Month: December 2015 | Page 5

10 December, 2015

Why oil prices have fallen below $40 per barrel

A few months back I wrote a series of columns on oil. In these columns, I maintained that it is very difficult to predict the price of oil over the long term, given that there are way too many factors involved, other than just demand for and supply of the commodity. At the same time I said that in the short-term the price of oil will continue to go down. And that is precisely what has happened.

Data from the Petroleum Planning and Analysis Cell (PPAC) tells us that as on December 8, 2015, the price of the Indian basket of crude oil stood at $ 37.34 per barrel. In fact, during the course of this week, oil prices have touched a seven year low.

What is happening here? The Organization of the Petroleum Exporting Countries (OPEC), an oil cartel of some of the biggest oil producers in the world, met last Friday on December 4, 2015.

The statement released by OPEC after the meeting as usual was very general in nature. It said: “emphasizing its commitment to ensuring a long-term stable and balanced oil market for both producers and consumers, the Conference [i.e. OPEC] agreed that Member Countries should continue to closely monitor developments in the coming months.”

What does this “really” mean? In the past, the OPEC has adjusted its oil production depending on oil demand. If the demand was high, it increased production so as to ensure that oil prices did not go up too much. This was done in order to ensure that other forms of energy did not become viable. If the demand was low, it cut production in order to ensure that oil prices did not fall too much.

In the last one year, OPEC has abandoned this strategy primarily on account of all the oil that is being produced by the shale oil companies in the United States. As shale oil started to hit the market, the OPEC countries started to lose market share. Hence, they decided not to cut production any further, and try and maintain market share, even if that meant low oil prices.

The major producers within the OPEC (the likes of Saudi Arabia, Kuwait and Iraq) produce oil at anywhere between $9 to $20 a barrel. It costs anywhere between $29 to $90 per barrel to produce shale oil, as per the International Energy Agency (IEA).

Hence, the idea was to engineer low oil prices and in the process make shale oil unviable and help OPEC countries maintain their market share. Nevertheless, despite low oil prices, the US shale oil industry is not shutting down at the rate it was expected to, when the price of oil started to fall, around a year back.
And this explains why OPEC continues to produce oil full blast. It wants to kill the US shale oil industry. Further, what the OPEC’s statement released last Friday really means is that the cartel will maintain its production at over 31.5 million barrels per day. In fact, members of the OPEC have always known to cheat on the side and produce more than their allocated quotas. Hence, the daily production is likely to be more than 31.5 million barrels per day.

As the newsagency Bloomberg reported: “There’s as much as 2 million barrels of oversupply in the market, and OPEC’s meeting on Friday means “everyone does what they want,” Iran’s Oil Minister Bijan Namdar Zanganeh said in Vienna on Dec. 4.”

Take a look at the following two charts from the International Energy Agency. One is a chart showing the World Oil Supply. And the other shows World Oil Demand.

As per the chart, the World Oil Supply during the period July to September 2015 was at 96.9 million barrels per day. The demand on the other hand was lower than the supply at 96.35 million barrels per day.

The OPEC oil supply during the period July to September 2015, went up in comparison to the period April to June 2015. The OPEC production between April to June 2015 was at 31.5 million barrels per day. Over the next three months it jumped to 31.74 million barrels per day. Hence, OPEC contributed significantly to the jump in global oil supply.

In fact, the production of OPEC is likely to increase in the months to come as the sanctions on Iran are lifted and the country is allowed to export more oil.

Over and above this, the global oil inventory is at a record high. As a recent IEA report points out: “Stockpiles of oil at a record 3 billion barrels are providing world markets with a degree of comfort. This massive cushion has inflated even as the global oil market adjusts to $50/bbl oil. Demand growth has risen to a five-year high…with India galloping to its fastest pace in more than a decade. But gains in demand have been outpaced by vigorous production from OPEC and resilient non-OPEC supply – with Russian output at a post-Soviet record and likely to remain robust in 2016 as well. The net result is brimming crude oil stocks that offer an unprecedented buffer against geopolitical shocks or unexpected supply disruption.”

As the report further points out: “The stock overhang that first developed in the US on the back of soaring North American crude production, has now spread across the OECD. Since the second quarter, inventories in Asia Oceania have swollen by more than 20 million barrels. In Europe, record high Russian output and rising deliveries from major Middle East exporters are filling the tanks.”

What this clearly means is that oil prices are likely to stay low over the next few months. Further, the forecast is for a fairly mild winter in Europe as well as North America. This means that the demand for diesel, which is the fuel of choice for heating in Europe as well as North East America, is unlikely to go up at a rapid rate. The stockpiles of diesel are at a five-year high.

The column originally appeared on The Daily Reckoning on December 10, 2015

10 December, 2015

Delhi’s real estate obsession defies logic

I was recently in Delhi to attend a few family functions. And as often happens in Delhi, when you want to make a conversation with someone you don’t know that well or you meet only once in a few years, you end up talking about real estate.

During the course of these discussions over plates of oily Kashmiri food, which I have stopped liking many years back, or cups of tea and coffee, I came to realise that the Delhi middle class is still obsessed with the idea of owning real estate. Of course, I am drawing this conclusion from a small sample, but that is the drift I get every time I go to Delhi.

This love for owning real estate continues, despite the fact that the real estate sector in Delhi and the National Capital Region (NCR) surrounding it, continues to be in a mess. Lakhs of people are still stuck with homes which are under-construction and have been under-construction for a while now. Despite this, still others are ready to buy under-construction homes so that when the price goes up, they can cash-in.

The arguments offered in favour of owning real estate all centre around a very basic point that the American writer Mark Twain made: “Buy land, they‘re not making it anymore.” The thing is that everything that sounds sensible isn’t necessarily sensible.

The real estate scene in Delhi and NCR has been rather dull over the last few years. Prices in many areas have fallen by close to 20%. In areas where prices have not fallen they have been stagnant. In fact, investors in real estate would have made more money with a greater peace of mind, by investing their money in bank fixed deposits. In fact, even if they had let their money sit idle in savings bank accounts paying 4-6% per year, they would have made more money.

Nevertheless, those who own more than one home, continue owning their second or third home, in the hope that the trend will reverse and they will make money someday. This during an era when the rental yields in Delhi are around 1.5-2%. Rental yield is essentially the annual rent that can be earned from a home divided by its market price.

Owners of real estate miss out on this return as well primarily because there is a great fear that once a home is let out, the kirayedar for the lack of a better word (tenant just doesn’t sound the same) will not vacate when the contract runs out.

In fact, I know of people who have bought a second home on a home loan, as an investment. In some cases, the home is still under-construction. This means that the interest on the home loan needs to be paid, without the possession in sight. In cases where fully-constructed homes have been delivered, they are paying an interest of 10-11% on their home loan, while getting a rental yield of 2%. Some tax benefits are also there.

But the basic question is why would you borrow at 10-11% and earn a return of 1.5-2% on it? Beats me. For those who have put in their savings, it still doesn’t make any sense to be earning 1.5-2% per year, when the rate of inflation is 5%.

This proposition only makes sense if the money being deployed is black money (i.e. no tax has been paid on the income earned) and cannot be invested through the conventional modes of investment. The irony is that it takes more paperwork in India to open a bank account than to invest in real estate. Also, real estate comes with own share of hassles. There are maintenance charges and property taxes to be paid every year and these eat into the savings of real estate owners.

Nevertheless, these people are still confident that real estate prices will rise someday. And they are not ready to sell in at the current market price. Why is that?

They are ‘anchored’ to a certain price. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Most of us suffer from a common psychological failing. We credit and become attached to any number we hear. This tendency is called the “anchoring effect” and it’s been demonstrated to hold in a wide variety of situations.”

How does this apply in case of the real estate scenario in Delhi and NCR? The current crop of investors in real estate has heard numerous success stories and the huge amount of money and returns made by the investors in the past. They are anchored to these returns and are waiting for higher prices. This means they won’t sell at current prices.

There hope of higher prices won’t materialise anytime soon given that a huge amount of homes are still under-construction. In many cases the construction has stopped. At the same time new home launches continue.

What people also don’t realise is that even in a situation when prices are not falling, they are losing money once they start taking inflation into account. This is referred to as a time correction. And that is clearly on in Delhi and other parts of the country.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Huffington Post India on December 9, 2015

9 December, 2015

Why post graduates and PhDs want to be peons

At a recent literature festival two well-respected veteran journalists were a part of a discussion. During the course of the discussion one of them said that he was travelling through Bihar recently, in the run up to the state assembly elections held in October and November, earlier this year. And he was surprised to know that in Bihar a job actually means a government job. To this the other senior journalist added that it means the same in other parts of the country as well.

This at a very basic level explains the fascination a large part of India has for government jobs. It is another extension of what we like to call a mai-baap sarkar.

In fact, over the years, reports have regularly appeared in the media about people with post graduate degrees, engineering degrees, MBAs and even PhDs, applying for jobs at the lowest level in the government.

Take the recent example from Uttar Pradesh. For a 368 posts of grade IV staff (peons) at the state Secretariat, the Uttar Pradesh government received 23.25 lakh applications. This included around 250 PhDs, 25,000 post graduates and 1.52 lakh graduates. “If we start interviewing such large number of applicants, it will take more than two years to complete the process,” a state government official told The Indian Express.

If 23.25 lakh people are applying for 368 jobs, it clearly shows the sad state of job creation in the state of Uttar Pradesh. What is even more surprising is that people with good degrees have applied.

Nevertheless what happened in Uttar Pradesh is not an isolated example and has been happening in other parts of the country as well. Take the case of Rajasthan University which sometime in 2011 wanted to employ 15 peons. It got 3000 applications for it. The Vice Chancellor of the University told NDTV that the university had received applications from: “candidates who’ve done PhD, MPhil, MBA and Msc…We are really surprised to get applications from such highly-qualified people.”

Or take the recent case in Chhattisgarh where 75,000 applications were received for 30 posts of peons in the Directorate of Economics and Statistics of the Chhattisgarh. The applicants included post graduates in arts and sciences and engineers as well, a news-report said.

What explains this trend? Lack of jobs is one answer. The fascination for government jobs and the job security that comes with it, is another. The fixed hours that government jobs have to offer is another possible reason. But there is a fourth answer to this as well. At lower levels, the government jobs are much better paying than the private sector. And there is data to back it up.

As the Report of the Seventh Pay Commission points out: “To obtain a comparative picture of the salaries paid in the government with that in the private sector enterprises the Commission engaged the Indian Institute of Management, Ahmedabad to conduct a study. According to the study the total emoluments of a General Helper, who is the lowest ranked employee in the government is Rs 22,579, more than two times the emoluments of a General Helper in the private sector organizations surveyed at Rs 8,000-9,500.”

Hence, the IIM Ahmedabad study “on comparing job families between the government and private/public sector has brought out the fact that…at lower levels salaries are much lower in the private sector as compared to government jobs.”

This explains why so many people end up applying for jobs of peons with the government. The economic incentive is at work. It also explains why so many people with degrees end up applying for low-end jobs with the government. Over and above the salary, any money from corruption can also be added to the kitty.

Further this is not a recent phenomenon and has been at work for a while now. As Professor R Vaidyanathan of IIM Bangalore put it in 2008: “Most of the discussion on the emoluments of the government employees focuses on the senior level positions like that of Secretary etc. But more important is the positions at the lower end of the hierarchy. There was an interesting news item sometime ago about there being over 11,000 applicants for just three posts of peons advertised by the Haryana Electricity Regulatory Commission.”

So what is happening in 2015 was also happening in 2008. As Vaidyanathan writes: “This is hardly surprising considering the lower the category of position in government the larger is the number of aspirants. The salary and perks in government are significantly higher than those of the private sector at the lower levels. Reports suggest that post-implementation of the Pay Commission report [the Sixth Pay Commission i.e.], the lowest-level worker will get more than Rs 10,000 per month as pay. In the private sector, a peon or similar-category position might fetch around Rs 3,000 or at best Rs 5,000. An important consideration is the hours of work involved.”

Another point that needs to be discussed here is that we are producing many more engineers and MBAs than can be possibly absorbed in adequate jobs. As Akhilesh Tilotia writes in The Making of India: “An analysis of the demand-supply scenario in the higher education industry shows significant capacity addition over the last few years: 2.4 million higher education seats in 2012 from 1.1 million in 2008.” In 2016, India will produce 1.5 million engineers. This is more than the United States (0.1 million) and China (1.1 million) put together.

The number of MBAs between 2012 and 2008 has also jumped to 4 lakh from the earlier 1 lakh. Also, the quality of many of these engineers and MBAs is not up to the mark. As Tilotia writes: “India faces a unique situation where some institutes (IITs,IIMs, etc.) are intensely contested while a large number of the recently-opened institutes struggle to fill seats…With most of the 3 million people wanting to pursue higher education now having an opportunity to do so, the big question that should…be asked…are all these trained personnel required? Our analysis seems to suggest that India may be over-educating its people relative to the current and at least the medium-term forecast requirement of the economy.”

And this to some extent also explains why people with good education degrees apply for jobs of peons.

The column originally appeared on The Daily Reckoning on December 9, 2015

9 December, 2015

The Halo Effect of Amit Shah

When the Bhartiya Janata Party (BJP) won the Lok Sabha elections in May 2014, a lot of credit for its success went to Amit Shah. He was deemed to be a master strategist and a hard worker. A lot was written on how Shah worked round the clock to ensure a BJP victory. Explanations were offered on how Shah picked up winning candidates, engineered local alliances and so on.

The rise of Amit Shah in public consciousness is an excellent example of the halo effect. Author and strategist Michael Mauboussin defines the halo effect as “our proclivity to attach attributes to what has succeeded, solely because of the success.” The media went around looking for reasons behind the success of Amit Shah and found them. As Phil Rosenzweig writes in The Halo Effect…and the Eight Other Business Delusions that Deceive Managers “We want explanations. We want the world around us to make sense…We prefer explanations that are definitive and offer clear implications.”

This tendency to build a halo around those who are successful is not just limited to politics. It’s a very important part of success in business as well. As Jason Zweig writes in The Devil’s Financial Dictionary: “If the price of a company’s stock has gone up strongly, the people who run the company will seem almost superhuman. In early 2000, for instance, with Cisco Systems’ stock up more than 100,000 percent over the previous decade, Fortune magazine called its chief executive, John Chambers, “the world’s greatest CEO.””

If you are the kind who reads business newspapers and magazines regularly, you are unlikely to miss out on profiles of business leaders. These profiles typically look into the background of what makes these leaders so successful, at the time they are successful. These days the profiles of those who run ecommerce firms are very popular in the media. They get the kind of readership that nothing else does (at least in the business media). What none of these profiles seem to talk about is that these businesses are loss-making and are likely to continue to be loss making.

The point being that the media writes good things only up until the going is good. Getting back to Amit Shah, after the success of May 2014, the BJP lost elections first in Delhi, and then more importantly in Bihar. Both these defeats were hugely embarrassing for the party.

And not surprisingly, knives are now out for Shah. Some analysis suggest that he is a Gujarati and doesn’t have a feel of the entire country. This has been offered as one of the explanations for why the BJP lost Bihar. Then there were also some news reports that suggested that Shah will be replaced as the BJP president soon.

The same media that built a halo around Shah is now busy pulling him down. In fact, what is happening to Shah now, also happened to Chambers at Cisco.

After a 100,000 percent increase in price, the stock price of Cisco fell by 80% in a year. As Zweig writes: “A year later with the stock price down almost 80%, Fortune described Chambers as having dangerously blind to the signs of the coming collapse. The same company run by the same man seemed utterly transformed as soon as its stock price fell.”

Why does this happen? As Mauboussin told me in an interview a few years back: “The idea is that when things are going well, we attribute that success to skill—there’s a halo effect. Conversely, when things are going poorly we attribute it to poor skill…So the answer is that great success, the kind that lands you on the covers of business magazines [or other magazines], almost always includes a very large dose of luck. And we’re not very good at parsing the sources of success.”

Nevertheless, the media couldn’t have just written that luck played a large role in Shah and BJP’s success in 2014. That would have been boring.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column was first published in the Bangalore Mirror on December 9, 2015

8 December, 2015

Why it is easier to acquire land in Gujarat & Punjab than Bihar, Kerala & Bengal

Land acquisition has been a tricky subject in the country of late. The issue has been discussed threadbare in the media over the last few years. But one point seems to have been missed out on. I came across this rather basic and very interesting point in Sanjoy Chakravorty’s book The Price of Land—Acquisition, Conflict, Consequence.

In this book published in 2013, Chakravorty uses data from the 2005-2006 agriculture census. I will use data from the 2010-2011 agricultural census in this column and make the same points that Chakravorty is making.

The basic point that Chakravorty makes is that it is easier to acquire land in states where the average landholding is larger in comparison to states where the average landholding is smaller. As Chakravorty points out: “In Kerala, where 96 per cent of all landholding are marginal, the average marginal holding size is 0.35 acres [the actual number is around 0.34 acres. The writer seems to have rounded it off to 0.35 acres]. In Bihar, where almost 90 per cent of all holdings are marginal, the average marginal holding size is 0.62 acres.”

How do things look if we were to use data from the 2010-2011 agricultural census? The above paragraph would read like this: “In Kerala, where 96 per cent of all landholding are marginal, the average marginal holding size is 0.33 acres. In Bihar, where almost 91 per cent of all holdings are marginal, the average marginal holding size is 0.61 acres.”

As we can see the numbers haven’t changed much between 2005-2006 and 2010-2011.
Chakravorty further points out: “In both these states [i.e. Bihar and Kerala] the marginal holdings make up little over half of all agricultural land area. In Tamil Nadu, Uttar Pradesh and West Bengal, over 75% of all landholdings are marginal. It may be very difficult to bring these lands to the market.”

In Bihar farmers with marginal landholders own 57% of all agricultural land. In Kerala, the number as of 2010-2011 stands at 58.6%. In Tamil Nadu, Uttar Pradesh and West Bengal, 90%, 79% and 82% of all landholdings are marginal.

What this means is that the moment a large amount of land needs to be acquired for an infrastructure project or setting up a factory or a mine, a large number of landholders need to be dealt with. In many cases, some arm of the government (state or central) wants to acquire land for private businesses. And this is not easy.

Further, many other states like Gujarat, Rajasthan and Punjab have larger average landholdings. As Chakravorty writes: “From the smallest landholders(marginal farmers in Kerala, averaging 0.35 acres per holding) to the largest (50 acres in several states, even larger in some), it is not difficult to see how a price such as Rs 10 lakh per acre can be perceived very differently by different landholders based on the size of their holdings. For example, an average large landowner in Gujarat would be paid more than Rs 4 crore for his land (because the average large landholding size in the state is over 41 acres), whereas the average marginal landowner in Kerala would be paid Rs 3.5 lakh.”

How do things look if we use 2010-2011 agriculture census data? The average large landowner in Gujarat owns around 52 acres. Hence, at Rs 10 lakh per acre he would be paid Rs 5.2 crore. In fact, even if we look at marginal landowner in Gujarat things are much better. The marginal landowner in Gujarat owns around 1.2 acres. At Rs 10 lakh per acre the payment is Rs 12 lakh. In Kerala, the average marginal landowner owns 0.33 acre as per the latest agriculture census, and this amounts to a payment of Rs 3.3 lakh. In Bihar with an average size of 0.61 acres, the payment would be Rs 6.1 lakh.

In fact, Punjab is another state where the average marginal landholding is significantly large. The average size in case of marginal landholding in Punjab is 1.5 acres. At Rs 10 lakh per acre, this would involve a payment of Rs 15 lakh. The average size of a landholding in Punjab is around 9.3 acres. And at Rs 10 lakh per acre, it would involve a payment of Rs 93 lakh.

Given this difference in average landholding size, it is easier to acquire land in parts of the country where average the landholding size is larger because that ultimately leads to higher payments. As Chakravorty writes: “Based on this information on land distribution alone, it is possible to conclude that land acquisition is likely to very difficult in some states; Kerala, Bihar, and West Bengal top this list. It is also likely to be significant challenge in Tamil Nadu and Uttar Pradesh, and to a lesser extent, in Andhra Pradesh and Assam.”

In fact, information is available even at a district and sub-district level. Given this, identifying parts of the country where land fragmentation is lower and hence, land acquisition should be easier. Nevertheless as Chakravorty puts it: “This is not hard to do because the information already exists. Having this information should make the task of identifying land for acquisition easier, but to the best of my knowledge, has never been done.”

This is not surprising given that there was very little resistance to forceful land acquisition carried out by the government up until very recently. But now that is no longer possible, hence, more out of the box solutions need to be looked at.

The column originally appeared on The Daily Reckoning on Dec 8, 2015