15/02/2012 - 10:35

Political pain as price of power bites

15/02/2012 - 10:35

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Energy costs to business will cause headaches for the federal government as the carbon tax approaches.

Energy costs to business will cause headaches for the federal government as the carbon tax approaches.

SOME people might hate it, but there’s no getting around the fact that the economies of the Western world have an ‘energy-cost’ foundation. Lower the cost of energy and the economy booms; raise the cost and it slows, or slumps.

Last week provided an insight into exactly what that means. In Australia, the aluminium maker, Alcoa, hit a brick wall comprising low metal prices, a high Australian dollar, rising electricity prices, and the threat of even higher prices after the introduction of a carbon tax.

In the US, the economy showed the first signs of a significant recovery after almost four years of recession or sluggish growth. The driver of the rebound in the US is cheap energy from newly exploited pools of shale gas and shale oil.

Criticised by environmentalists, the shale boom in the US is widely seen as the best thing to have happened in that country in at least three decades.

Not only has it put the US on the road to energy independence, it has slashed power bills and, when combined with a competitive (low value) currency, has restored confidence in the US economy.

Apart from gas consumers enjoying much lower energy bills (in the some cases cut by more than 50 per cent) there is another effect being felt in US industry – a boom in oil and gas drilling, and the provision of services to the drilling and oil production sector.

Over the course of 2012, an estimated $US145 billion will be spent by explorers, developers, pipe-laying contractors, trucking companies, and builders erecting oilfield workers’ accommodation in the shale-gas frontier states of North Dakota, Pennsylvania, Idaho and Ohio. In the year 2000 the total spent on similar services was $13 billion.

The US energy revolution has been credited with helping the world’s biggest economy grow by an annualised 2.8 per cent in the December quarter, up from 1.8 per cent reported for the September quarter. Unemployment is also trending down, falling to a three-year low of 8.3 per cent.

There is a dark side to the US shale gas/oil boom, however, as BHP Billiton is discovering. Having spent an estimated $20 billion buying US shale tenements, it is now confronting the dilemma of what cheap gas does to a producer – slashes profit margins.

The solution, which all major US gas producers are following, is to adjust their exploration targets, looking for pools of oil trapped in association with gas.

No-one knows where this refocus will go because the exploration and production technology from hard-rocks such as shale is new, but it appears that the application of capital and technical skills is already producing a sharp increase in domestic US oil production.

Australia could, in theory, enjoy the same benefits from tapping shale for its gas and oil, though the questions are when, and at what price?

Energy costs, when combined with an uncompetitive exchange rate, and the layering of an additional cost in the form of the carbon tax, are producing a deadly cocktail of costs for manufacturing industries, especially in the rust-belt states of Victoria, NSW and South Australia.

That’s why the Australian government is being forced to prop up foreign car makers every time they threaten to close production lines, why Alcoa has held its hand out for a fistful of taxpayer dollars, and why other energy-intensive manufacturers will do the same as the carbon tax gets closer.

Dollar dazzled?

RATHER than relying on government handouts, there might be a more conventional boost heading the way of hard-hit exporters – a currency crash.

While not good news for champagne drinkers, buyers of luxury sports cars and exotic foreign holidays, at least one international bank believes the Australian dollar has reached what it calls an ‘antipodean tipping point’.

HSBC said in its latest Currency Weekly that both the Australian and New Zealand currencies were “significantly overvalued on conventional measures”.

Using a purchasing power parity (PPP) model the bank reckons: “the Australian dollar is nearly 40 per cent overvalued and the New Zealand dollar is about 18 per cent overvalued”.

If the HSBC calculations are correct, the Australia dollar could fall to less than US70 cents.

Noting the both the Australian and New Zealand currencies have moved to record highs over the past few months, HSBC said currency traders were making a number of mistakes.

Firstly, it is a mistake to view the currencies in the simple context of high commodity prices and the ‘risk’ mood of global markets.

“Instead, both currencies have significant downside risks based not only on their extreme valuation, but also on their balance of payments dynamics, poor risk/reward compared with some other G10 (major) alternatives, and their declining role as a China proxy as the Chinese currency market develops,” HSBC said.

If the bank’s case is valid it might be good time to stock up on French wine and German cars.

A look at Libor

SLOWLY, ever so slowly the ‘Libor scandal’ seems to be building a head of steam.

Not widely understood outside the specialised world of international finance, a number of government inquiries are peeling back the way in which Libor, or the London Interbank Offered Rate, is set on a daily basis.

For decades Libor, which is the world’s most important interest rate barometer, was set by a group of banks comparing the interest rate they charged each other during the day-to-day business of shuffling money around. Libor then became the benchmark on which interest rates worldwide were set.

Never previously questioned, what is now being alleged – and what has cost a number of bankers their jobs in London – is that some of the banks that participated in setting Libor had colluded, and provided early information to clients on the rate so they could trade on futures markets ahead of the rate being announced.

Switzerland’s Competition Commission said in a statement last week that financial derivative traders “might have manipulated” their submissions on the Libor rate by “coordinating their behaviour, thereby influencing the reference rate in their favour”. In simple English, that’s called cooking the books – on a grand scale.

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“With money in your pocket, you are wise, and you are handsome, and you sing well too.”

Jewish proverb


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