Wednesday, November 07, 2007

Johnny Biofuelseed's free lunch

It's certainly understandable that in a time of $100 a barrel oil many laud the promise of biofuels. Yet, Ricardo Hausmann, an economist at Harvard's Kennedy School of Government is guilty of overstating the case for them. For instance, he boldly claims the following:

Peering into the future seldom produces a clear picture. But this is not the case with bio-energy. Its long-term impacts on the global economy appear to be pretty clear, making many long-term predictions quite compelling, including the demise of the price-setting power of the Organisation of the Petroleum Exporting Countries and the end of agricultural protectionism.

While no one can deny that biofuels will be part of tomorrow's energy mix, that's a stretch. Let's begin with the following claim:

Second, the world is full of under-utilised land that can grow the biomass that the new technology will require. According to the Food and Agriculture Organisation, the world has a bit less than 1.4bn hectares under cultivation. But using the Geographic Information System database, Rodrigo Wagner and I have estimated that there are some 95 countries that have more than 700m hectares of good quality land that is not being cultivated. Depending on assumptions about productivity per hectare, today’s oil production represents the equivalent of some 500m to 1bn hectares of biofuels. So the production potential of biofuels is in the same ball park as oil production today

It is very unseemly for an economist to claim that there's a free lunch to be had. After all, why is all that land being underutilized? Maybe there are good reasons for that! It's not as if there's a shortage of land hunger in those countries. Also, let's not forget the inconvenient truth that some of that land is bound to be forested and turning into cropland is, shall we say, not an attractive proposition given our climate change worries.

Let's check out another of his claims:

Fifth, the increase in the price of agricultural land and of food will relieve governments from the current political pressure to protect the agricultural sector. Governments that, as a consequence of the land glut, have been protecting and subsidising farmers will see them grow rich either because they “plant” biofuels themselves or because other producers switch into them, lowering the supply and increasing the price of other crops.

The man clearly underestimates the power of the agricultural lobby. Even at today's high prices, farmers and big agro firms are set to push through a massive farm bill that leaves subsidies intact.

And last but not least, Hausmann dismisses the impact of higher food prices by saying that will create pressures to liberalize agricultural trade. Maybe. But it's not at all clear that liberalization would lead to lower prices, specially if, as he argues, subsidies are reduced. Let's not forget that even if a biofuel boom leads to higher rural incomes overall, some groups will be net losers due to high food prices, like landless agricultural workers.

Why come down so hard on Hausemann? I'm not against biofuels. But overselling their promise will lead to unnecessary policy mistakes, with long-term negative consequences. Yes, it's certainly worthwhile to promote R&D in this area, but subsidies, mandates and tariffs should not be used to promote their use.

Monday, November 05, 2007

Is PetroChina really worth 1 trillion dollars?

That's the firm's market capitalization as implied by its price in the Shanghai bourse following its IPO there (see here). But the price of its NYSE-quoted ADR's gives a market cap of "only" 398 billion.

This, of course, is the result of capital controls in China, leading to what is probably the biggest case of segmented markets in history. Of course, this is just a degree of insanity quibble, as there's no way PetroChina is worth a cool one trillion.

After all, ExxonMobil has three times the revenues PetroChina has, and twice its net income. Even if China keeps growing at its current rate, that's a big gap to overcome (and lets not forget the bulk of those profits come from upstream activities, which grow slowly if at all).

Friday, November 02, 2007

Employment: Bear trap

Stephen Colbert would be pleased by the pain the employment figures have been inflicting on bears. The October figures were impressive, posting a 166,000 gain in payrolls, nearly twice the level that economists were expecting.

I should stop here, but my inner grizzly won't let me. So once again I resume my hopeless crusade and take issue with some numbers, particularly those related to construction employment.

Construction is a study in contrasts. Residential building has collapsed, with real investment falling 23% between its peak in the 4th quarter of 2005 and the past quarter, with no improvement is sight (it fell 16.4% in 3Q07 versus the year-ago period). In the same time frame, non-residential construction investment has risen steadily, a total gain of 24.5% (and 13% versus 3Q06). But given the fact that residential construction is larger than its counterpart, total construction spending has fallen over 10% over the last 8 quarters (and 6.8% in 3Q07 vs 3Q06).

And yet, total construction employment rose 1.4% between the 4th quarter of 2006 and the past quarter. During this period, residential construction employment (including contractors) fell only 3.1%, while non-residential construction employment jumped 5%. In other words, one fell very little and the other didn't rise as much as it should have. The same holds over the past year.

This graph plainly shows that the response of employment to the fall in construction investment has been remarkably muted by past standards. This is and remains very odd, in a good way, but odd nonetheless.

Thursday, November 01, 2007

Economic sugar rush and other treats

Well, there's no denying that the third quarter GDP advance was pretty impressive, with growth coming in at an annualized 3.9% rate. I don't want to put a bearish spin on the numbers, so let's start with the positives:

1. Consumer spending: The 3% annual growth rate is very solid. Based on modest employment growth and rising compensation, it was strong across the board. There's no sign that consumers are slowing down due to lower home equity.

2. Investment: Residential investment is still dismal, contracting at a 20% annual rate. But nonresidential construction is going very strong (12.3% growth) and equipement and software investment posted its best showing since the 1st quarter of 2006.

3. Net exports: Real export growth was a blistering 23%, more than offsetting an uptick in imports.

4. Government expenditures: They made a positive contribution by rising 3.7%.

Now, let's look at the caveats:
1. Inventories grew very strongly, adding 0.36 to the 3.9% growth rate, which may be a modest drag on growth looking forward.

2. Residential investment will fall some more and nonresidential construction has grown at what looks to be an unsustainable pace, specially considering faltering corporate profit growth.

3. Export growth looks too high, although the dollar's fall will make net exports a key contributor to growth for the near future.

4. Federal defense outlays jumped 9.7%, also an unsustainable rate, although this variable is extremely volatile.

The end result is that the 3.9% growth rate will probably be revised down. However, the underlying rate is quite likely above 3% which is still a good result. Last year's 3rd quarter GDP advance orignally came in at 1.6% and ended up revised downwards to 1.1%.

Where does all this leave us looking forward? Yesterday's 25 bp cut in the fed funds rate certainly was a signal that a significant slowdown lies ahead. How deep will it be?

The most recent analyst survey, from The Economist, places 2007 GDP growth at 2%. This would imply, given the current numbers, a contraction of 0.3% in the fourth quarter. Ouch. Given the margin of error and the fact that this year's forecast might be raised a bit, my guess is that 4th quarter growth will come in flat. The Fed is buying insurance against the possibility of the coming slowdown becoming entrenched.

As to 2008, it all depends on the consumer. So far, they have shaken off the twin blows of rising energy prices and falling home values. It seems they believe these are temporary phenomenons and are set on waiting them out. This will continue until it stops and it's impossible to forecast when that will happen (if at all). The key, in my opinion, lies in the labor market. If job growth falters, things will get uglier very fast.