bank was apologetic but I knew that there was no reason for her to be – it wasn’t her fault that the nation had undergone a massive ZIRP experiment.

One side effect is that banks have now effectively become a vehicle for 1) making transactions 2) providing services. They are no longer really a vehicle for making money (i.e. earning interest, especially compounded interest, that is meaningful over time). Thus your money now is more of a way to avoid charges on those services (free checking, or avoiding low balance charges, or access to certain types of transactions without fees) than a means of making money.

The traditional function of banks is to take your deposits and turn around and “leverage” that money to make loans to others. Since banks can count on not everyone to show up and demand their deposits back on the same day (unless there is a bank run), and they should be able to earn money on the difference between the cost of the money to them (they can borrow at the lowest rates) and what they charge loan customers, this should fund much of their profits.

The newspaper industry is dying because they provided journalism as a service but made their money selling advertising (effectively as a local monopoly for many years). When businesses and individuals stopped buying advertising (hello, Craigslist), the “service” that they provide, journalism, had to pay the bills. As a result this industry has gone into free fall since then.

Banks and many other financial institutions generally do a lot of services but make their money on the spread between what they pay you and what they pay for interest in terms of their cost of money. Then they take that difference and it generally subsidizes everything else. If that difference becomes negligible, then the financial institution has to make money in some other manner, or see their profits wither like the newspaper industry.

With interest rates so low and money washing into their doors, banks should be able to make up for everything on loans. However, everyone is conservative about loaning money right now unless it is secured, and the home equity loan pipeline has mostly dried up since many houses have lost their equity buffer. I don’t have direct experience with this but have heard that it is generally not easy getting a business loan, the type of loan that is riskiest unless it too is essentially secured in some other manner (property, receivables, etc…).

As a customer, if in the medium to longer term, if you assume that interest rates will stay very low, then you have options that you probably wouldn’t have considered otherwise. For one – you may just want to consider taking a portion of your money out of the bank and just convert it into gold in your safety deposit box. The biggest argument against gold historically is that it doesn’t produce a return – it just sits there, and has storage costs to boot. While both items are true, a safe deposit box is cheap to rent each year (mine is about $100) but on top of it keeping your money in a financial institution has transaction costs, as well. You can do the same thing by buying GLD the Gold ETF which may have other advantages with regards to transaction costs and sales taxes.

Another alternative is to purchase foreign currency and put it in your safe deposit box. This traditionally has been a terrible strategy because it earns nothing but in an era of almost zero returns on major currencies around the world the side effects of this strategy are lessening almost by the day.

Since the banks can only make so many loans that are basically secured and there hasn’t been a lot of impetus by them to move into more risky types of business loans, they are basically awash in cash. In some circumstances, they have considered paying negative interest rates for large blocks of cash, and this has happened with short term debt instruments quoted in some markets, as well.

The last part of this is to strip the concept of “compound interest” out of your heads. One of my blogs is for teaching kids about investing and if I was starting this years ago I would have made a big pitch for the advantages of investing your money for long periods of time and watching it grow with the “magic” of compounding interest. It is hard to make this case with interest rates far below 1% unless you have large quantities or buy specific vehicles which take you near 1% and even that is a gigantic time frame to “double” your money. If you assume 1% / year then it takes about 70 years (give or take) to double your money – better than the straight-line model of 100 years but in all cases virtually irrelevant for practical purposes (nice calculator here).

Thus some interesting side effects for me are

1) the lost “opportunity cost” of holding cash in gold is now negligible

2) the lost “opportunity cost” of physically holding non-US currencies is now negligible

3) the margin that financial institutions receive on interest is now very low and they will need to either expand into riskier non-secured loans (which they haven’t done) or start charging for services and transactions (or see their margins crumble)

4) with 3) above and interest rates near zero the real “value” of your money with the bank is in avoiding / minimizing transaction costs and being able to take advantage of better services

5) the concept of “compounding interest” is basically dead on risk-less instruments, and for riskier instruments it is but one component of total return (probably the least essential component)

Cross posted at Trust Funds for Kids